Unfortunately, the outcome could barely meet the lower level of expectation without any market surprises. During the period, net profit has risen 15.7% to 18.73b and turnover accounted for 13.1% surging to $118.26b. If we take the plunged of 5% euro into consideration, the turnover figure should be recorded to be 18%, but still under the management target of 20% annually. Since then, share price has dropped around 11% to the one-month lowest of $57.5. The short-term dive is mainly due to the mismatch of the product mixture and their expectation of optimistic Christmas sales. Apart from these, Esprit still possesses great fundamentals that should deserve a Buy rating at present relatively low level. We suggested $59 to be the fair value to retain and our target price is $73 within this year.

After our meeting with the management, the mismatch of fashion mix should be regarded as a one-time error and worth an excuse for rectification in the coming year. Esprit has long employed their unique theory focusing on primitive and casual concepts before the twist of the erroneous mix previously. Indeed, the under-perform retail sector growth has been proved to be the retail risk of consumer tastes. In order to correct the shortcoming, Esprit has recently constituted a product audit committee to cure the hole and further strengthened the existing set-up.

Since overall economic conditions have gradually recovered, they predicted that the Christmas sales would be enormous that lured them to double their inventory. As a result, accompanying with the mismatch product mix, leftovers have been stacked in the warehouse that is detrimental to the profit. Esprit has proposed to clean up the remaining stocks in March and April and the new global collections would be released afterwards with certain flexibility comparing to competitors due to their diversified global aspirations.

Several Key Issues regarding Esprit as a good pick

• Fixing the US business – Over the past couple years, Esprit has tried several moves hoping to re-entry into the US business. One big thing is that it has hired a consultancy firm in carrying out attempts to get them back the right business module. From recent records, sales in the US have been improved and up by 82.7%. While over the next couple years, we expect Esprit’s US business to achieve steady growth and become one of the profit drive.

• Major European macroeconomic indicators largely positive – The European business has took up 80% of total turnover for Esprit, with Germany occupied around 50% of it. According to RBS/NTC Research’s eurozone purchasing managers’ index published on 23 February 2006, the manufacturing sector has expanded at its fastest pace in 19 months in February. Furthermore, an unexpectedly steep rise in the Ifo German business sentiment index reached their highest level since 1991. German consumer confidence rose to its highest level for 5 years according to data from GfK market research company. With rising sentiments and supporting evidence among manufacturers and consumers, we forecast Germany economy will growth towards the 2 percent level. Other indicators also signify the improving situations within Europe. As a result, we expect Esprit European business will proceed a steady growth supporting by better economic conditions.

Risks

We rate Esprit to be Low Risk as it reflects steadiness business even during the downturn in Europe. In addition, the group has a respectable earnings record over the past 4-5 years and whose outlook remains positive with good visibility. For more thorough analysis, several risks need to be considered: 1) weakening in the euro against the US dollar; but as the Europe economy getting better, the chance would be minimal. 2) France economy would be affected by epidemic resulting in slowing down; UK would also remain to be in stagnant stage for longer. Both economies would certainly influence the earning growth of Esprit. 3) Aggression from rival retailers such as H&M and Inditex would pose severe competitions to drive down profit margin. These risks could impede the share price from reaching our target price.

Our principal valuation methodology is P/E as Esprit’s earnings have been growing steadily. Our 20X target gives us a target price of around HK$73.