Raymond Industries (229) (February 9, 2004)

11 March 2003

Buy

Stock Code

229.HK

Price (6/2/04)

HK$2.475

Target Price

HK$3.46

 

 

Key Data

 

Shares Outstanding

360M

Market Capitalisation

HK$891M

52 week high/low

HK$2.85/HK$0.79

ROA

3.87%

ROE

8.77%

Current ratio

0.71x

Gearing

0.55x

Major shareholder

 

Mr. Wilson Wong Kin Lae

25.9%

Silver Talent Dev.

14.5%

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.

As at 31 Dec (HK$・000)

2001A

2002A

2003F

2004F

Turnover

343,973

558,952

802,299

1,042,989

Gross Profit

101,678

155,991

223,841

304,553

Net Profit

38,714

47,499

73,563

108,748

Basic EPS (HK$cents)

12.32

15.11

22.62

30.21

Diluted EPS (HK$cents)

N/A

N/A

22.07

28.86

P/E (x)

20.1

16.4

11.2

8.6

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 appliances

Vertically 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 paper

Jinfeng 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

For the year ended 31 Dec (HK$'000)

2001A

2002A

2003F

2004F

Turnover

343,973

558,952

802,299

1,042,989

Cost of sales

(242,295)

(402,961)

(578,458)

(738,436)

Gross profit

101,678

155,991

223,841

@304,553

@

 

 

 

@

Other revenue, net

1,551

577

6,000

14,000@

Selling expenses

(11,481)

(19,585)

(28,080)

(39,634)@

General and administrative expenses

(43,407)

(64,220)

(89,055)

(115,772)@

Other operating income (expenses)

(1,035)

3,813

2,000

2,000@

Operating profit

47,306

76,576

114,706

165,147@

Finance costs

(1,944)

(20,674)

(24,809)

(32,252)@

@

 

 

 

@

Profit before taxation and share of profit (loss)

 

 

 

@

of an associate

45,362

55,902

89,897

132,895@

Share of profit (loss) of an associate

(1,802)

1,947

-

-@

Profit before taxation

43,560

57,849

89,897

132,895@

Taxation

(4,806)

(9,481)

(14,833)

(21,928)@

Profit after taxation

38,754

48,368

75,064

110,967@

Minority interests

(40)

(869)

(1,501)

(2,219)@

@

 

 

 

@

Profit attributable to shareholders

38,714

47,499

73,563

108,748@

Dividends

25,144

28,287

44,138

65,249@

Earnings per share (HK$cents)

 

 

 

@

Basic

12.32

15.11

22.62

30.21@

Fully diluted

N/A

N/A

22.07

28.86

Source: Raymond Industrial, Tung Tai estimates

Consolidated Balance Sheet

As at 31 Dec (HK$'000)

2001

2002

Non-current assets

 

@

Goodwill

9,316

9,051

Fixed assets

292,953

777,525

Interests in jointly controlled entities

4,782

31,662

Interest in an associate

79,112

-

Non-current deposits

-

450

@

386,163

818,688

Current assets

 

@

Inventories

57,092

123,905

Debtors, net

45,517

131,490

Bills receivable

-

4,100

Deposits, prepayments and other receivables

4,634

8,575

Amounts due from related companies

733

21,194

Bank balances and cash

50,276

118,441

@

158,252

407,706

Current liabilities

 

@

Creditors and accrued charges

(58,765)

(102,764)

Bills payable

-

(14,613)

Taxation payable

(4,529)

(4,301)

Dividends payable

(259)

(240)

Amounts due to related companies

-

(5,612)

Amounts due to jointly controlled entities

-

(65,369)

Current portion of long-term bank loan

-

(35,819)

Short term bank loans

(78,000)

(327,729)

@

(141,554)

(556,447)

Net current (liabilities) assets

16,698

(148,741)

Total assets less current liabilities

402,862

669,948

Non-current liabilities

 

@

Non-current rental deposits

-

(823)

Long-term bank loans

-

(35,205)

Deferred taxation

(1,275)

(718)

@

(1,275)

(36,746)

Net assets

401,587

633,202

Share capital

157,150

157,150

Reserves

245,968

384,278

Shareholders' funds

403,118

541,428

Minority interests

(1,531)

91,774

@

401,587

633,202

Source: Raymond Industrial

Consolidated Cash Flow Statement

For the year ended 31 Dec (HK$'000)

2001

2002

Operating activities

 

@

Net cash inflow generated from operations

84,556

275,289

Hong Kong profits tax paid

(1,150)

(7,166)

Overseas tax paid

(1,898)

(6,493)

Net cash inflow from operating activities

81,508

261,630

@

 

@

Investing activities

 

@

Purchase of fixed assets

(122,241)

(41,538)

Proceeds from disposal of fixed assets

441

158

Interest received

1,551

494

Cash acquired from the reorganisation of an associate

-

39,767

Cash injected to jointly controlled entities

-

(88,362)

Cash inflow from dissolution of an associate

6

-

Net cash outflow from investing activities

(120,243)

(89,482)

Net cash inflow (outflow) before financing

(38,736)

172,148

@

 

@

Financing activities

 

@

Expenses incurred in connection with a

 

@

contemplated public listing of a subsidiary's shares

-

(2,489)

Additions of short-term bank loans

78,000

241,884

Repayment of short-term bank loans

(37,712)

(264,287)

Additions of long-term bank loans

-

14,139

Repayment of long-term bank loans

-

(47,045)

Interest paid

(1,944)

(20,674)

Dividends paid

(25,750)

(25,163)

Net cash (outflow) inflow from financing

12,594

(103,635)

@

 

@

Increase (Decrease) in cash and cash equivalents

(26,142)

68,513

Cash and cash equivalents, beginning of year

74,888

50,276

Effect of foreign exchange rate changes

1,530

(348)

Cash and cash equivalents, end of year

50,276

118,441

Source: Raymond Industrial




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