Buy
Potential release of hidden value Significantly improved interim results Turnover and net profit in 1H03 surged 52.8% and 3.15 times respectively. Raymond launched new products boosted the results. Contribution from Cheung Fung and rental income also helped the rise. Overall gross profit margin was enhanced from 24.9% to 27.5%. Benefiting from outsourcing trend Low production costs in China continue to be attractive to foreign brands. Raymond has received more outsourcing orders from Japan and Europe. Orders from new customers are expected to be new drivers. Promising prospects of cigarette paper production China’s WTO accession and demand for high-end cigarettes are expected spur the demand of good quality cigarette paper. Entry barriers can enable Jinfeng to enjoy a two-year monopoly. We believe there is a possible spin-off of cigarette paper business. It can bring exceptional gain to Raymond. Undemanding valuation Raymond is trading at 11.2x and 8.6x FY03 and FY04 prospective PER, which are undemanding. Yields in FY03 and FY04 are expected to reach 5.3% and 7%, respectively. We recommend a buy on Raymond and we believe it should be trading at 12x FY04 prospective PER, which is equivalent to $3.46.
Source: Raymond Industrial, Tung Tai
estimates Company background Raymond Industrial has been engaged in electrical appliance manufacturing since its establishment nearly 40 years ago. It has considerable experience in producing small appliances. There are four main streams of products, including environmental products, battery, health and personal care products, and kitchen products. With gross floor area of 1.1M sq. ft., the group’s production base is located in Nansha, Pan Yu, Guangdong. A new production facility at the factory was completed and capacity is expected to increase by 50%. In 1998, Raymond acquired part of Sichuan Jinfeng Paper. Jinfeng is principally engaged in the manufacture and sale of cigarette paper. Raymond’s holdings in Jinfeng is 30.4%, through a 50.75% interest in Cheung Fung Technology. Raymond has a commercial building in 410 Kwun Tong Road, Hong Kong. To date, it has 97% occupancy rate. In 1H03, rental income was $2.93M. The management expects annual rental contribution to be approximately $14M when the rent-free period expires. A $150M loan is due to the building, but $120M of it was paid. Significantly improved interim results 1H03 turnover
increased 52.8% and net profit surged 3.15 times 1H03 turnover increased 52.8% y-o-y to $287.5M. Net profit even
surged 3.15 times from $5.5M to $23.1M. It was mainly due to new small
appliance sales and profit contribution from Cheung Fung Technology. During the
first half of the year, Raymond launched a number of new small appliances and
that boosted sales. Gross profit margin improved from 24.9% in 1H02 to 27.5% in
1H03. Cheung Fung’s half-year contribution, compared with only 3 months in
2002, also helped the rise. Rental income from the commercial building in Kwun
Tong was $2.93M and occupancy reached 97%. Together with only slight increase
in expenses, net profit surged. Electrical home appliancesVertically
integrated production enables Raymond to have high profit margin Raymond has three main product lines in electrical home appliances, namely environmental products, health & personal care products, and kitchen products. Its production is vertically integrated that it processes the components of its products. It has various departments, including tooling, injection molding, metal stamping, tubular heating element, and surface treatment. Profit margin for electrical appliances reaches 25-30%. Raymond has five main products, shavers, hair setters, humidifiers, air cleaners and toast ovens. It has been producing shavers for its largest customer, Remington, for over 15 years. Currently, Remington accounts for over 20% of Raymond’s turnover. As the group brings in new customers, client portfolio can be diversified. Raymond has been engaged in the production of battery since 1997/98. Existing customers include, but not limited to, Mitsubitshi, Funai, JVC, and Skyworth. It will confirm the distribution right of Mitsubitshi battery early this year. Strong growth
in electrical appliance sales achieved in 1H03 Growth in the sector has been strong during the past two years.
Turnover from electrical home appliances in FY02 was $442.5M, up 28.7% from
$343.9M in FY01. In 1H03, turnover jumped 38.5% y-o-y to $213M. The surge was
due to new products launch. In the past, first half of the year was low season.
Seasonal effect is expected to be reduced in the coming years as the product
mix is enriched. Raymond will raise its production of humidifiers. It projects
humidifier production to double to 1M units in 2004. The group will also add
dehumidifier to its product mix. Projected production volume is 200,000 units
this year. Toast oven production volume is expected to increase to 1.5M units,
resulting from a new customer. Turnover from appliances is expected to reach
$600M for FY03. Cigarette paperJinfeng was granted the production permit
of cigarette paper in China. It can produce cigarette paper in the highly
regulated industry Cigarette industry is a highly regulated industry in China because
industrial and commercial tax revenue generated ranks the highest. According to
China Tobacco Administration, tax revenue from tobacco industry amounted to
$160B yuan in 2003. Firms can produce cigarettes only if they obtain permits
from the government. Jinfeng was granted the production permit of cigarette
paper by China Tobacco Administration. At present, there are only 17 cigarette
paper manufacturers in China. Among them, only five companies have the ability
to produce grade A1 paper, which is the highest quality paper, and Jinfeng is
one of them. Jinfeng has a 23% market share in A1 paper in China. It has even
80% market share in Shandong region. New production lines commencing operation can enhance production capacity The company currently has three production lines, PM1, PM2, and PM3.
