Chinese consumers continue to spend. On the macro front, economic dataremain encouraging, indicating continued growth of domestic demand even asexternal demand stays weak. The 7.9% economic growth in 2Q09 exceeded ourprojection of 7.4% and consensus estimate of 7.8%. Retail sales continued to holdup, supporting recent data showing buoyant sales of real estate and autos. Wemaintain our 7.6% GDP growth forecast for the full year.

　　We recommend investors to buy selective stocks in a selldown as we believethat the sector will re-rate further as we expect a recovery in 2H09. The sector hasre-rated in recent months and is now trading at an average of 13x CY10 P/E, withthe HK-listed brand owners fetching high double-digit valuations. We believe thesector could be re-rated further should earnings surprise on the upside. Weanticipate another round of upgrades post-results.

        Getting back on its feet. In our last sector report, we turned positive on the Chinasportswear sector on the back of operational data which indicated that the worstwas over. Recent data obtained from interviews with the brand owners continue tosupport our hypothesis. On the demand side, retail sales remain above the Marchlow while on the supply side, inventory levels continue to ease as distributors sell offexcess stock. Those with excess stock from 2008 are confident of clearing thembefore end-3Q09.

　　Buying opportunities in a selldown. Given the recent rally, we expect some profittaking

　　Expect positive surprises in 1H09 results. Although the market has upgradedearnings estimates in recent weeks, we believe that for selected companies, 1H09results could come in above expectations. The upside surprise is likely to come fromhigher revenue as replenishments could beat expectations. Gross margin expansionis unlikely to happen though operating expenses may come in lower than expectedas some brand owners has shelved expansion plans in view of the downturn.

　　Planting foothold in lower-tier cities. We expect competition to step up in 2010 as more mass-market brands gain funding support through IPOs. Given theintensifying competition in the sportswear market, we believe that brand owners must expand into lower-tier cities in order to sustain growth and profitability.

　　Top pick is Dongxiang. We are upping our target prices for the HK-listed companies. Dongxiang replaces Anta as our top pick. We also add Xingquan to ourtop picks as we like it for its attractive valuations, strong growth profile and niche asan outdoor sports brand. Dongxiang, Anta and Xingquan remain OUTPERFORMs.

　　Investment in A&P to continue. With competition heating up in the sportswearsector, it is increasingly important to invest in branding, especially with a series ofinternational competitions coming up. The good news is that the brand ownersappear to be watchful of spending and are keeping to their previous targets.