Model Portfolio pick Belle International Holdings (HK: 1880) controls 46 percent of the ladies footwear market in China, a steadily growing sector. The company’s core brands continue to gain market share, even in smaller cities where the company has been expanding. The company also has been focusing on its so-called secondary brands that sell at lower price points, an area of future growth for the company.

Belle saw first-half 2012 earnings increase by 11.7 percent to USD347 million, while sales grew by 15.4 percent year-over-year to USD2.5 billion.

Footwear sales were up 17 percent, with same store sales growth (SSSG) rising around 7 percent. Gross profit margins declined slightly but are still solid at 67.6 percent, while earnings margins were unchanged at 25 percent. Management expects a weak third quarter but a strong end of year quarter, with guidance for a “mid-to-high single digit” SSSG for the second half of 2012.

Management has long said that the sector-wide price war is likely to lead to margin pressure on the company. Nevertheless, based on its strong brand franchise, management believes the magnitude of margin erosion will be lower than sector average. That said, the company will stick with its plans for an annual 10 percent growth rate in new store openings.

The sportswear division saw sales up 12 percent in the first half, while gross profit margins up by 37 percent. Earnings increased a relatively meager 5.2 percent, but the flagging sportswear niche appears close to reaching a bottom.

The sportswear division has been the company’s weakest link, but management has been gradually turning it around. The company’s main brands, Nike and Adidas, are better positioned in China than local sportswear brands.

The sportswear market in China is fiercely competitive but Belle’s premium brands should prove the winners over the long term. The sportswear division is still a relatively small part of the company, contributing a little over 30 percent of revenue and around 12 percent of profits, which provides plenty of room for growth.

Remember that Belle’s long-term growth is largely predicated on the higher wages of China’s rising middle class. This increased spending power should help the country’s mid- to high-end women’s footwear market continue growing by 10 percent to 13 percent over the next three years.

China is the world’s biggest footwear market, with estimated sales of more than 2.4 billion pairs, representing 13 percent of global footwear sales. Ladies’ footwear represents 60 percent of the market, men’s footwear accounts for 30 percent and children’s footwear makes up the remaining 10 percent.

Belle has been pushing for more exposure in department stores, which still represent a growing retail outlet in China. Department store operators covet Belle’s well-regarded portfolio of brands, making it easier for the company to secure favorable shelf space.

The company also has been expanding into men’s and children’s footwear. Belle is in a good position operationally to expand its product lines. The company boasts one of the industry’s most efficient supply chains, which allows for a shorter production and delivery cycle and substantially lower inventory costs.

With USD620 million in cash and strong cash flows, Belle is in the enviable position of being able to easily cover its yearly capital expenditures of around USD150 million, as well as afford new acquisition opportunities. Belle International Holdings remains a buy up to HKD15.