5 June 2003 BUY
A Powerful
Swimwear Kingdom Stable Orders Growth Tack Fat has a strong client base of which clients are renowned international brands. With the political conflicts in the Middle East as catalyst, orders have been diverted to Asian countries. Given the group’s reputation, more new orders are expected and the growth can be sustained. Fast Growing Blue Cat Business The number of specialty stores of Blue Cat, the most popular cartoon character in China, is rising exponentially. Tack Fat can benefit from the 20-year exclusive manufacturing agreement of apparels and the exclusive license right to open retail stores. Progressive Expansion Plans Foreseeing the growth in orders, Tack Fat has been actively expanding production capacities. In addition, the group is in negotiation of brand acquisitions. Attractive Valuation Assuming a 30% payout ratio, dividend yield reaches 3.56% for FY03 and 4.37% for FY04. Tack Fat is only trading at FY03 PER of 8.46x and FY04 PER of 6.86x, which are attractive when compared with those of other garment manufacturers and retailers.
Source: Tack Fat Group, Tung Tai
estimates Tack Fat
Group is well established with diversified production bases Tack Fat Group primarily engages in design and manufacturing of swimwear, casual wear and sports wear. The group has adopted progressive strategy since its establishment in 1969. By the end of 70s, China started to open its economy. Recognizing the advantage of low production costs, Tack Fat moved its production base into the mainland in 1982. As the group continued to grow, it set up another production base in Cambodia in 1993, where production costs were lower than China as well as fewer quota and tariff restrictions on garments. Tack Fat has three production plants, two located in Cambodia and one in Luoding, China with 90,000 square metres in gross floor area and over 10,000 labour. Strong
European and US client base Tack Fat has established long-term and close relationships with over 30 renowned international brands, including Walmart, Sears, Target, Union Bay, Calvin Klein, Speedo, Arena, Lee, Reebok, Wrangler, and Mexx. The group’s customer base is well diversified with its five major customers accounting for about 38% of turnover and the largest customer accounting for less than 10%. Casual wear, swimwear and sports wear account for 65%, 30% and 5% of turnover respectively. Given the stable relationship between Tack Fat and its customers, we expect the breakdown for FY03 to have little change. Competitive Strengths Stable orders growth Orders increased due to political conflicts
in the Middle East. With its well established client base and high quality
products, double-digit growth is expected to sustain According to management, the group’s orders on hand have grown by double-digit y-o-y and the Group has secured four to five months’ orders. Orders from both Europe and the US have increased. After the 911 incident, US clients tended to avoid placing orders on manufacturers in the Middle East, so a lot of orders have been diverted to Asian countries, including Cambodia. The war between US and Iraq early this year has hurt the business of many OEM manufacturers. However, Tack Fat could again benefit from the orders shift. Tack Fat has received 4M units of swimwear order from Speedo recently. We believe US firms will continue raising their proportion of sourcing from Asia because of the low costs. With its leading position in swimwear manufacturing and stringent quality control, we expect the group can further expand its market share in Asia. Fewer quota restrictions in Cambodia Product
pricing can be more competitive with fewer quota restrictions One of the benefits of setting up production base in Cambodia is there are fewer quota restrictions. There is no tariff for garment exports to EU members if materials from ASEAN are used and also no quota. In addition, no quota for swimwear exports to US is required. Tack Fat also owns 20% of total pants quota in Cambodia so that costs can be lower and product pricing can be more competitive. Starting from 2003, quota and tariff have been lifted on garment exports, using materials from PRC, to Canada. Though sales to Canada accounts for a low percentage in the group’s turnover, the group can benefit from the potential growth in orders. Economies of scale
Low
production costs in Cambodia and bulk orders have helped achieve economies of
scale Production costs in China are low when compared to many other countries. However, wage in Cambodia is only US$45, compared with US$60-80 in China. Since more than 60% of the group’s production takes place in Cambodia, its overall costs can be lower than other manufacturers whose production base is solely in the mainland. Moreover, Tack Fat deals with bulk orders only, so economies of scale can be achieved. Benefiting from China’s accession to WTO According to WTO agreement, for all WTO members, quota on textiles will end by the end of 2004. European and American companies will further take the low cost advantage in China and source materials there. With one of its production bases located in China, Tack Fat can benefit from the good prospects. Though there will be competition from other manufacturers, the group has established close relationships with its clients, so the impact will be minimal. Future
growth drivers Blue Cat The 20-year
exclusive manufacturing agreement enables Tack Fat to tap the tremendous market
