Hongguo

[la papillion]

I've written pages on this company, but to spare you the agony of reading through all the details, I decided to do a short summary. For those who wants more details, I'll provide the links so that you can read more.

Hongguo

Business

Hongguo sells mainly ladies fashion shoes. They have 2 in-house brands, called C.Banner and E.blan. C.banner is very well known in PRC, being ranked in the top 5 based on market shares. They also do OEM manufacturing for international shoe brands, like Guess?, Nine west, Kenneth cole and Colorado. Their third business is in retailing. They acquired a company that holds the distributorship for brands like Tommy Hilfiger, Ermenegildo Zegna, Hugo BOSS, G2000, U2, Bodyline, MaxMara, Lumberjack, Byford, Naturalizer, Via spiga and Naughty Monkey.

Major competitors

I would say their main competitors are listed in HK. Belle and Prime success (both listed in HK) are worthy of mention. Unlike these two competitors who also do sportswear, Hongguo deals mainly in medium to high end ladies' fashion shoes. Hongguo has no desire to venture into the hot sportswear segment in the near future. Hongguo's C.Banner brand holds 4.48% market share in FY06, compared to Prime Success's Daphne (4.06%) and market leader Belle (7.53%) in FY06.

Ratio analysis

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ROE for Hongguo is a pretty high 26% on average. Net margins stands around 18% while gross margins is at 37%. They do not have long term debts and the debts to equity ratio shows the total liabilities. Current and quick ratios are all very healthy, showing no signs of being insolvent in the near future. All the POS are funded mainly by their internal cash flows, so this is one company that can last in bad times and good.

http://bp1.blogger.com/_3qF-4FCPF1I/SCe68ju-RQI/AAAAAAAAA0E/-_6QVn2JemQ/s1600-h/pic+12.gif



Earnings per share is growing very well at a CAGR of 25% for the past 5 years since listing. In fact, despite their small market cap compared to the other 2 competitors, their earnings per share way exceeds the other two.

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Growth prospects

China has a per capita shoes sales of 2.3 pairs per year. This means that every person on average buys 2.3 pairs of shoes per year in China. Compare this with 3.9 pairs in South Korea and 7.3 pairs in US. Males are the major consumers of luxury goods in China (surprise surprise!) - the only country in the world that is like that. As china grows and the female starts earning more, their spending power will increase. It's justifiable to say that the per capita shoes sales will increase from 2.3 pairs per year.

There is also a rising proportion of middle class with greater disposable income, exactly the group that Hongguo shoes are targeting on.

Management

The founders own 46% of the shares. Management are forthcoming in the annual reports, with their plans laid out for all shareholders to see. They did what had been said in the annual report without fail. The management do have a clear idea of the growth plans for hongguo and all is laid out in the annual report. As such, there are no surprises.

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Valuation

Lowest and highest PE ratio of hongguo is 5.5 and 26.3 respectively. Based on FY07 earnings, PE at current price of 0.540 is an undemanding 9.7. Using DCF (with earnings instead of free cash flow or cash or dividends), with earnings growth of 15% over 10 yrs without perpetuity (compared to historical earnings growth rate of 25% over 6 yrs) and a discount rate of 5%, I get a value of 1.07. Since most of the value of a DCF analysis comes from the perpetuity value, I consider this a conservative estimate.

I expect to see at least $1.60 for hongguo with an investment horizon of 10 years. This is based on projection of earnings with constant ROE for the next ten years, multiplied with the lowest historical PE of 5.5.

Risk

1. I mess up the valuation and all I said is bullshit
2. Their brand of shoes are no longer attractive in the eyes of the consumers
3. Some major disaster, man-made or natural, could strike and cause sentiment in consumers to drop, affecting Hongguo's business

All the risks can be reduced by buying at a margin to the intrinsic value of say $1. At current price, it offers around 50% margin, thus promising safety of principal and an adequate return should the business carries on as usual and the risks are not played out.

