Outperform
A Compelling Industrial Play Strong
customer base Chanco has established close relationship with customers including
renowned brands such as Uniqlo, Calvin Klein, Armani Exchange, Polo Ralph
Lauren, Gap, and Esprit. Proven
track record The management
has more than two decades of experience in the industry. Turnover and net
profit have grown substantially between FY00 and FY02.
Expansion of markets Tapping the huge retail market of the mainland, the group will increase sales in mainland. The growth of customers such as Esprit in Europe and Gap in the US will also contribute to sales increase. Undemanding valuation With the expected FY03 and FY04 P/E at 4.7x and 3.5x respectively, valuation is undemanding among industrial peers.
Source: Chanco, Tung Tai estimates Company Backgound Based in Dongguan, Chanco is principally
engaged in design and manufacture of men’s and ladies’ leather accessories on
OEM and ODM basis. Chanco was established in the 1970s and has more than 20
years of expertise in the leather belts business. In FY02, belts accounted for
98% of the group’s turnover. Small leather goods and leather took 1% shares
respectively. Chanco has developed a broad customer base. Major customers include Uniglo, Calvin Klein, Gap, Armani Exchange and Esprit. The group aims to target middle to high-end markets. Besides manufacturing on OEM basis, Chanco develops its own brand-STRANGER, which was launched in November 2002. Through various fashion apparel retailers, Chanco’s products were sold around the world. Japan is Chanco’s biggest export market, accounted for 62% of turnover in FY02. Chanco uses different types of leather
including genuine leather, synthetic leather, bonded leather and webbing belts
for manufacturing belts. Genuine leather is the major raw material used by
Chanco. The Group sources genuine leather from various countries such as
Brazil, Italy, USA, South Korea, Hong Kong and Taiwan. Competitive Strengths Strong Customer
Base Chanco has a broad customer base that customers are renowned fashion
brands. The group has maintained close relationship with customers in which
Calvin Klein, Armani Exchange, Polo Ralph Lauren, Uniqlo, Liz Claiborne,
Esprit, Bossini, Tough, and Baleno have been buying Chanco’s products for over
five years. Uniqlo, the group’s largest customer, has 570 chain stores in
Japan, giving extensive presence to Chanco’s products. Design Capability Chanco’s senior
management has over 20 years of experience in manufacturing leather goods. We
believe the experience will be invaluable for sourcing good quality raw
materials and quick response to market trends. The design team, comprising 20
members, has about 3 to 7 years in design and product development and is
capable of innovating new products according to customers’ needs. Proven track
record Turnover of the group has grown remarkably by 70% from 2000 to $150M
in 2002. Net profit also increased 112% between 2000 and 2002. Future Plan and Prospects Expansion to the
PRC
market The group also plans to tap
the market opportunity in the PRC. It has obtained sales licenses in February
2003. Sze Cheik Factory, which was expanded last year, has commenced operation
in August 2002. Ngai Luen Leather Goods, which is for production of domestic
sales, is expected to commence operation in 1Q 03. The group will establish
sales offices, appoint marketing agents in major cities, actively participate
in various trade fairs and advertise in trade magazines in the PRC. Retail sales in China amounted to 440.44B
yuan last year, up 9.2%. In the past four years, retail sales has grown by 8.9%
on average . At this rate, retail sales after five years can reach 674B yuan.
We expect the vast growth of mainland consumption market can be sustained.
Therefore, Chanco is on the right direction and we expect Chanco can generate
significant turnover in the coming years. Product
Diversification Chanco plans to increase the high profit margin (about 90%, due to the
use of scrap leather which has been written off in previous years) small
leather goods in its product mix. By doing so, the group can diversify its
products and optimize the use of raw materials. The group can also gain
presence in the growing accessories market. The group estimates the sales of
small leather goods would increase to 3% of turnover in FY03. Vertical
Intergration Chanco intends to acquire leather processing factories in the mainland,
which can enable the group to maintain more stable supply of cowhides and
increase the profit margin Risk
factors Reliance on a
single market Chanco’s biggest market is Japan, accounting for 62% of the group’s
turnover in FY02. Uniqlo is the major customer of Chanco, accounting for about
40% of the group’s revenue. In the event of any adverse changes in Japan’s
economy affecting the retail market and/or the business relationship between
Chanco and Uniqlo, the group’s profitability and performance may be adversely
affected. However, Chanco will develop the PRC market through
customers such as Bossini and Baleno and later will add its own brand. Potential
growth in other markets, such as Esprit in Europe and Gap in the US, can enable
the group to have a more balanced portfolio. Japan market is expected to
account for 50% of revenue in FY03. Fluctuation in
costs Cost of raw materials accounted for about 70% of the group’s total
costs and expenditures. It may fluctuate due to various reasons, such as change
in suppliers and natural disasters. Any fluctuation on raw material prices will
have effect on profit. The outbreak of mad cow disease in 2000 drove up the
price of leather by nearly 30%. Due to reduced leather supply and uneven
quality of cowhides, production loss increased substantially, causing the
overall gross profit to drop by nearly 30%. As the group will acquire leather processing
factories to purchase raw hides and skins for all of its finished products, the
group can better control the quality and prices of raw materials. Conclusion Though net profit decreased to $13M in 2001
due to the outbreak of mad cow disease, it rebounded to $41M in 2002. In 2003,
we expect net profit to be about $36M. Gross profit margin of the group is about 35-38%.
It would be lowered by 2% due to the relocation of production facilities in
July 2002. However, the increase in sales order will raise utilization rate of
the larger new factory and thus economies of scale can be achieved. Added by
the potential acquisition of leather processing factories, profit margin is
expected to be further improved. Payout ratio decided by the group would be
30%, representing a prospective yield of 5%. Expected P/E is only 4.7X and 3.5X
for FY03 and FY04. Valuation is undemanding among industrial stocks given the
lower P/E than its peers and the high yield. |
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