potential of Blue Cat Blue Cat is the most popular cartoon character in the mainland. Over 1000 TV stations broadcast the cartoon. Retail sales potential of Blue Cat products is enormous. Currently, there are about 2300 specialty stores nationwide, grew from 1200 stores in July last year. The group projects that the number of stores can reach 3000 by the end of this year and 5000 in five years. To tap the huge market potential, Tack Fat signed a 20-year exclusive manufacturing agreement with Hunan Sunchime Digital Cartoon Development and Blue Cat Development in 2002 for the design and manufacturing of Blue Cat apparels for all Blue Cat specialty stores in the mainland. Blue Cat apparel orders were over $30M in 1H03. We expect the orders will be over $60M for FY03. Given the impressive growth of specialty stores, demand for apparels will definitely increase. The group expects orders growth to be over 10% each year. Profit margin of Blue Cat apparels is the highest among the group’s products. Given its accelerating growth, we believe it is one of the future profit drivers. Exclusive
right to open specialty stores In addition, Tack Fat has 5% stake in Blue Cat Development and has the exclusive license right to open Blue Cat retail stores in the mainland. During the year, the group opened 72 stores through franchises. At present, it directly manages 8 stores. Tack Fat Group has the option to buy the 51% stake in Blue Cat Development owned by Mr. Kwok Wing by 2005. If the option is being exercised, the group can have controlling stake in the extensive Blue Cat sales network. However, the group does not have any plan at the moment. The group has entered into a letter of intent with Yue Yuen Industrial in April 2003 that Yue Yuen has the option to subscribe up to 20% of issued capital of Tack Fat. Details of the agreement are yet to be determined. We believe the two parties will have cooperation in retail sales in the future. Yue Yuen’s move demonstrates its confidence in Blue Cat. Expansion of capacities The group has
been expanding its production facilities for future orders To cope with the rising demand, Tack Fat has been actively expanding its production capacities. As at 31 March 2002, annual production capacities of swimwear, casual wear and sports wear were 550,000, 750,000, 60,000 dozens respectively. As the production capacities of swimwear and casual wear had double-digit growths in 1H03, we expect the full-year capacities will grow by about 20%. In the coming years, capacities will grow with orders. The group plans to spend $50-60M in FY03 on expanding production capacities in both Cambodia and China. Utilization rate increased from 94% in FY02 to 95% in 1H03. Given the stable orders growth, we expect the high utilization rate to sustain. Acquisition of brands Acquisition
can raise the overall gross profit margin The group is in negotiation with some European casual wear brands on possible acquisitions. Apart from enhancing the diversity of brand portfolio, acquisition can also create synergy effect. We expect the acquisition can expand the higher margin ODM business and thus raise the overall gross profit margin. Valuation Tack Fat has much experience in manufacturing of casual wear, swimwear and sports wear. With its diversified client base, orders growth is expected to be stable. We estimate FY03 turnover to increase from $710.5M in FY02 to $888.1M in FY03, up 25% and FY04 turnover will also post a 25% growth. CAGR from 2001 to 2004 is expected to be 18.46%. The strong growth is partly attributable to Blue Cat business. We estimate that turnover of Blue Cat casual wear can reach $70M in FY04. Net profit is expected to grow from $82.3M in FY02 to $107.4M in FY03, up 30.5%. CAGR from 2001 to 2004 can reach 28.91%. Though there is some pricing pressure for some bulk orders, cost of raw materials also decreases. Hence profit margin can be maintained. In fact, profit margin can rise potentially due to the gaining weight of ODM business, including the rapid growth of Blue Cat orders. We expect gross profit margin can stay at about 34% and has further upside potential. It is definitely more attractive than its peers. The group’s financial position has been improved. Cash on hand is about $100M, compared with $77M of 31 March 2002. Gearing ratio (total liability over total asset) decreased from 64.9% in FY02 to 46.4% in 1H03. The group will continue its effort to further lower it. Inventory turnover dropped from 113 days in FY02 to 103 days in 1H03. Receivable turnover also fell from 48 days to 45 days. We expect the figures can be maintained at these levels due to stringent control by the management. Assuming a dividend-payout ratio of 30% for FY03 and FY04, yields will be about 3.56% for FY03 and 4.37% for FY04. Currently, Tack Fat Group is only trading at FY03 PER of 8.46x and FY04 PER of 6.86x. Compared with other garment manufacturing and retail companies, Tack Fat Group is undervalued. The possible acquisition of controlling stake in Blue Cat Development from Mr. Kwok Wing in three years makes the valuation look more attractive. To be conservative, our target price is $0.99, representing FY04 PER of 10x.
Source: IBES, Tung Tai estimates Profit and loss
account
Source: Tack Fat Group, Tung Tai estimates Cash flow statement
Source: Tack Fat
Group Balance sheet
Source: Tack Fat Group |
| ||
| Research Home Page | |
|
| If you would like to know more about a specific stock, you can ask us by emailing:Mr Kenny Tang. This circular is for information only. The information and opinion presented are believed to be accurate but are not guaranteed and without legal responsibility. Neither the information, nor any opinion expressed, constitutes a solicitation by us of the purchase or sale of any securities or futures contract, or options thereon. |