For those dying to read more and how I derived some of those figures quoted, do take a look at my humble blog. The link to hongguo (9 articles in all) can be found here: http://bullythebear.blogspot.com/search/label/Hongguo

[la papillion]

Here's the chart for Hongguo plotted together with their EPS per year. For more detailed view, you can view here: http://bp2.blogger.com/_3qF-4FCPF1I/SCWxtkYVDRI/AAAAAAAAAzM/LKHkvk1O2EA/s1600-h/HG+chart.gif



*Note: EPS on the chart is in RMB, not SGD as shown.

Earnings per share had been growing steadily every year since listing. There's a strong support level at 0.50 mark, so if you have a more detailed chart, you can see it.

[blid2def]

Ah crap. Okay, here's a very inelegant workaround right now. It looks like shit, but it does give you the ability to get to that clickable image thing. As you know, there are 2 different links - one for the small image, and one for the larger one.

Using the img tags on the smaller image works. It doesn't work for the larger image, I guess, due to hotlink protection. The workaround, is to wrap the smaller image with the URL of the larger image, making the smaller image clickable (i.e. you see the small one in the forum, you click on it and it leads to the large one). That means you need to use 2 bbcode pairs, viz:

Code: Select all

[url=<url of the larger image>][img]<url of the smaller image>[/img][/url]


(do not put in the "<" ">" symbols - they're there just to show what sorts of info fit between the bbcode tags)

Example:

Code: Select all

[url=http://bp2.blogger.com/_3qF-4FCPF1I/SCWxtkYVDRI/AAAAAAAAAzM/LKHkvk1O2EA/s1600-h/HG+chart.gif][img]http://bp2.blogger.com/_3qF-4FCPF1I/SCWxtkYVDRI/AAAAAAAAAzM/LKHkvk1O2EA/s400/HG+chart.gif[/img][/url]


Sample:


Ultimate clumsiness, but hey it works.

ps. This post follows my PM to you about the issue, so you can ignore my PM.

[winston]

Hi la pap,

The following are some notes that I've:-
1) Fidelity, Shroder and UBS has been selling
2) Moon Capital, NewSmith and Franklin has been buying
Please check the SGX websites for the latest transactions

The following are some Target Price:-
1) Lehman 0.88 Aug 10
2) DBS 0.94 Apr 29 Mar 26 from 1.32 Jan 3
3) DMG 0.6 Apr 29 from 0.72 Aug 8
4) UOB 1.24 Apr30 Feb 26 from 1.52 Aug 8 Jun 24 from Mar 12 from 1.05 Dec 5 PE 18
5) UBS 1.38 Feb 26 from 1.45 Aug 7 from 1.50
6) Westcomb 0.82 Apr 30 from 0.83 Feb 26 from 1.56 PE 22

Some comments:-
1) Whenever I go to the middle class shopping malls in China, I see a lot of Belle, Tribecca and Staccato.
2) I think OEM margins are a bit thin
3) Luxury goods in China cost > 30% than say HK. So a lot of the people who buys luxury good in China, tend to shop overseas rather than in China.

Take care,
Winston

[millionairemind]

I used to own HongGuo back in late 2005 early 2006 at about 20cts.. cos it fitted all the criteria I looked for in a Singapore listed stock.

1. PE/G ratio less than 0.25 (growth is 4x faster than PE)
2. Strong cash position
3. Low debt
4. Among the top 5 in the industry peers.
5. Decent future expansion plans..

I sold it at 33cts a few months later just before result release in early Feb 2006.. thinking that having bagged 60% gain in 3-4 months was decent enough effort.. to my eternal regret... (one of my many, haha... I am just an idiot, still am .. including buying Unisteel at 40cts and selling for 50% gain in a couple of months and TPV at 20cts and selling at 30cts when it finally hit around $1.80 2 years later...)

That was 2 years ago. Back then I was not conditioned enough to go buy stocks that keep breaking new highs.

Now I know better..

[la papillion]

Some comments:-
1) Whenever I go to the middle class shopping malls in China, I see a lot of Belle, Tribecca and Staccato.
2) I think OEM margins are a bit thin
3) Luxury goods in China cost > 30% than say HK. So a lot of the people who buys luxury good in China, tend to shop overseas rather than in China.

