Tack Fat (928) (June 5, 2003)

11 March 2003

5 June 2003

BUY

Stock Code

928.HK

Price (as at 3/6/03)

HK$0.68

Target Price

HK$0.99

 

 

Key Data

 

Shares Outstanding

1335.6M

Market Capitalization

HK$908.2M

52 week high/low

HK$0.73 / HK$0.366

ROA

12.72%

ROE

41.34%

Current ratio

1.28x

Gearing

0.46x

Major shareholder

 

Mr. Kwok Wing

36.2%

Mr. Kwok Chiu

36.2%

A Powerful Swimwear Kingdom

Stable Orders Growth Tack Fat has a strong client base of which clients are renowned international brands. With the political conflicts in the Middle East as catalyst, orders have been diverted to Asian countries. Given the group’s reputation, more new orders are expected and the growth can be sustained.

Fast Growing Blue Cat Business The number of specialty stores of Blue Cat, the most popular cartoon character in China, is rising exponentially. Tack Fat can benefit from the 20-year exclusive manufacturing agreement of apparels and the exclusive license right to open retail stores.

Progressive Expansion Plans Foreseeing the growth in orders, Tack Fat has been actively expanding production capacities. In addition, the group is in negotiation of brand acquisitions.

Attractive Valuation Assuming a 30% payout ratio, dividend yield reaches 3.56% for FY03 and 4.37% for FY04. Tack Fat is only trading at FY03 PER of 8.46x and FY04 PER of 6.86x, which are attractive when compared with those of other garment manufacturers and retailers.

As at 31 March (HK$M)

2001A

2002A

2003F

2004F

Turnover

641.1

710.5

888.1

1065.7

Gross Profit

216.3

469.6

301.1

361.3

Net Profit

61.8

82.3

107.4

132.4

EPS (HK$cents)

-

8.04

8.04

9.91

PER (x)

-

8.46

8.46

6.86

Source: Tack Fat Group, Tung Tai estimates

Tack Fat Group is well established with diversified production bases

Tack Fat Group primarily engages in design and manufacturing of swimwear, casual wear and sports wear. The group has adopted progressive strategy since its establishment in 1969. By the end of 70s, China started to open its economy. Recognizing the advantage of low production costs, Tack Fat moved its production base into the mainland in 1982. As the group continued to grow, it set up another production base in Cambodia in 1993, where production costs were lower than China as well as fewer quota and tariff restrictions on garments. Tack Fat has three production plants, two located in Cambodia and one in Luoding, China with 90,000 square metres in gross floor area and over 10,000 labour.

Strong European and US client base

Tack Fat has established long-term and close relationships with over 30 renowned international brands, including Walmart, Sears, Target, Union Bay, Calvin Klein, Speedo, Arena, Lee, Reebok, Wrangler, and Mexx. The group’s customer base is well diversified with its five major customers accounting for about 38% of turnover and the largest customer accounting for less than 10%.

Casual wear, swimwear and sports wear account for 65%, 30% and 5% of turnover respectively. Given the stable relationship between Tack Fat and its customers, we expect the breakdown for FY03 to have little change.

Competitive Strengths

Stable orders growth

Orders increased due to political conflicts in the Middle East. With its well established client base and high quality products, double-digit growth is expected to sustain

According to management, the group’s orders on hand have grown by double-digit y-o-y and the Group has secured four to five months’ orders. Orders from both Europe and the US have increased. After the 911 incident, US clients tended to avoid placing orders on manufacturers in the Middle East, so a lot of orders have been diverted to Asian countries, including Cambodia. The war between US and Iraq early this year has hurt the business of many OEM manufacturers. However, Tack Fat could again benefit from the orders shift.

Tack Fat has received 4M units of swimwear order from Speedo recently. We believe US firms will continue raising their proportion of sourcing from Asia because of the low costs. With its leading position in swimwear manufacturing and stringent quality control, we expect the group can further expand its market share in Asia.

Fewer quota restrictions in Cambodia

Product pricing can be more competitive with fewer quota restrictions

One of the benefits of setting up production base in Cambodia is there are fewer quota restrictions. There is no tariff for garment exports to EU members if materials from ASEAN are used and also no quota. In addition, no quota for swimwear exports to US is required. Tack Fat also owns 20% of total pants quota in Cambodia so that costs can be lower and product pricing can be more competitive. Starting from 2003, quota and tariff have been lifted on garment exports, using materials from PRC, to Canada. Though sales to Canada accounts for a low percentage in the group’s turnover, the group can benefit from the potential growth in orders.

Economies of scale

Low production costs in Cambodia and bulk orders have helped achieve economies of scale

Production costs in China are low when compared to many other countries. However, wage in Cambodia is only US$45, compared with US$60-80 in China. Since more than 60% of the group’s production takes place in Cambodia, its overall costs can be lower than other manufacturers whose production base is solely in the mainland. Moreover, Tack Fat deals with bulk orders only, so economies of scale can be achieved.

