Sales contraction and margin erosion. The 60% yoy earnings plunge was due to a significant decline in turnover and margin erosion as a result of the slowdown in retail sales and destocking by distributors. In order to help distributors to clear their inventories and compensate them for heavy retail discounting, Hongxing offered bigger wholesale discount to distributors by slashing the average selling prices (ASPs) of its products. In addition, sales volume plummeted as distributors cut orders to destock their inventories.
Retail inventory still high. Distributors, by cutting orders in 1H09, saw their unsold inventory level fell slightly from the peak of over five months at the start of 2009 to four-and-a-half months at end-Jun 09 (vs two-and-a-half months last year). However, Hongxing’s inventory days surged from 23 days at end-08 to 40 days at end-Jun 09, due to order cancellations by distributors.
Slash 2009-11 earnings forecasts by 27-28%. Based on the worse-thanexpected 1H09 results for Hongxing, we slash our 2009-11 earnings forecasts by 27-28%. The Group is subject to huge earnings risk due to: a) inventory level is still high and b) intensifying competition in the low-end sportswear segment.
Valuation/Recommendation. Based on our new earnings forecasts, the stock is trading at 10.5x 2009F PE vs 5-6x for S-share consumer stocks. Given the high earnings risk, we maintain SELL rating with a fair price of S$0.10, based on 5.5x 2010F PE.
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