Peace Mark (Holdings) Ltd. (April 16, 2003)

Peace Mark

STRONG BUY

Stock Code      304.HK

Price(as at 9/4/03)    HK$0.415

Target Price      HK$0.90

Key Data

 

Shares Outstanding

630.9M

Market Capitalisation

HK$261.8M

52 week high/low

HK$0.504/0.141

ROA

4.1%

ROE

7.2%

Current ratio

2.76

Gearing

0.427X

Major shareholders

 

A-One Investment Ltd

31.36%

Mr Chau Cham Wong

9.52%

Mr Leung Yung

9.34%

Heading for Success

Transformation of Business Model By acquiring 2 existing brands, Milus and Sergio Valente, Peace Mark is expanding into OBM. In addition, Peace Mark is moving downstream to capture the distribution profits through the JV with Omni in the US.

Tapping the Tremendous China Market Through authorized distribution, Peace Mark has been actively establishing sales network in China and targets to have over 200 sales points by FY04. Moreover, Peace Mark plans to set up a network of service centers, providing repair services of high-end Swiss brands. The mainland market potential is enormous and will contribute to the bottom line.

Dividend Payout Resumption As Peace Mark’s financial status has been improved, dividend payout has been resumed from 1H03. Assuming a 34% dividend payout ratio for FY03 and 30% for FY04, yield reaches 7.2% for FY03 and 7.7% for FY04.

Attractive Valuation Peace Mark is only trading at 4.8X FY03 PER, which is very compelling, when compared to 8X average of industrial or manufacturing stocks. This means that the share price should have 100% upside potential.

As at 31st March (HK$M)

2001A

2002A

2003F

2004F

Turnover

852.4

931.2

1042.9

1200

Gross Profit

128.8

129.9

146

178.8

Net Profit

17.2

36.4

54.6

66.7

EPS(HK$)

0.142

0.198

0.087

0.106

PER(x)

2.92

2.1

4.8

3.9

Source: Peace Mark, Tung Tati Securities

Since its founding in 1983, Peace Mark has been a leading timepieces manufacturer and distributor. Peace Mark has successfully transformed itself from an OEM manufacturer to an ODM manufacturer. It designs, manufactures and distributes timepieces for a variety of international brands. To enhance its profitability, Peace Mark developed licensing and OBM manufacturing business. With its production facilities located in Shenzhen and Dongguan, China and Bienne, Switzerland, Peace Mark serves mainly the US, European and Asian markets.

Competitive Strengths

High Degree of Vertically Integrated Production

Recognizing the benefits of vertical integration, Peace Mark has deployed a lot of resources on upgrading and improving its production line. It demonstrates strong capability in design, product engineering, components manufacturing, electroplating and assembly.

Peace Mark has a strong design and product engineering team, that comprises 22 designers and 78 product engineers. The group is sensitive to market trends and caters to customers’ needs. For components manufacturing, Peace Mark has invested more than $80M last year in upgrading its facilities. Peace Mark projects a profit margin can be increased from 1% to 1.5% starting from FY03. Currently, Peace Mark produces about 30% of stainless steel components with the remaining components outsourced.

To complement excellent design, Peace Mark invested in an electroplating factory with a partner in the industry. Peace Mark has also developed highly automated assembly lines for watch assembly, thereby reducing yield loss and enhancing high efficiency.

To further strengthen its production, Peace Mark acquired machines that produce watch components such as bands and cases composed of various materials. The sum invested was less than $10M. We believe the investment in production will lead to further cost savings and contribute to the bottom line immediately.

Extensive Distribution Network Across The Globe

A wide distribution network is extremely important for creating market demand. Peace Mark has successfully built an extensive sales network worldwide. It has distribution agents in Canada, USA, UK, China, Japan, Korea, Malaysia, Singapore, Philippines, Taiwan, Thailand, Dubai, Chile, Mexico, etc. This robust network spurred demands for collaboration from many name brands.

Further Penetration into the US market

In order to further expand its distribution network in the US, Peace Mark has formed a joint venture with Omni Quartz in August 2002. Peace Mark invested a sum of US$3M to take a 51% stake for the acquisition of Omni’s existing business network, logistics infrastructure, intellectual property and other tangible assets. After forming the JV, Peace Mark became the sole supplier of Omni. Omni’s total reliance on Peace Mark’s supply proves its confidence on Peace Mark’s expertise on timepieces.

Peace Mark contributes design and production capability, while Omni provides logistics infrastructure, a workforce of 150 employees and 85,000 square feet of distribution centres. Leveraging on Omni’s sales network, Peace Mark’s designs can be sold both in upscale department stores and major retail chains. The synergy effect is well demonstrated by the WalMart program in which 48 designs are suggested to be sold. Sergio Valente, the brand acquired in the JV, also has dominant presence in drug store chain in the US. The program covers 65% of the total drug store chains.

By establishing the JV, Peace Mark has captured the distribution profits. Profit margin can be enhanced from 16% to over 20%. Furthermore, Peace Mark has direct inventory information so that products can be delivered in a more timely and efficient manner.

