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.

Sponsored Links

S-Shares Results Review Summary and Outlook

In summary, two-thirds of the S-share companies under review saw their earnings rose for 2008, although most of the growth came during the first half of 2008.

Discretionary consumer companies saw significant demand slowdown in the second half of 2008, which became even more apparent in the 4th quarter. Companies either faced a slowing of revenue growth (like China Hongxing) or had to sacrifice lower margins (Hongguo and China Sports) to maintain sales growth via product discounts or by keeping ASPs low.

Meanwhile, the earnings outlook for discretionary consumer companies is fairly muted. We expect companies to continue spending on A&P to maintain their brand visibility, whilst also likely to embark on discounts either directly or indirectly to consumers to induce spending, which would pressure margins.

Consumer staple companies like Pacific Andes, China Fish, and Celestial NutriFoods were less affected. While companies under this segment also saw a slowdown in second half of 2008, impact was less significant. We still saw a 7% and 19% growth for China Fishery and Celestial NutriFoods respectively. Raffles Education continued to deliver robust growth largely on operating efficiency.

Going forward, we believe the impact of a slowdown in consumer sentiment will impact more on branded staple food like Celestial NutriFoods.

Shipyards like Cosco and Yangzijiang were hit by provisions. In view of the deteriorating conditions for shipping industry, the shipyards have prudently made higher provisions for doubtful debts and cost overrun in 4Q08. In line with its profit guidance, Cosco plunged into losses of S$24m in 4Q08, due mainly to provisions for inventory write-downs, doubtful debts and cost overrun at its shipbuilding division. Yangzijiang’s FY08 earnings fell short of our estimate by 5%, blames on a provision of RMB200m. Stripping this out, its bottomline would have come in 5% above our expectation.

Hongguo Int: Inventories Still High

4Q08 results were slightly below expectations, with net earnings falling 30% yoy to RMB25m. Margins narrowed due mainly to lower ASP in sales promotion, higher staff costs and rentals for more POS. Management plans to maintain its expansion momentum in FY09 and is not paying final dividend for FY08. Going forward, we expect store sales to decline on weaker consumer sentiment in FY09, and margins will continue to decline during inventory sell-down. Hence, despite more POS, we are projecting lower earnings over the next 2 years and downgrade our call to FULLY VALUED, and target price to S$0.12, pegged to 3.0x FY09 PER.

4Q08 revenue jumped 21% yoy to RMB279m, net profit fell 30% yoy to RMB25m. On the full year basis, earnings declined 3% to RMB106m, on the back of a 20% yoy growth of revenue to RMB884m. The decline in earnings was mainly attributable to higher distribution expenses related to staff costs and rentals for more POS.

Inventories still high. The company made RMB8m allowance for inventories in FY08, and by end-FY08, there was still RMB344m inventories on the B/S. We expect the mounting inventories would hurt gross margin and may incur some write-off in FY09.

Management plans to open another 120 POS in FY09 vs 129 new POS in FY08. Looking ahead, we expect store sales to decline due to poor consumer sentiment, mitigating the expansion of distribution network, thus leading to flattish revenue growth in FY09. In addition, gross margin is expected to narrow further, resulting in a forecast c. 35% drop in net earnings in FY09.

The counter is currently trading at 4.2x FY09 PER. Considering its uninspiring earnings prospects over the next 2 years, and a lack of near term catalyst, we are downgrading our recommendation to FULLY VALUED, and target price to S$0.12, pegged to 3.0x FY09 PER, which is in line with our valuation for small consumer goods player in the PRC.