Hongguo International Holdings - Sell: Better Inventory But Weaker Margins

What’s new – We revise up our 2009E and 2010E earnings by 7% and 17%, respectively, to mainly reflect better sell-through in 1Q09. Our target price is raised to S$0.22 (from S$0.19) on EPS revision and rollover, but we maintain a Sell rating as we think the risk-reward still looks unfavorable given margin compression risk, weaker earnings growth and lower ROE. We forecast a 10% earnings decline over 2009-10E, compared to 8% earnings growth over 2007- 08. Our 2009-10 earnings estimates are 5-10% below consensus.

Discounting to clear inventories – 1Q09 revenue was up 22% yoy and inventory days improved from 199 days in Dec-08 to 164 days in Mar-09 as Hongguo offered bigger discounts to clear some old inventories. However, the group gross margin declined 6ppt to 36%. The gross margin for its core C.banner brand declined 11ppt to 40% and mgmt expects to offer similar discounts in Q209. While we remain cautious on margins, we think the risk of an inventory write-off has reduced given the improved inventory days.

Outlets addition target lowered – Hongguo has revised down its outlets addition target for 2009 from 120 to 100 as mgmt believes there are still uncertainties on the macro environment. During 1Q09, Hongguo added 35 outlets for the C.banner and E.blan brands but also closed down 8 outlets for JUC.

1Q09 results – Net profit was down 34% yoy to Rmb23m though sales was up 22%. Net margin was down 7ppt to 8.3% due to decline in gross margin and higher opex and tax rate. Hongguo has net-cash of Rmb160m. Capex in 2009 should be lower than Rmb10m. No dividends declared for 1Q09 and FY08.

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