Summary

Effective Marketing positioning—

The marketing positioning of China Dongxiang is high-end fashion sports. The generic competitive strategy for the Group is differentiation focus.

Faster pace for expanding retail network and higher production capability --

The number of Kappa Brand retail outlets operated directly and indirectly by the distributors of the Group reached over 2700 and the director predicted that it would reach over 2800 at the end of 2008.

The acquisition of Phenix and termination of Rukka Brand –

The Group has decided to terminate its Rukka Brand business in 2008 because its products are similar to the ski and outdoor sportswear lines of Phenix. The Group is planning to introduce Phenix Brand products to the PRC market in late 2009.

Lower average selling price due to seasonal effect for apparel products

Increase in orders from distributors for 2Q09 by 31%--

Fierce competition in China sports wear market—

Deceleration in sales growth due to financial crisis—

Valuation—

Our DCF-based target price is HK$3.69 Buy.

Effective market positioning

The marketing positioning of China Dongxiang is high-end fashion sports. The generic competitive strategy for the Group is differentiation focus. It would keep develop its production differentiation in order to deviate itself from other competitors. The Group added fashion element for the sports wears in order to increase its market exposure and competitiveness. The Group continued to adopt a distinct and coherent marketing and promotion strategy. This included the securing of strategic sponsorships and implementing a promotion strategy through selected media and other advertising channels that the Group considered to be the most effective way to convey the image of their products. They also sought channels that were the most efficient in targeting the Group`s desired consumer demographic.

Faster pace for expanding retail network and production capability

In the PRC market, the Group has adopted a “primary distributor`` policy to sell the Group`s products to a limited number of distributors. Under this policy, the Group typically appoints only one primary distributor in one defined geographical area of a market. This policy effectively motivates distributors and enhances their loyalty. As of 30 June 2008, the Group had 41 distributors who directly or indirectly operated 2,487 retail outlets selling Kappa Brand products in the PRC and Macau. This represented a net increase of 542 retail outlets (or 27.9%) compared with the 1,945 retail outlets as of 31 December 2007. The distribution of retail outlets covered all major provincial capital cities and many other large urban areas and towns in China.

Since the second half of 2007, the Group has been launching its flagship store plan by co-operating with its distributors to open flagship stores in prime shopping locations of first-tier cities in the PRC. As of 30 June 2008, 8 flagship stores were opened in Beijing, Guangzhou, Tianjin, Hangzhou, Suzhou, Harbin and Changsha. The Group also plans to open up to 10 flagship stores by the end of 2008.

And the group has just announced that the number of Kappa Brand retail outlets operated directly and indirectly by the distributors of the Group reached over 2700 and the director predicted that it would reach over 2800 at the end of 2008. The expansion is faster than the group expected. Therefore, we would be positive towards the performance of the group this year.

The acquisition of Phenix and termination of Rukka Brand

On 1 May 2008, the Group completed the acquisition of a 91% shareholding of Phenix, a company primarily engaged in the design, development, marketing and sales of its owned branded products in Japan. These brands include: “Phenix`` in the ski and outdoor sportswear markets, “Kappa`` in the football, athletic and golf wear markets, “X-NIX`` in the snowboard sportswear market, and “Inhabitant`` in the casual wear market. The sales in the Japanese market for the six months ended 30 June 2008 represented two months sales of Phenix in May and June 2008.

The Group was the exclusive distributor and licensee for Rukka Brand products in the PRC. Rukka Brand is a Finnish sportswear brand specializing in high-quality function-focused products. The Group has been operating sales of Rukka Brand products through the retail outlets of consignees since late 2006. However, following the acquisition of Phenix, the Group has decided to terminate its Rukka Brand business in 2008 because its products are similar to the ski and outdoor sportswear lines of Phenix. The Group is planning to introduce Phenix Brand products to the PRC market in late 2009. The termination of Rukka Brand business will streamline and focus the Group`s efforts in launching its self-owned skiwear and outdoor product brands. The sales of Rukka Brand products for the six months ended 30 June 2008 were only RMB 4,596,000 (or 0.3% of total sales), an insignificant amount for the Group.

Increase in orders from distributors for 2Q09 by 31%

There are over 43 distributors to involve for the China Dongxiang sales order meeting for second quarter of 2009. The sales orders for 2Q09 have increased by 31% yoy. We would be positive for the next year performance of China Dongxiang.

Lower average selling price due to seasonal effect for apparel products

The seasonal mix of sales of apparel products for the six months ended 30 June 2008 was different from the same period in 2007. As a result of the cold winter near the end of 2007, many winter products had been delivered early to our distributors before 31 December 2007 in order to meet the market demand. For this reason, sales of our winter products in the first quarter of 2008 were comparatively lower than the same period in 2007. The snowstorm that hit in the first quarter of 2008 also affected the opening of new Kappa shops and sales of our 2008 spring products. Nonetheless, sales rebounded rapidly and there was a strong up tick in the sales of summer products during the second quarter of 2008.

Overall, the proportion of summer product sales was higher while winter and spring products sales were lower during the six months ended 30 June 2008 compared to the same period in 2007. Since the unit average selling price of summer products was approximately 75% and 40% of the unit average selling price of the spring and winter items respectively, the change in the seasonal mix of sales caused the overall 6.2% decrease in unit average selling prices despite the fact that the unit average selling price for similar products remained fairly stable.

For footwear products, the movement of unit average selling price during the six months ended 30 June 2007 and 2008 was mainly a result of the Group`s pricing strategy. Initially, the Group has adopted a high selling price strategy on a trial basis for those new products and therefore the unit average selling price reached the level of RMB187. The selling prices have been subsequently adjusted to a lower level and the unit average selling price for the year ended 31 December 2007 has already reduced to approximately RMB164. In fact, the unit average selling price of RMB176 for the six months ended 30 June 2008 represented an increase of 7.3% compared to RMB164 for the year ended 31 December 2007.

Risk factors

Fierce competition in China sports wear market

Competition in the sports wear market is very fierce. The Group needs to face the strong international brands such as Nike and Adidas. The high level of inflation would decrease the purchasing power of the low and middle class more significantly. We would expect the fierce competition in sports wear market for the low and middle class consumers.

Deceleration in sales growth due to financial crisis

Furthermore, we would also worry the effect of recent financial crisis on China economy. We would expect the economic growth momentum would slow down and lower the purchasing power of the target customers of the group. China inflation rate still maintain high though the growth is decelerating due to the worldwide financial crisis. We would expect the target consumers would shift higher proportion of their budget expenditures to saving for worldwide economic instability. And thus, the sales growth of the group would slow down.

Valuation

Our DCF-based target price is HK$3.69 with assumption of 5% terminal growth rate and 16%WACC is also assumed. We lowered our target price due to the expected decreasing revenue growth. At our DCF-based target price, which suggests a potential 65.4% upside, China Dongxiang would trade at a 2008E P/E of 15x, 2009E P/E of 12x and 2010E P/E of 9x.