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Stella International Holdings Limited (1836): IPO

Thursday, June 28, 2007

14696

Stella International Holdings Limited(1836)

Recommendation on 28 June 2007
Recommendation	stag
Target Price	$18.200

Weekly Special - 000157.SZ Zoomlion

STELLA-GIANT IN THE SHOES-MANUFACTURING INDUSTRY

Stella is one of the largest ODM footwear manufacturers with production facility base in China developing and manufacturing both casual and fashion footwear products for a number of worlds leading and branded footwear companies across the globe. The Group owns 4 production plants in Guangdong province with 144,800 sq. meter production floor place, 36 production lines, as well as 300 development teams, the estimated production capacity in 2006 amounted to approximately 45 million pairs of shoes per year. In 2006, the Groups sales volume of footwear reached 43.4 million pairs. Stella targets overseas instead of Chinas domestic market. 91.1%, 92.2% and 90.7% of the revenue were generated from North American and European markets between 2004 and 2006 respectively.

CUSTOMER BASE- LEADING BRANDS & CHAIN-RETAILER WORLDWIDE

The Groups client base is board and it mainly targets middle range to high end customers or chain-store retailer.

FLEXIBLE PRODUCTION STRATEGY

The Group stated that one of their competitive strength is their flexibility to produce wide range of tailor-made designs with short lead time in a cost effective way. To cater for the increasing amount of orders and saturating production capacity, Stella outsources some of the private label footwear production to another 6 entitled and contracted manufacturers in China and Vietnam.

ESTABLISHMENT OF RETAIL BUSINESS

In 2006, Stella established its own retail distribution network selling women fashion footwear and other accessories under the brand name “Stella Luna”. The Group currently operates 37 retail stores across 21 cities in PRC, and 3 retail stores in Thailand. In 2007, the Group plans to open another 25 retail points, of which 3 of those are expected to outbound to Macau and Taiwan. In FY06, retail business accounted for less than 0.3% of total turnover, but we expect its proportion will pick up in the long run and benefit from the growing domestic demand in PRC.

FINANCIAL HIGHLIGHTS

Stella has reported a stable revenue growth, while the net profit margin dropped slightly from 12.77% in FY05 to 11.72% in FY06. We worry that Stellas net profit margin is possibly to suffer further squeeze.

USE OF PROCEEDS

The Group is seeking up approximately HKD 2.4bn to HKD 3.02bn with the listing price ranging from HKD 12.5 to HKD 15.5 per share. The allocation of the use of net proceeds is as follows:

1) 44% -- Potential acquisition of footwear and related brands and businesses;

2) 27% -- Servicing and repayment of the short-term loan facilities granted by HSBC and Chinatrust Commercial Bank used for the financing of a special dividend to be paid prior to the listing date;

3) 10% -- Expansion of manufacturing capacity;

4) 10% -- General working capital purpose;

5) 9% -- Expansion of the Groups retail business.

OUR CONCERNS

1) We concern whether the Groups future profitability and net margin will squeeze further to a lower level because of the follows reasons:

1.1) Saturating production capacity require Stella to outsource the entitled and contracted 3rd parties facilities to manufacture part of its orders and result in rising operational expenses

1.2) Tax payment to government. Tax payable to PRC government in FY06 surged to USD 2.3mn, up 472.8% compared to FY05. In the wake of new Enterprise Income Tax Law announced in the Tenth Peoples Congress in March 2007, a 25% statutory rate will apply to all domestic and foreign-funded enterprises with effective in the begin of 2008. The preferential tax rates of its subsidiaries will expire in 2009 and 2010.

1.3) RMB appreciation will exert adverse influence on the Group given that most of its footwear products were exported to overseas market (FY06 97.1%).

1.4) Increase of labor cost and problem of labor shortage in Guangdong province

2) Retail Business contributed less than 1% to Stellas turnover, and we cannot foresee a significant pickup in the near future. In other words, we conclude that the Group is hard to be benefited from “China Concept” in the short run.

3) Among 27% of the net proceeds collected are used for clearing the short-term debt. We concern the reason behind paying special dividend to its mother group prior to the listing in stock market with the use of fund capitalized from the stock market.

VALUATION AND RECOMMENDATION

According to the prospectus, FY07 PE multiple ranges from 12.4X to 15.3X, it is quite close to its peer, Yue Yuen International (551.HK), the largest branded manufacturer worldwide, trading at 14X PE multiple currently. Given our concerns over the potential squeeze of Stella, our rating to Stella is “SUBSCRIBE with caution”. With the market sentiment for IPO, we set our 12-month target price for Stella at HKD 18.2.