China apparels industry - Eratat Lifestyle (ERAT SP; S$0.195, TP S$0.43, Buy)

China Sports announced yesterday that their exclusive master distributor right for FIFA has been terminated by the association.

We believe this unexpected turn of events adds further pressure on China Sport’s management. 9M10 sales took a 36% yoy hit while net profits fell 53% on higher expenses.

Although management assured that FIFA related sales contribution was insignificant, we believe will crimp China Sports ability to boost revenue.

Fellow peer China Hong Xing also has had a lacklustre performance year to date. Though 3Q10 net profit grew 6% yoy from 3Q09, total net profit for 9M10 fell more than 200% yoy.

The aforementioned developments shed light on the tough operating environment for the Chinese sporting apparels industry.  

Eratat’s share price fell 2.6% in early day trade. We believe this could be largely due to the markets aversion to the lacklustre performance of China ’s sports apparel industry.

However, we believe that Eratat should not be penalised for perceived association with the China sports apparel industry.

Eratat lifestyle has manoeuvred a product transition from sporting apparels to fashion lifestyle products. Management’s foresight is showing early fruits, as we saw strong earnings growth for 1H11.

Unlike its peers, Eratat Lifestyle also saw an uptick in margins, from conscious cost control measures and higher ASP as brand recognition increased.  

Going forward, the company will continue to focus on its brand equity expansion to ensure successful product transition.

There is also a possibility of listing on a foreign exchange, as Eratat Lifestyle could require more capital to accelerate expansion.

With Malaysian listed sports apparel maker Xingquan announcing a TDR recently, Eratat Lifestyle could follow suit, which could act as a catalyst for the share price, in our view.

Valuations appear cheap with current share price of S$0.195 34% backed by strong net cash per share of 6.7 Scts.        

In addition, we believe Eratat Lifestyle has limited downside risks with net net working capital of 23.4Scts per share and prospective dividend yield of 6.7%.

We currently have a Buy recommendation with target price of S$0.43.