Benefiting from China’s accession to WTO

According to WTO agreement, for all WTO members, quota on textiles will end by the end of 2004. European and American companies will further take the low cost advantage in China and source materials there. With one of its production bases located in China, Tack Fat can benefit from the good prospects. Though there will be competition from other manufacturers, the group has established close relationships with its clients, so the impact will be minimal.

Future growth drivers

Blue Cat

The 20-year exclusive manufacturing agreement enables Tack Fat to tap the tremendous market potential of Blue Cat

Blue Cat is the most popular cartoon character in the mainland. Over 1000 TV stations broadcast the cartoon. Retail sales potential of Blue Cat products is enormous. Currently, there are about 2300 specialty stores nationwide, grew from 1200 stores in July last year. The group projects that the number of stores can reach 3000 by the end of this year and 5000 in five years. To tap the huge market potential, Tack Fat signed a 20-year exclusive manufacturing agreement with Hunan Sunchime Digital Cartoon Development and Blue Cat Development in 2002 for the design and manufacturing of Blue Cat apparels for all Blue Cat specialty stores in the mainland.

Blue Cat apparel orders were over $30M in 1H03. We expect the orders will be over $60M for FY03. Given the impressive growth of specialty stores, demand for apparels will definitely increase. The group expects orders growth to be over 10% each year. Profit margin of Blue Cat apparels is the highest among the group’s products. Given its accelerating growth, we believe it is one of the future profit drivers.

Exclusive right to open specialty stores

In addition, Tack Fat has 5% stake in Blue Cat Development and has the exclusive license right to open Blue Cat retail stores in the mainland. During the year, the group opened 72 stores through franchises. At present, it directly manages 8 stores. Tack Fat Group has the option to buy the 51% stake in Blue Cat Development owned by Mr. Kwok Wing by 2005. If the option is being exercised, the group can have controlling stake in the extensive Blue Cat sales network. However, the group does not have any plan at the moment.

The group has entered into a letter of intent with Yue Yuen Industrial in April 2003 that Yue Yuen has the option to subscribe up to 20% of issued capital of Tack Fat. Details of the agreement are yet to be determined. We believe the two parties will have cooperation in retail sales in the future. Yue Yuen’s move demonstrates its confidence in Blue Cat.

Expansion of capacities

The group has been expanding its production facilities for future orders

To cope with the rising demand, Tack Fat has been actively expanding its production capacities. As at 31 March 2002, annual production capacities of swimwear, casual wear and sports wear were 550,000, 750,000, 60,000 dozens respectively. As the production capacities of swimwear and casual wear had double-digit growths in 1H03, we expect the full-year capacities will grow by about 20%. In the coming years, capacities will grow with orders. The group plans to spend $50-60M in FY03 on expanding production capacities in both Cambodia and China. Utilization rate increased from 94% in FY02 to 95% in 1H03. Given the stable orders growth, we expect the high utilization rate to sustain.

Acquisition of brands

Acquisition can raise the overall gross profit margin

The group is in negotiation with some European casual wear brands on possible acquisitions. Apart from enhancing the diversity of brand portfolio, acquisition can also create synergy effect. We expect the acquisition can expand the higher margin ODM business and thus raise the overall gross profit margin. 

Valuation

Tack Fat has much experience in manufacturing of casual wear, swimwear and sports wear. With its diversified client base, orders growth is expected to be stable. We estimate FY03 turnover to increase from $710.5M in FY02 to $888.1M in FY03, up 25% and FY04 turnover will also post a 25% growth. CAGR from 2001 to 2004 is expected to be 18.46%. The strong growth is partly attributable to Blue Cat business. We estimate that turnover of Blue Cat casual wear can reach $70M in FY04. Net profit is expected to grow from $82.3M in FY02 to $107.4M in FY03, up 30.5%. CAGR from 2001 to 2004 can reach 28.91%.

Though there is some pricing pressure for some bulk orders, cost of raw materials also decreases. Hence profit margin can be maintained. In fact, profit margin can rise potentially due to the gaining weight of ODM business, including the rapid growth of Blue Cat orders. We expect gross profit margin can stay at about 34% and has further upside potential. It is definitely more attractive than its peers.

The group’s financial position has been improved. Cash on hand is about $100M, compared with $77M of 31 March 2002. Gearing ratio (total liability over total asset) decreased from 64.9% in FY02 to 46.4% in 1H03. The group will continue its effort to further lower it. Inventory turnover dropped from 113 days in FY02 to 103 days in 1H03. Receivable turnover also fell from 48 days to 45 days. We expect the figures can be maintained at these levels due to stringent control by the management.

Assuming a dividend-payout ratio of 30% for FY03 and FY04, yields will be about 3.56% for FY03 and 4.37% for FY04. Currently, Tack Fat Group is only trading at FY03 PER of 8.46x and FY04 PER of 6.86x. Compared with other garment manufacturing and retail companies, Tack Fat Group is undervalued. The possible acquisition of controlling stake in Blue Cat Development from Mr. Kwok Wing in three years makes the valuation look more attractive. To be conservative, our target price is $0.99, representing FY04 PER of 10x.

