Sino Golf (September 26, 2003)

11 March 2003

Buy

Stock Code

361.HK

Price(as at 25/9/03)

HK$1.51

Target Price

HK$1.96

 

 

Key Data

 

Shares Outstanding

302.2M

Market Capitalisation

HK$456.3M

52 week high/low

HK$1.67/HK$0.616

ROA

4.3%

ROE

11.6%

Current ratio

2.56x

Gearing

0.54x

Major shareholder

 

Mr. Augustine Chu and Asso

59.18%

Can swing higher

Vertically integrated production Sino Golf provides one-stop services that it participates in design, prototyping, testing and assembly of golf clubs. The group provides value-added services that few golf club manufacturers offer.

Synergy effect from golf bag business Golf bags sales have been growing from 17% of total turnover in FY02 to 20.5% in 1H03. As the new factory commences operation early next year, further increase in sales is highly possible. The group・s target is to achieve 500,000-600,000 unit sales.

Benefiting from outsourcing trend and develop Japanese market Due to low labour costs in China, outsourcing trend will continue and Sino Golf will benefit from it. Moreover, the group will further develop Japanese market. Even if the group can only have a small market share, sales can be boosted significantly.

Undemanding valuation Sino Golf posted strong interim results. We expect FY03 top line and bottom line to grow 28% and 43.8%, respectively when compared with FY02 on a full-year basis. Assuming 60% payout ratio, FY03 and FY04 yield reach 6.4% and 7.8%. The stock is trading at 9.3x FY03 PER and 7.7x FY04 PER, which is undemanding. We think it should trade at 10x FY04 PER, or $1.96.

HK$M

2001A

2002A*

2003F

2004F

Turnover

252.5

230.5

393.3

472.0

Gross Profit

75.3

68.1

120

141.6

Net Profit

30.4

25.5

48.9

59.3

Basic EPS (HK$cents)

10.1

8.45

16.19

19.61

P/E (x)

15.0

17.9

9.3

7.7

*only nine months・ results are shown as financial year end date has been changed from 31 March to 31 December

Source: Sino Golf, Tung Tai estimates

Company background

The group is principally engaged in design and manufacture of golf clubs, club heads, shafts and golf bags on ODM and OEM basis. The group・s production base is located in South East China, including five factories in Zheng Cheng, Dongguan, Shunde, Guangdong and Xiamen, Fujian. One new factory in Dongguan, Gunagdong, for golf bag production is expected to commence operation in early 2004. Currently, the group possesses 4.5M units production capacity for golf clubs, 5.5M units for club heads, 3.5M units for shafts and 400,000 units for golf bags. When the new plant commences operation, golf bags・ production capacity can be increased to 1M units.

Sino Golf・s main product is golf club. North America is the group・s largest export market

In FY02, golf clubs and components accounted for 83% of total turnover, representing $191M, in which $157M is from golf clubs, $28M is from club heads and $5M is from shafts and accessories. Golf bags accounted for the remaining 17% of total turnover, or $39M. North America is the group・s largest export market, accounting for 72% of total turnover. Europe and Japan came the second and third, accounting for 10% and 6% of total turnover respectively.

Strong 1H03 results

During six months ended 30 June 2003, turnover surged 36.5% y-o-y to $200.4M. Net profit even jumped 80% from $13.6M to $24.6M. Gross profit margin was 30.6%. Though it was lower than 33.1% of six-months ended 30 September 2002, it was higher than 29.8% and 29.5% in FY01 and FY02.

Competitive Strengths

Vertically integrated production

Sino Golf・s production is vertically integrated and the group provides value-added services

Nearly 70% of Sino Golf・s total production is completed golf clubs. Sino Golf provides one-stop services that few golf club manufacturers offer. The group participates from design, prototyping, testing and production of components to assembly of golf clubs. The group・s factory in Zheng Cheng also assumes R&D function of golf components, which enables the group to cooperate with customers in the engineering of products. Moreover, it can shorten lead time due to faster reaction to customers・ needs. Most manufacturers in Taiwan are mainly engaged in production of club heads and provide less value-added services.

Broad customer base

The group has a well diversified customer base

The largest customer of Sino Golf accounts for only about 20% of total turnover and its five largest customers account for about 60% of total turnover. Moreover, the group has maintained 4-5 years of relationship with its major customers. Sino Golf・s client base is well diversified when compared with its Taiwanese peers that a single customer can account for over 50% of turnover. This is because their major customers are first tier customers and place bulk orders on them. However, most of them merely produce club heads, as those first tier brands have not significantly outsourced other parts of production. Sino Golf・s major customers are from upper second tier brands to lower of first tier brands. 