1. Belle and staccato are from the same parent company Tribecca I'm not sure. You will definitely see more shops by Belle and perhaps daphne, since they have so much more stores in PRC than Hongguo. Since you've been there, help me see see look look, are the quality of the shoes good? Are there many people shopping for them?

2. Yes, you're right. OEM margins is quite low, around 7 to 10%, unlike the higher margin of selling their own in-house brands. However, Hongguo plans to keep a 80:20 mix of retail to OEM business, so the overall margins will not be so affected.

3. That does make sense But I suppose hongguo isn't exactly a luxury brand. It's mid to high price only. Each pair cost around 80 and above SGD, making it more comparable to equivalent brands of say Rockport, but not so high end like Prada.

[la papillion]

I used to own HongGuo back in late 2005 early 2006 at about 20cts.. cos it fitted all the criteria I looked for in a Singapore listed stock.

1. PE/G ratio less than 0.25 (growth is 4x faster than PE)
2. Strong cash position
3. Low debt
4. Among the top 5 in the industry peers.
5. Decent future expansion plans..

I sold it at 33cts a few months later just before result release in early Feb 2006.. thinking that having bagged 60% gain in 3-4 months was decent enough effort.. to my eternal regret... (one of my many, haha... I am just an idiot, still am .. including buying Unisteel at 40cts and selling for 50% gain in a couple of months and TPV at 20cts and selling at 30cts when it finally hit around $1.80 2 years later...)

That was 2 years ago. Back then I was not conditioned enough to go buy stocks that keep breaking new highs.

Now I know better..

Hoho, why did you sell it? cos it reached target price?

Have you ever hit on a multibagger? I sold a 2-bagger and sitting on another 2-bagger now

[winston]

1. Belle and Staccato are from the same parent company Tribecca I'm not sure. You will definitely see more shops by Belle and perhaps daphne, since they have so much more stores in PRC than Hongguo. Since you've been there, help me see see look look, are the quality of the shoes good? Are there many people shopping for them?

The shops that I see a lot of people are Belle, Daphne, Tribecca & Staccato. I also checked with some people and they do buy their shoes at these 4 shops.

Sorry, C.Banner and E.blan are not shops that I noticed. Hence, my reluctance to invest in Hongguo. However, I did buy Belle and Price Success before.

3. That does make sense But I suppose hongguo isn't exactly a luxury brand. It's mid to high price only. Each pair cost around 80 and above SGD, making it more comparable to equivalent brands of say Rockport, but not so high end like Prada.

The comment on luxury goods referrd to their distributing business eg, Zegna, Hugo Boss. Tommy Hilfiger, G2000, U2, Bodyline, MaxMara, Byford should be ok.

[millionairemind]

le

Hoho, why did you sell it? cos it reached target price?

Have you ever hit on a multibagger? I sold a 2-bagger and sitting on another 2-bagger now

haha - like I said, I was an idiot, still am...

Sold it cos' I tot 50% gain on a stock in a couple of months was good effort.

yes, I do have a few multibaggers like CG Industrial, Celestial Nutrifoods... I pyramided up on CG so when I sold it, it netted me a very handsome profit that made my year.

Anyway, now that I am better off as trend follower, waiting for my next stock to become another multibagger... haha... Will let you know if I sold too soon...

There is so much I still don't know about the mkt... keep learning every day..

[la papillion]

Hongguo 2Q FY08

Income statement

1. There is a jump in revenue from 166 mil RMB in 2Q07 to 188 mil RMB in 2Q08, representing a jump of 13.3%. Net profit increased from 26.8 mil RMB to 27.9 mil RMB.

2. Gross profit margin increased from 41.6% to 45.2%. Net profit margins decreased from 16.1% to 14.8% quarter to quarter. I'm currently monitoring net profit margin situation.

3. Selling and distribution/admin expenses(SDA) to revenue (%) increased from 24.5% to 28.0%.

4. Net profit margin drops mostly due to share of losses of JV (580k RMB), finance cost (395k RMB) and a drop in 'other operating income'.