 

Stock code

 

P/E (x)

 

Div. Yield (%)

 

 

FY02

FY03

FY04

 

Tack Fat Group

928

8.46

8.46

6.86

2.10

Texwinca Holdings

321

15.42

13.94

12.1

3.59

Giordano International

709

10.55

11.74

10.12

7.6

U-Right International Holdings

627

6.44

5.18

4.20

0

Good Fellow Group

910

9.82

9.82

8.09

1.46

High Fashion International

608

N.A.

N.A

N.A.

2.73

Source: IBES, Tung Tai estimates

Profit and loss account

Year ended 31 March (HK$M)

2001A

2002A

2003F

2004F

Turnover

641.1

710.5

888.1

1065.7

Cost of Sales

(424.8)

(469.6)

(587)

(704.4)

Gross profit

216.3

240.9

301.1

361.3

Other revenue

3.1

3.2

3.2

3.2

Other net (loss)/income

0.2

(0.2)

(0.2)

(0.2)

Selling expenses

(94.5)

(104.2)

(130.2)

(156.2)

Administrative expenses

(23.8)

(25.7)

(31.9)

(38.4)

 

 

 

 

 

Profit from operations

101.4

114

142

169.7

Finance costs

(33.5)

(23.3)

(23.6)

(23.7)

Profit from ordinary activities before taxation

67.9

90.7

118.4

146

Taxation

(6.1)

(8.4)

(11)

(13.6)

Profit attributable to shareholders

61.8

82.3

107.4

132.4

Dividends attributable to shareholders

 

 

 

 

Interim dividend declared and paid to the then

 

 

 

 

shareholders during the year

-

24

10.6

-

Final dividend proposed after the balance sheet date

-

8.3

21.6

-

 

 

32.3

32.2

39.7

 

 

 

 

 

DPS(HK$cents)

-

0.625

2.42

2.97

EPS(HK$cents)

6.04

8.04

8.04

9.91

Source: Tack Fat Group, Tung Tai estimates

Cash flow statement

For the year ended 31 March HK$M

2001

2002

Net cash inflow (outflow) from operating activities

133.9

72.1

Returns on investments and servicing of finance

 

 

Interest received

1.3

1.5

Interest paid

(26.8)

(17)

Interest element of finance lease rentals paid

(1.6)

(1.8)

Dividends paid

(36)

(24)

 

 

 

Net cash outflow from returns on investments and

 

 

servicing of finance

(63.1)

(41.3)

Taxation

 

 

Hong Kong profits tax paid

(1.9)

(5.3)

 

 

 

Investing activities

 

 

Capital expenditures

(36.8)

(14.8)

Purchase of permanent textile quota entitlements

(4.7)

-

Decrease/(increase) in amount due from related company

(5.8)

0.2

 

 

 

Net cash outflow from investing activities

(47.3)

(14.6)

Net cash outflow before financing

21.5

10.9

 

 

 

Financing

 

 

Increase/(decrease) in long term bank loans

(0.4)

17.4

Increase in short term bank loans

29.4

47

Decrease in long term payable

-

(7.8)

Capital element of finance lease rentals paid

(10.8)

(18)

(Decrease)/increase in amount due to shareholders

28.9

(35.8)

 

 

 

Net cash inflow from financing

47.2

2.9

Increase in cash and cash equivalents

68.7

13.8

Cash and cash equivalents at 1 April

(93.5)

(24.8)

Cash and cash equivalents at 31 March

(24.8)

(11)

 

 

 

Analysis of the balances of cash and cash equivalents

 

 

Cash and bank balances

85.6

77.2

Bank overdrafts and bank loans repayable within three months

(110.4)

(88.3)

from the date of advance

 

 

 

(24.8)

(11)

Source: Tack Fat Group

Balance sheet

As at 31 March HK$M

2001

2002

Non-current assets

 

 

Fixed assets

246.8

259.8

Intangible assets

9.3

5.3

Club debentures

1.2

1.2

Deferred taxation

4.4

4.4

 

261.7

270.7

Current assets

 

 

Inventories

131.9

145.7

Trade receivables

65.3

94.2

Prepayments, deposits and other receivables

11.7

22.3

Amount due from related company

64

63.8

Cash and cash equivalents

85.6

77.2

 

358.5

403.2

Current liabilities

 

 

Bank loans and overdrafts

213.3

238.2

Finance lease obligations

15.2

9.4

Bills payable

8.5

2

Trade payables

63.6

50

Accrued expenses and other payables

9.2

10.7

Tax payable

1.5

4.4

 

311.3

314.7

Net current assets

47.2

88.4

Total assets less current liabilities

308.9

359.1

Non-current liabilities

 

 

Bank loans

16.3

33.7

Finance lease obligations

40.6

41.6

Other payable

7.8

-

Amount due to shareholders

80.1

44.3

Deferred taxation

2.7

2.9

 

147.5

122.5

Net assets

161.5

236.6

Capital and reserves

 

 

Share capital

6.6

6.6

Reserves

154.9

230

 

161.5

236.6

Source: Tack Fat Group




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