Author

研究部 (Research Team)
輝立証券

Phone:	(852)22776555	Email:	research@phillip.com.hk
For Research Report and Business enquiry

China Dongxiang Group (3818.HK) - Solid & sustainable financial performance with stable gross profit margin

Tuesday, April 14, 2009

5153

China Dongxiang Group(3818)

Recommendation on 14 April 2009
Recommendation	Buy
Price on Recommendation Date	$2.990
Target Price	$4.050

Weekly Special - 603179.CH Xinquan

Summary

Solid & sustainable financial performance –

The Group achieved a 94.2% surge in sales from RMB 1,711.0 million for the year ended 31 December 2007 to RMB 3,322.2 million for the year ended 31 December 2008. Profit attributable to equity holders increased by 86.4% to RMB 1,367.7 million (2007: RMB 733.6 million) compared to the corresponding period in 2007. Basic earning per share was RMB24.12 cents (2007: RMB 15.89 cents).

Increases in unit average selling prices and total unit sold --

The increases in unit average selling prices of apparel and footwear products were 3.2% and 2.8% respectively from year ended 31 December 2007 to 31 December 2008. Total apparel and footwear product units sold increased by 64.9% and 68.2% respectively for the year ended 31 December 2008.

Overall gross margin maintained --

The overall gross profit margin of the Group for the year ended 2008 was 58.5%, remained the same as the overall gross margin for the year ended 31 December 2007.

Acquisition of equity interests in joint ventures of six major distributors --

Valuation—

Our target price is HK$4.05 Buy.

Solid & sustainable financial performance

China Dongxiang achieved a 94.2% surge in sales from RMB 1,711.0 million for the year ended 31 December 2007 to RMB 3,322.2 million for the year ended 31 December 2008. Profit attributable to equity holders increased by 86.4% to RMB 1,367.7 million (2007: RMB 733.6 million) compared to the corresponding period in 2007. In 2008 and 2007, China Dongxiang recorded a one-off gain of RMB146.0 million from acquisition of Phenix and a one-off interest income of RMB44.7 million from over-subscription monies to the Global Offering respectively. If the one-off gain or income were excluded, the core operations of China Dongxiang still enjoyed a high growth in profit attributable to equity holders of 77.4%. China Dongxiang realized a compound annual growth rate (``CAGR``) of 96.7% and 111.3% in sales and net profit respectively from 2006 to 2008. For the year ended 31 December 2008, the cost of goods sold of the Group amounted to RMB 1,378,475,000 (2007: RMB 710,450,000), represented an increase of RMB 668,025,000 (or 94.0%). This trend was in line with the overall increase in sales. The gross profit of the Group amounted to RMB 1,943,762,000 (2007: RMB 1,000,573,000), represented an increase of RMB 943,189,000 (or 94.3%). Basic earning per share was RMB24.12 cents (2007: RMB 15.89 cents).

Increases in unit average selling prices and total unit sold

The increases in unit average selling prices of apparel and footwear products were 3.2% and 2.8% respectively from year ended 31 December 2007 to 31 December 2008. The increases were mainly due to general increase in selling prices of autumn and winter products. In particular, for apparel products, China Dongxiang has launched more high-end ``Rugby`` series in their autumn collection and the proportion of higher price jacket products has been increased in their winter collection. Total apparel and footwear product units sold increased by 64.9% and 68.2% respectively for the year ended 31 December 2008 compared with the year ended 31 December 2007. The strong demand for the Kappa Brand products has driven the high growth in sales volume.

Overall gross margin maintained

The overall gross profit margin of China Dongxiang for the year ended 2008 was 58.5%, remained the same as the overall gross margin for the year ended 31 December 2007. The gross profit margin of Kappa Brand in China segment increased by 2.8% from 59.9% for the year ended 31 December 2007 to 62.7% for the year ended 31 December 2008. The increase in gross profit margin was mainly due to the general increase in unit average selling prices of our apparel products, the major class of their products which accounted for 71.8% of Kappa Brand's total sales in China segment, in 2008 whilst costs have been reduced due to tighter cost control has been exercised. The international sourcing and Rukka Brand businesses have lower gross profit margins compared with Kappa Brand business. The combined gross margin of these two small business segments for the year ended 31 December 2008 was 17.8%, a decrease of 4.7% compared to 22.5% for the year ended 31 December 2007. The drop in gross margin is due to the rapid appreciation of the RMB against the US Dollar in 2008. Since the purchases for the international sourcing business were mainly denominated in RMB and sales was mainly denominated in US Dollar. As a result, the gross profit margin of our international sourcing business was diminished. The gross profit margin in Japan segment for the year ended 31 December 2008 was 40.7%. It was relatively lower than the gross profit margin 62.7% of Kappa Brand products in China segment. It was due to keen competition and higher production cost in Japan.

Acquisition of equity interests in joint ventures of six major distributors

On 1 January 2009, the Group acquired 30% equity interests in each of six joint ventures in the PRC. The six major distributors of the Group in Hangzhou, Shanxi, Shenyang, Tianjin, Nanjing and Ningbo set up the joint ventures. The six joint ventures are mainly engaged in distribution and retailing of sport-related apparel, footwear and accessories of various brands including Kappa of the Group in the PRC. The total cash consideration for the acquisition is RMB 152,100,000 and will be injected into the six joint ventures as additional capital injection. Up to the date of this announcement, management is still in the process of measuring the fair values of assets and liabilities of the joint ventures acquired on the date of acquisition; accordingly no details of such assets and liabilities are disclosed. We would take it positively for the acquisition because we would expect the operation of the six major distributor would improve and thus the performance of sales of China Dongxiang.

Risk factors

-- Slow down in growth of the consumption level

-- Potential price competition in sports wear market

Valuation

We recommend a “Buy” rating on China Dongxiang. It has been traded between 7.2x and 22.1x throughout past a year and currently 11.4x. We forecast 2009 EPS to be HKD 0.405, and 12-month target price is HK$ 4.05 implying 2009 P/E of 10x. Its historical PE is trading at 7.2x to 36.3x in the past 2 years. We believe China Dongxiang trading below its fair value because of its higher growth potential than its competitors Li Ning and ANTA and higher margins than industry average.

More...

This report is produced and is being distributed in Hong Kong by Phillip Securities Group with the Securities and Futures Commission (“SFC”) licence under Phillip Securities (HK) LTD and/ or Phillip Commodities (HK) LTD (“Phillip”). Information contained herein is based on sources that Phillip believed to be accurate. Phillip does not bear responsibility for any loss occasioned by reliance placed upon the contents hereof. The information is for informative purposes only and is not intended to or create/induce the creation of any binding legal relations. The information provided do not constitute investment advice, solicitation, purchase or sell any investment product(s). Investments are subject to investment risks including possible loss of the principal amount invested. You should refer to your Financial Advisor for investment advice based on your investment experience, financial situation, any of your particular needs and risk preference. For details of different product's risks, please visit the Risk Disclosures Statement on http://www.phillip.com.hk. Phillip (or employees) may have positions/ interests in relevant investment products. Phillip (or one of its affiliates) may from time to time provide services for, or solicit services or other business from, any company mentioned in this report. The above information is owned by Phillip and protected by copyright and intellectual property Laws. It may not be reproduced, distributed or published for any purpose without prior written consent from Phillip.