U-Right International (627) (December 31, 2003)

11 March 2003

Buy

Stock Code

627.HK

Price(30/12/03)

HK$0.42

Target Price

HK$0.67

 

 

 

 

Key Data

 

 

Shares Outstanding

1451.2M

 

Market Capitalisation

HK$609.5M

 

52 week high/low

HK$0.445/HK$0.209

 

ROA

3.87%

 

ROE

6.7%

 

Current ratio

1.86x

 

Gearing

0.12x

 

Major shareholder

43.16%

 

Leung family

 

Your right choice

Extensive distribution network U-Right has over 300 distribution points in China, 25 self-managed retail shops in Hong Kong, and 15 franchise shops in the Middle East. It also signed distribution agreement with distributors in Japan and Spain. It will continue to extend its global reach.

Texcote Technology Texcote business has a much higher margin than ordinary garments. Texcote Technology can be applied to various textile products. As U-Right owns global intellectual rights in Texcote, it can receive license fees and share the turnover by partners. 5 new production lines will be installed by mid-2004 and the group will have a total of 10 new productions lines by mid-2005. It is expected to strengthen Texcote processing ability substantially.

Tapping enormous China market potential U-Right・s strategy is to expand into second- to third tier cities. During the period of 1998-2001, consumer spending growth rates for some provinces are higher than that of Guangdong. As U-Right has positioned itself as middle-end brand, we believe the market potential will be huge.

Attractive valuation U-Right is trading at 7.6x and 6.3x prospective FY04 and FY05 PER, respectively. Yields are 3.9% and 4.8%. Valuation is attractive given the earnings growth potential. We believe it should be trading at 10x FY05 PER, which is equivalent to $0.67.

As at 31 March (HK$'000)

2002A

2003A

2004F

2005F

Turnover

459,059

579,652

763,910

1,033,797

Gross Profit

175,637

166,338

252,090

347,873

Net Profit

37,599

23,827

75,229

103,574

Basic EPS (HK$cents)

4.52

2.22

5.88

7.14

Diluted EPS (HK$cents)

N/A

2.19

5.50

6.72

P/E (x)

9.3

18.9

7.6

6.3

Source: U-Right International, Tung Tai estimates

Company background

U-Right is principally engaged in design, manufacture, distribution and retail of men and ladies casual wear for China and Hong Kong market. It has transformed from a retailer to a brand owner. To diversify its business, the group acquired 51% stake in Texcote Group in 2002. It also owns the global intellectual property rights for Texcote Technology. Then it started to apply Nano technology to its apparel. Since then, U-Right・s business has been divided into two streams, garments retail and distribution, and Texcote processing and licensing.

U-Right outsources 90% of its production to over 100 OEM sub-contractors in China. Reliance on a single sub-contractor is minimal. The other 10% of output is produced by the group・s production line. The largest 5 customers account for 52% of total turnover and the largest customer accounts for 13% as at 31 March 2003.

Extensive distribution network

The group has an extensive distribution network in the PRC. It is also expanding its global reach

U-Right has an extensive distribution network in the PRC and Hong Kong. It has over 300 distribution points on the mainland and 25 self-managed retail shops in Hong Kong. Due to fierce competition in major cities in China, the group・s targets are second to third tier cities. The group has positioned its brand, U-Right, as middle-end brand, making it affordable to a large number of people. The group has 15 franchise shops in the Middle East. It also signed distribution agreement with distributors in Japan and Spain in July 2003. 

Texcote Technology

Textile products treated by Texcote technology have much higher margin than ordinary garments. In addition, U-Right can receive license fees and derive income from joint ventures

Textile products using Texcote-Processing Technology have major advantages of being water repellent, stain resistant and breathable without changing the texture or appearance of fabric. Therefore, profit margin for Texcote business can reach 50-60%, which is much higher than that (30-40%) of ordinary garments.  As U-Right owns the global intellectual rights of Texcote Technology, it can receive license fees, ranging from $5M to $8M, from joint venture partners. In addition, the group can share the turnover by joint venture partners. At present, the group has a number of joint venture partners, namely, Kiu Hung International, Maytron Enterprise, Onlen Fairy・s Land and Guangdong Da Zhong Medical Products Plant.

Encouraging interim results

Turnover in 1H04 increased by approximately 20% and net profit surged over 98%

The group recorded encouraging results in 1H04. Turnover increased 19.6% y-o-y from $263M to $315M. Net profit surged 98.2% y-o-y to $37.8M. Turnover from Texcote jumped from $3.2M in 1H03 to $53M and accounted for 16.8% total turnover, representing 16x spectacular growth. During the SARS period, sales in Hong Kong had dropped by 20-30%, but it has recovered in recent months. Turnover from Hong Kong retail sales dropped only 8.6% y-o-y to $52M. The group aims at maintaining full-year sales at the same level as in FY03. Net profit surged as Texcote business has become profitable, compared with a loss in the same period of last year. It was also helped by reduction in expenses. Expenditure on advertising on Texcote was lower than that of last year. Administration expense also decreased. The management expects their growth will be in line with turnover growth thereafter.

Texcote business gaining share has enhanced gross profit margin

In 1H04, 78.7% of revenue comes from China, 16.5% from Hong Kong and the remaining 4.8% from overseas market. Overall gross profit margin of the group increased slightly from 36.2% in 1H03 to 36.5% in 1H04. The increase in share by high profit margin Texcote business was offset by a drop in Hong Kong retail business. Profit margin for retail sales in Hong Kong is higher than that in China because the group can only earn the wholesale margin for sales in China. Revenue from China has increased from 66% of total turnover in 1H03 to 78.7% 1H04. Export sales accounts for 4.8% of total turnover. The group will continue to extend its global reach, but we do not expect it to raise the turnover share substantially because the profit margin for exports is relatively low.

