Zaino - Luggage products still the key growth driver

China Zaino’s 2Q09 net profit of RMB 69.6m (-35% yoy, -32% qoq) was within our expectations. The group’s strategy to maintain market share in current challenging market conditions, and higher tax rates led to weaker profitability. No interim dividends were declared.

Revenue from luggage products grew at a slower pace in 2Q, due to the switch towards low-pricing product mix to secure its market share. Backpacks, on the other hand, saw declining sales volumes but ASP rose due to high-quality new models. Looking forward, the group reckons that its luggage products will remain the key growth driver, targeting a sales volume of 4.5m units, an increase of near 30% from a year ago.

The group believes that the ASPs for its luggage products and margins could have bottomed in 2Q09. While hefty A&P expenses and lack of store expansions will limit earnings growth for the 2H09, the group is upbeat on a recovery in 2010. They are in the midst of planning the next phase of expansion by year-end, targeting to add 500 POS a year over the next 2 years.

Inventory days stood at a healthy level of 10 days, while net cash grew to RMB 878.7m or 19.3 cts/per share. The group plans to set aside RMB 170m for advertising and billboards in FY09 and RMB255m for its new production facility that will be ready by 1Q10. They will also be setting aside capital for network expansion. Interim dividends were held back to buffer against the uncertainties.

We kept our earnings estimates unchanged. Our target price is increased to 50 cents, rolled forward to 6x FY10 PER, based on the average PER of S-chips. At a mere 3x forward PER (82% discount to HK branded sports maker), China Zaino is clearly undervalued given its extensive store network of 3250 POS and market dominance on backpacks in the PRC.

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