The JV is estimated to generate an annual turnover of $200M. Profit after minority interest is likely to be $7M. Based on this estimation, the initial investment is likely to be recouped in 2 to 3 years. Riding on the success of the JV, Peace Mark is in negotiation with an UK distributor to form a JV that can enable Peace Mark to extend its market in Europe. Details will be confirmed by the end of 2003.

Expanding into Licensing and OBM business

Having rich experience in OEM and ODM business, Peace Mark decided to expand into the higher margin OBM (own brand manufacturing) business. Profit margin of OBM can reach 40%, compared to about 12% and 18% for OEM and ODM. Sergio Valente is the brand acquired through the JV with Omni. Peace Mark also acquired a Swiss brand, Milus, in March 2002. According to management, Milus was originated in Switzerland in 1919 and it has been well received in Europe, Japan and Germany. The brand has its own design house in Bienne, Switzerland. Peace Mark will enhance the brand awareness through its existing network. Peace Mark is one of the few Hong Kong companies that have acquired Swiss brand names.

Besides OBM, Peace Mark is the licensee of a portfolio of famous brands. Each brand has its niche market, enabling the licensing to be well diversified.

Tapping the Tremendous China Market

Despite the global economic downturn, retail sales market in China remained robust. The good performance was supported by the sustained economic growth. Mainland’s GDP growth is expected to be over 7% this year. Purchasing power, especially from the middle class, is surging with affluence. Mainland customers have becoming more brand conscious and are more willing to spend on high-end watches. According to TDC, annual consumption in China is low i.e. 5 pieces per 100 persons when compared to 23 pieces and 12 pieces of developed and developing countries. The watch market potential is enormous. At the same time, following the accession of the WTO, import tariffs will be lowered and restrictions on foreign goods will be gradually relaxed.

To tap the vast mainland market, Peace Mark has been actively establishing sales network in China. It has signed 5 distributors that cover 87 sales points. Pierre Cardin is the first brand used for market development. Peace Mark targets to have 200 outlets by 2004 and contributes a turnover of $80M. Peace Mark adopts a prudent policy in selecting distributors that it carefully assesses their track records. It targets to sign about 22 distributors and risks will be much diversified.

The first flagship store located in Guangzhou was opened in Oct 2002. The store currently serves the wholesale market, but penetration into the retail market is possible. We believe flagship shop will be the future trend and it is an effective way to introduce foreign brands into the market. Peace Mark is the forerunner in this area.

Establish Service Centres in China

As China becomes more affluent, demand for the high quality Swiss watches will increase and it will create a corresponding repair services market. However, there are very few qualified repair service providers in the mainland. To tap the huge market potential, Peace Mark is planning to set up 100 service centers for watches in China. The service centers will provide specialized repair services for high-end Swiss watches. Among them, 40 will be fully equipped and 60 will be served as collection centers. $24M has been set aside from August’s right issue for the purpose of the service centers.

5 staff obtained certificates from the largest Swiss movements manufacturer in recognition of their skills. Two fully equipped centers have been opened in Guangzhou as a pilot run. Peace Mark is negotiating with several Swiss brands for authorized services agency.

Little Impact by SARS

Due to the outbreak of SARS in Asia recently, watch companies from infected countries, including HKSAR, were being barred from participating the 2003 Bazel and Zurich Watch Fair. Peace Mark has two separate booths, one in the Hong Kong Pavilion in Zurich, and the other in the Swiss Pavilion in Basel. As Hong Kong companies were being barred from participating in the Hong Kong Pavilion, Peace Mark’s Zurich booth was inevitably affected. The negative impact will be significant for small companies that rely heavily on the Fair for receiving orders. Peace Mark has established close relationships with its overseas OEM and ODM customers.

In addition, Peace Mark has another booth in the Swiss Pavilion for its own brand, Milus. The booth was operated by their Swiss marketing team. Peace Mark made use of their Swiss booth and their office in Bienne to replace the booth in Hong Kong Pavilion. Therefore, Peace Mark is much less affected than other small companies in this regard.

Since Peace Mark is well established and has a strong customer base, we believe SARS will have little impact on it. On the other hand, Peace Mark may benefit from the orders diverted from the small companies.

Valuation

Having rich experience in timepieces manufacturing, Peace Mark is the market leader in the industry. Its production is highly vertically integrated that costs are at their minimum. We believe the investment in production facilities has started to pay off and further cost benefit will be enjoyed in coming years. Apart from the strong capability in production, Peace Mark has an extensive sales network. The JV in the US enables Peace Mark to further penetrate into the market and capture the distribution profits. The proposed JV in Europe is also likely to be a success.

One of the future growth drivers is the expansion into the high margin OBM. Together with the licensing business, Peace Mark’s business will be well diversified. The promising China market offers enormous business opportunity. We expect the sales network and service centers in China are the long term growth drivers.

Peace Mark has resumed dividend payout in 1H03. To be conservative, assuming a 34% dividend payout ratio for FY03 and 30% for FY04, yield will be about 7.2% for FY03 and 7.7% for FY04 based on the current price of $0.415. Currently, Peace Mark is trading at FY03 PER of 4.8X and at a deep discount of 64% to NAV/share at $1.15 for 1H03. Given the leading position in the industry and the earnings growth potential, Peace Mark is seriously undervalued.




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