Pou Sheng &Yue Yuen:Subsidiary account analysis,we remain positive

Pou Sheng miss likely stemmed from rebates; ODM turnaround has just begun

    In this report, we try to answer two questions:

    (1) why Pou Sheng’s 1Q17earnings missed heavily despite decent retail trends; and

    (2) how sustainable isYue Yuen’s ODM recovery. Using subsidiary accounts reported by Pou Chen(9904TT) as our main tool, we discover that

    (1) Pou Sheng’s earnings miss waslikely due to a delayed recognition of rebates and support from brands, while

    (2) Yue Yuen’s Chinese plants have just started to turn around. We thereforemaintain our positive views on both names.Pou Sheng: weak 1Q17likely due to delayed recognition of rebates

    In Figure 1, we break down Pou Sheng’s operating profit by subsidiaryaccounts (details in Figure 11). Most of Pou Sheng’s subsidiaries are regionalsales companies and we assume their reported profit is a reliable measure togauge Pou Sheng’s retail performance. Surprisingly, we found that PouSheng’s subsidiary profits explain only a portion of its reported operating profit(42%/51% in 2015/2016). We believe a majority of the gap (between subsidiaryprofits and reported operating profit) comprises rebates and support frombrands. This would mean that:Pou Sheng’s earnings miss in 1Q17 was driven by a sharp reduction inrebates and support YoY, while company fundamentals (as measured byretail subsidiaries’ profits) were intact (Figure 2).

    Rebates and support could kick in later in 2017 to boost Pou Sheng’soperating margin. We do not expect full-year rebates and support to dropsharply YoY in 2017, given that Pou Sheng’s major brands are stillexecuting their “2020 strategy”. Company guidance (2Q17-4Q17 operatingmargin to reach 6-7%, up 0.4-1.4ppt YoY) also hints that rebates andsupport will pick up later in 2017.