Here's a summary of quarterly ratios:

-------------------------1Q08-------------1Q07--------2Q08----------2Q07
Gross margin--------41.6%-------------39.4%---------45.2%----------41.6%
Net margin----------15.3%-------------16.8%---------14.8%----------16.1%
SDA to revenue------23.1%-------------19.7%---------28.0%----------24.5%


Half year results

No need to talk so much, a table of ratios will do the trick.

-------------------------1H08-------------1H07
Gross margin--------43.3%-------------40.5%
Net margin----------15.1%-------------16.5%
SDA to revenue------25.3%-------------22.0%

As mentioned, I'm a little worried over their net margins. It's to be expected while their new shops are opening and hence net margins continue to fall. As long as it stabilise around 15%, I'll be happy.

1H08 revenue is 412 mil RMB, while 1H07 revenue is 342 mil RMB. For a little perspective, the full FY07 revenue is 739 mil RMB, so the 1H08 revenue is already 56% of last FY's revenue. My full year FY08 revenue of around 890 to 1000 mil RMB is on track. Net earnings of 62 mil RMB for 1H08 also compares well with full year FY07's earnings of 110 mil RMB. Baring unforeseen circumstances, I'm sure Hongguo FY08 results will be better than last financial year.


Balance sheet

-----------------------------1H08------------1H07
Current ratio----------------3.6-------------2.8
Total debt to equity(%)------27.4------------37.1
ROE(%)-----------------------11.7------------11.4%

There's no long term liability. The notes payable to trade creditors are interest-free and secured on fixed deposits, amounting to 16.3 mil RMB in 1H08, compared to 37.8 mil RMB in 1H07. No big changes in balance sheet items for Hongguo. As usual.


Cash flow

Net cash from operating activities for 2Q08 dipped to -12.2 mil RMB, from 14.5 mil RMB 2Q07. Main culprit is the huge amount of notes payable. I think there's nothing alarming about one quarter of negative cash generated from operations, esp when it's used for paying down their notes payable. As mentioned in the balance sheet, the notes payable from their current liabilities dropped by more than 50%. Hongguo is using its cash flow generated from its operations to pay it off.

As for investing activities, there is no disposal of subsidiary for this 2Q, so there is a dip in the net cash from this part of cash flow. Again, nothing important worth mentioning here.


Others

EPS for Hongguo in 1H is $0.1563 RMB. My target for FY08 EPS is $0.32 RMB.

Here's the contribution to revenue and by its different brands

C.Banner --- 62.2%
E.Blan ---- 9.2%
Contract manufacturing --- 17.0%
JUC --- 6.9%
Naturalizer footwear --- 1.7%

Of note is that while all other business, there is an increase in new outlets for 2Q, there is actually a close of 6 retail outlets for Jiangsu Unity Corporation (JUC). This will be something to look out for in their annual report for FY08. Naturalizer footwear also started contributing to their revenue since 1Q08.

Production capacity dedicated to contract manufacturing segment was increased to 6 production lines. The management that they believed this current level of production is adequate in satisfying demand, hence there are no immediate plans to further expand production capacity in short term. This means there are no foreseeable big capex in the near term. Cash flow should further improve.


Value to price comparison

Annualised EPS for FY08 is SGD $0.06252. Last close is SGD $0.33 per share. This represents a PE ratio of 5.3x. This is around historical low PE of Hongguo, which is 5.5x (occurred in 2005 and 2006).

Dividend paid out in FY07 is SGD 1.418 cts per share. At last close of SGD $0.33 per share, it's around 4.3% dividend yield (based on FY07's dividend). Actual amount will vary as it's subjected to the exchange rates of USD because the dividends are actually paid in USD and posted in cheque, instead of the usual direct transfer to bank account. Not that it matters, actually.

Applying Graham's strict (current assets - total liabilties)/shares outstanding, we get SGD $0.192 per share. Using NAV [(total assets - total liabilites)/shares], we get SGD 0.267 per share.