Future growth drivers

Golf bag business

Golf bag business can create synergy effect. The group can further expand the sector as capacity enlarges

The group acquired a golf bag factory at the end of 2001. As the golf bag business expands, production capacity is insufficient for rising orders. At present, the group can produce 350,000 golf bags per year. As orders of last year were 400,000 units, which exceed production capacity, Sino Golf outsourced some of the production. Cost for the outsourced golf bags is approximately 10% higher than self-production. The new factory in Dongguan will commence operation early next year and production capacity will be increased to 1M units. Outsourcing costs can be reduced.

In FY02, golf bags account for 17% of total turnover. The group・s target is to achieve 500,000 V600,000 units sales, accounting for 25% or even higher in coming years. In FY03 interim period, golf bags accounted for 20.5% turnover. Current gross profit margin for golf bags is slightly above 25%, which is lower than overall gross margin. However, the group expects the margin can reach 30% in longer term, as volume increases and thus achieves economies of scale. We believe golf bags can create synergy effect, as they are complements of golf clubs. Golf bags market is more diverse than golf clubs. US market only accounts for about 35% of golf bags turnover, Europe accounts for 20%, Japan accounts for 10% and other parts of Asia accounts for 9%. The group・s businesses in different regions can be more balanced.

Outsourcing trend to China continues

Outsourcing trend will contribute to the group・s growth

In recent years, golf equipment manufacturers in the PRC and Taiwan posted strong revenue growth. Apart from organic growth in golfers・ population, outsourcing by US brands is a major factor for the growth. Low labour costs and increasingly skilled labour enabled manufacturers in China remain competitive. Firms from the US and Europe take advantage of low labour costs by setting up production base in China or outsource production to the country. We believe this trend will continue and Sino Golf will benefit from it.

Japanese market

Sino Golf will deploy more resources to develop the sizeable Japanese market

Sales contribution from Japan has remained low, at about 6-8% in recent years, as the group has been focusing on North American market. Japanese golf equipment market is also a sizeable market. According to the group, total golf equipment imports by Japan amounted to US$516M in 2001, not much lower than US$616M of USA. The group・s target is second tier brands, which accounts for about 40% of total market. Assuming Sino Golf can only fetch 5% of the second tier market, which we believe can be higher, Japan market sales will be US$10M. At present, the group・s exports to Japan are below US$2M. Leveraging on the experience of US brand golf club production, Sino Golf has its competitive edge over other golf manufacturers.  

Further penetration into US market

The group can further penetrate into the US market through the logistics and assembly centre

Sino Golf set up a logistics and assembly centre in California, USA in 2002. It is responsible for the assembly of some of golf clubs exports and majority of the golf bag exports to the US. Whether golf bags are assembled in the US depends on the classes of golf bags. Usually high-end golf bags are assembled in the US because transportation costs saved can more than offset the higher wages.

Besides ODM and OEM business in the US, the group aims at developing distribution business and captures the distribution profits in the future. The initial plan is to provide distribution services to buying groups that source products for individual shops. The group produces completed golf clubs, thus it has competitive advantage over other manufacturers that it can get direct access to retailers. We believe distribution business can enhance profit margin when the plan materializes. However, the magnitude of profit margin growth will depend on the scale of distribution business.

Conclusion

The group arranged a $105 syndicated loan in March 2003, partly for the repayment of short term borrowings. Gearing ratio (total bank borrowings and finance lease payables less time deposit divided by shareholders・ equity) was 53.6%, down from 62.2% at the end of 2002. Both current ratio and quick ratio have been improved from 1.38 and 0.85 in FY02 to 2.56 and 1.84 in 1H03.

The group posted strong growth in interim results. The group・s orders on hand are up to the end of 2003. We expect FY03 turnover to grow by 28% and net profit surge 43.8% when compared with FY02 on a full-year basis. Gross margin can be maintained to be over 30%. Assuming 60% dividend payout ratio, yield in FY03 and FY04 can reach 6.4% and 7.8%, respectively. Sino Golf is trading at 9.3x PER for FY03 and 7.7x for FY04, which are undemanding. With the high yield and potential growth, it should be valued at 10x FY04 PER, or $1.96.