PM1 and PM2 have production capacity of 5,000 and 7,000 tons per year,
respectively. PM3, with an annual production capacity of 4,000 tons porous wrap
paper, has commenced operation in 4Q 2003. PM4, which can produce 6,000 tons
tipping paper each year, is expected to commence operation in the first quarter
this year. Cigarette paper business accounted for nearly 26% of turnover in
1H03, compared with 18.2% in 1H02. The increase in contribution also boosted
interim results. Future growth drivers Outsourcing trend from Japan and Europe Outsourcing
trend from Japan and Europe continues to benefit Raymond China has the competitive advantage of low labor costs. International brands are shifting production bases or increasing their outsourcing to China. Raymond added a new customer, Reckitt Benkiser, in 2003 and will add another two. According to management, Raymond will launch a new product for Reckitt Benkiser, air freshener, this year. They project sales to be 10M units. Without its own brand to compete with its customers, Raymond can
continue to benefit from outsourcing trend from Japan and Europe. Matsushita, a
famous Japanese brand has placed huge amount of orders, anticipated to be $100M
in 2003, on Raymond. Raymond will launch 3 new products (dehumidifier, electric
fan, and one to be confirmed) for Matsushita. Fulfilling the stringent standard
of Japanese brands is not easy and it can be served as a guarantee on quality.
We expect more orders to come from Matsushita and possible orders from other
brands. Tobacco porous paper Demand for
high quality cigarette will grow and so for cigarette paper According to estimates, about 350 million people in China are smokers. China is the world’s largest cigarette consumer and producer. However, most manufacturers in the country produce low-end cigarettes. Following China’s entry to WTO, competition from foreign brands will inevitably increase. Imports of high-end cigarettes will rise. Domestic manufacturers have to improve their product quality in order to stay competitive. Besides, low tar cigarettes are gaining popularity and it spurs demand for high quality cigarette paper that can filter tar effectively. Entry barriers for cigarette paper
production are high. Moreover, further consolidation in the industry can be
beneficial to Jinfeng Profit margin for cigarette paper is very high, reaching 40% and that of porous wrap paper can even reach 60%. The high profit margin certainly attracts competition, but there exist entry barriers. Cigarette paper production is very capital intensive. It takes time to install the necessary machines. Moreover, producers have to apply for permits from the state. As a result, Jinfeng Paper can enjoy about a 2-year monopoly. Cigarette industry has been undergoing consolidation. According to China Tobacco Administration, cigarette production licenses in China fell from 1049 in 2001 to 582 at the moment. It is beneficial to larger size manufactures like Jinfeng. Jinfeng is
capable of producing good quality cigarette paper and can explore export
markets Jinfeng aims at offering a full range of cigarette paper. When PM4 production line commences operation in the first quarter of 2004, it can offer wrap paper, porous wrap paper, tipping paper and other specialty paper. Besides domestic market, it also exports cigarette paper to India and Vietnam. There is no cigarette manufacturing factory in the two countries and they have to rely on imports from Europe. As Jin Feng is capable of producing high quality cigarette paper at low cost, it has the competitive advantage and potential to further penetrate into the markets. As cigarette paper business becoming more profitable, we believe it is possible for Jinfeng to spin-off from Cheung Fung in future. The disposal of shares can bring exceptional gain to Raymond. Conclusion As at 30 June 2003, gearing (net debt over equity) of the group was 55%. It was mainly due to Cheung Fung. However, the debt was raised by project financing for the installation of PM3 and PM4 production lines. A JV under Raymond provided a loan guarantee of up to $185M to a third party for the leasing of machinery. In fact, Raymond is not liable for the debt. Accounts receivable turnover increased from 50 days in 2001 to 58 days in 2002 was also due to Cheung Fung. Credit period offered by Jinfeng is longer and therefore causing the accounts receivable to increase. There was a one-off provision for Cheung Fung in 2002. The group adopts a policy that makes provision for over 6- month accounts receivable. The management expects the amount not to be too large. Contribution from Kwun Tong commercial building in FY03 and FY04 are projected to be $6M and $14M, respectively. We project electrical appliance turnover to jump 43% to about $630M level in FY03 due to new product launch. Turnover from cigarette paper is also expected to increase 40%. We expect the overall turnover to gain 43.5% to $802M and gross profit margin to be maintained at 27.9%. We estimate net profit to reach nearly $74M. Raymond is trading at 11.2x and 8.6x prospective FY03 and FY04 PER, which is undemanding. Assuming 60% dividend payout ratio, which is quite high, yield in FY03 and FY04 reach 5.3% and 7%, respectively. We believe Raymond should be traded at 12x FY04 prospective PER, which is $3.46. Consolidated Profit and Loss Account
Source: Raymond
Industrial, Tung Tai estimates Consolidated Balance Sheet
Source: Raymond
Industrial Consolidated Cash Flow Statement
Source: Raymond
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