Consolidated Profit and Loss Account

 

 

Nine

 

 

 

Year ended

months ended

 

@

HK$・000

31 Mar 2002

 31 Dec 2002

2003F

2004F@

Turnover

252,492

230,497

393,344

472,012@

Cost of sales

(177,194)

(162,426)

(273,374)

(330,408)@

Gross profit

75,298

68,071

119,970

141,604@

Other revenue, net

6,293

5,010

10,568

8,454@

Selling and distribution costs

(11,361)

(10,051)

(18,094)

(18,880)@

Administrative expenses

(16,890)

(23,182)

(38,941)

(42,481)@

Other operating expenses, net

(11,213)

(6,601)

(11,407)

(14,160)@

Profit from operating activities

42,127

33,247

62,096

74,537@

Finance costs

(7,121)

(5,069)

(6,083)

(6,691)@

Profit before tax

35,006

28,178

56,013

67,846@

Tax

(3,219)

(2,003)

(5,041)

(6,106)@

Profit before minority interests

31,787

26,175

50,972

61,740@

Minority interests

(1,340)

(650)

(2,039)

(2,470)@

Net profit from ordinary activities

 

 

 

@

attributable to shareholders

30,447

25,525

48,933

59,270@

Dividends

30,374

25,385

29,360

35,562@

Earnings per share VBasic (HK$cents)

10.1

8.45

16.19

19.61@

Source: Sino Golf, Tung Tai estimates

Consolidated Cash Flow Statement

HK$'000

Year ended

Nine months

ended

 

31 Mar 2002

 31 Dec 2002

Cash flows from operating activities

 

@

Profit before tax

35,006

28,178

Adjustments for:

 

@

Interest expenses

5,624

3,872

Interest income

(766)

(278)

Depreciation

10,776

9,678

Amortisation of goodwill

764

811

Impairment of goodwill

500

-

Loss/(gain) on disposal of fixed assets

453

(3)

Loss on partial disposal of a subsidiary

-

148

Operating profit before working capital changes

52,357

42,406

@

 

@

Increase in inventories

(19,487)

(14,267)

Decrease/(increase) in trade and bills receivable

17,779

(14,294)

Increase in deposits, prepayments and other receivables

(24,474)

(7,251)

Increase/(decrease) in trade and bills payable

13,424

(4,094)

Increase/(decrease) in other payables and accruals

4,470

(2,841)

Effect on foreign exchange rate changes, net

(145)

131

Cash generated/(used) in operations

43,924

(210)

Interest received

766

278

Tax paid in the PRC

(123)

(10)

Hong Kong profits tax paid

7,477

-

Net cash inflow from operating activities

37,090

58

@

 

@

Cash flows from investing activities

 

@

Purchases of fixed assets

(18,224)

(9,754)

Proceeds from disposal of fixed assets

686

162

Acquisition of additional equity interest in a subsidiary

(500)

-

Acquisition of a subsidiary

(7,650)

(2,550)

Decrease in pledged time deposits

5,800

-

Net cash outflow from investing activities

(19,888)

(12,142)

@

 

@

Cash flows from financing activities

 

@

Proceeds from issue of share capital, net

1,364

-

New bank loans

41,583

47,910

Repayment of bank loans

(15,888)

(32,222)

Loan from a related party

-

2,500

Interest paid

(5,435)

(3,810)

Dividends paid

(21,154)

(43,770)

Interest element of finance lease and hire purchase contract rental payments

(189)

(62)

Capital element of finance lease and hire purchase contract rental payments

(2,441)

(944)

Capital contribution from minority interest

-

1,913

Net cash outflow from financing activities

(2,160)

(28,485)

@

 

@

Increase/(Decrease) in cash and cash equivalents

15,042

(40,569)

Cash and cash equivalents at beginning of period/year

63,955

78,997

Effect of foreign exchange rate changes, net

-

108

@

 

@

Cash and cash equivalents at end of period/year

78,997

38,536

Analysis of balances of cash and cash equivalents

 

@

Cash and bank balances

84,590

44,715

Bank overdrafts

(5,593)

(6,179)

@

78,997

38,536

Source: Sino Golf

Consolidated Balance Sheet

HK$'000

31 Mar 2002

31 Dec 2002

Non-current assets

 

@

Fixed assets

103,942

104,861

Goodwill

7,672

6,861

Other receivables

-

21,485

@

111,614

133,207

Current assets

 

@

Inventories

62,769

77,036

Trade and bills receivable

40,390

54,684

Deposits, prepayments and other receivables

37,554

23,320

Tax receivable

1,334

-

Cash and cash equivalents

84,590

44,715

@

226,637

199,755

Current liabilities

 

@

Trade and bills payable

36,320

32,226

Tax payable

-

659

Other payables and accruals

21,374

19,512

Bank borrowings

68,901

91,663

Finance lease and hire purchase contract payables

1,223

1,157

@

127,818

145,217

Net current assets

98,819

54,538

Total assets less current liabilities

210,433

187,745

@

 

@

Non-current liabilities

 

@

Bank borrowings

14,500

8,250

Finance lease and hire purchase contract payables

788

258

Deferred tax

1,695

1,695

@

16,983

10,203

Minority Interests

10,235

12,006

@

183,215

165,536

Capital and reserves

 

@

Issued capital

30,220

30,220

Reserves

122,775

123,530

Proposed final dividend

30,220

17,786

 

183,215

165,536

Source: Sino Golf




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