Future growth drivers

Texcote Technology

New production lines in Shunde can strengthen its Texcote processing ability substantially

U-right currently has one nanotechnology processing production line in Shenzhen. The maximum production capacity is 200,000 pieces of garments per month. Besides garments, the production line also has the flexibility to process other fabric products. Orders in hand for the existing production line has reached 6 months already. To tap the tremendous market potential, a new plant in Shunde with 10 new production lines and 300,000 sq.ft. gross floor area is under construction. 5 of them commence operation in mid-2004. Production volume can be increased by 1M items per month. The remaining 5 production lines commence operation in 2005. New production lines can process other fabric products such as plush toys, handbags, footwear, etc. The capacity expansion can strengthen its Texcote processing ability significantly.

Through cooperation with Da Zhong, the group・s nano medical products can have wide distribution. U-Right targets to set up a subsidiary to develop nano medical products

During SARS period in the first half of this year, U-Right launched anti-bacteria nano medical products processed by Texcote technology. The nano masks by U-Right had surpassed the new standards, which was changed and implemented by General Administration of Quality Supervision, Inspection and Quarantine (GAQSIQ) in June 2003. Da Zhong is one of the few authorized protective masks and medical products in the PRC. Through the distribution network of Da Zhong with over 500 distribution points, U-Right・s nano medical products can be sold through an extensive network. The group plans to set up a subsidiary to further develop nano medical products. Its target is to establish its own brand name in China. After the SARS outbreak this year, people are more conscious on hygiene. We believe future demand for quality medical products will be tremendous. It may become a fast growing sector in Texcote business.

Enormous China market potential

Consumer spending in many provinces has climbed during the period 1998 to 2001.

The group・s target of expansion in China is 30-50 franchise shops per year, focusing on second- to third-tier cities. According to National Bureau in Statistics, consumers spending in some provinces from 1998 to 2001 has been growing continuously and are listed as follows:

(in 100M yuan)

1998

1999

2000

2001

Hubei

1593.62

1593.94

1699.45

1899.35

Guangdong

3330.07

3435

3754.8

3907.02

Guangxi

952.63

978.81

1019.36

1075.89

Sichuan

1758.19

1826.99

2059.2

2076.8

Guizhou

548.69

568.06

600.07

611.31

Jiangsu

2513.52

2594.18

2815.51

3181.71

Zhejiang

1678.15

1727.94

1957.85

2197.33

Growth rates for some of them are even higher than that of Guangdong. We believe consumer spending in those provinces will pick up

The group・s distribution points are concentrated in Southern China, where consumer spending is the highest. However, it also has quite a lot of distribution points scattered in other provinces. Some of their growth rates are higher than that of Guangdong. CAGR for Guangdong between 1998 and 2001 is 5.47%. CAGRs for Sichuan, Hubei, Jiangsu and Zhejiang are 5.71%, 6.02%, 8.17% and 9.4%, respectively. We believe the growth momentum in consumer spending in other provinces will continue to be strong and can pick up that of Guangdong. U-Right has positioned itself as middle-end brand. The increasing affordability of consumers on the mainland will lead to larger demand of the group・s garments and market potential is huge.

Consumer spending (in million yuan) in some provinces from 1998 to 2001

According to CEPA, products with 30% value added in Hong Kong can be exempted from import tariff. To capitalize CEPA, the group is considering setting up a new plant in Hong Kong. It is in negotiations with international brands for Texcote technology treatment on their products.

Conclusion

As U-Right continues to add its distribution points in China, revenue from China is expected to have significant contribution. Excluding new shops, orders in hand has the same level as last year. Fuelled by the optimistic outlook of Texcote business, we believe net profit can have stable and sustainable growth in the coming few years. We expect FY04 turnover to jump over 30% and net profit to surge by over 300% to reach $75.2M.

Cash position of the group has been improving. As at 30 September 2003, cash in hand was $145M, compared with $108M at the end of March. Due to installation of 5 new production lines by mid-2004, capex for the first 6 months in 2004 is $50M. For the 5 new production lines to be installed by mid-2005, another $50M capex will be needed. Net gearing dropped from 28% to 12% in 1H04. As at 30 September 2003, current ratio was 1.86x.

Prospective FY04 and FY05 PER at current price are only 7.6x and 6.3x, respectively. Assuming a 30% dividend payout ratio, yields in FY04 and FY05 are 3.9% and 4.8%. Given the growth potential, valuation is attractive. We believe it should be traded at 10x FY05 PER, which is equivalent to $0.67.

Profit and loss account

For year ended 31 March (HK$'000)

2002A

2003A

2004F

2005F

Turnover

459,059

579,652

763,910

1,033,797

Cost of sales

(283,422)

(413,314)

(510,820)

(685,924)

Gross profit

175,637

166,338

252,090

@347,873

@

 

 

 

@

Other revenue

2,586

3,934

2,200

2,200@

Gain on disposals of subsidiaries

-

10,326

3,941

@-

Selling and distribution costs

(69,985)

(69,966)

(84,030)

(113,718)

Administrative expenses

(48,909)

(56,661)

(52,326)

(62,791)

Amortisation of goodwill

-

(6,651)

(6,000)

(6,000)

Other operating expenses

(3,489)

(5,816)

(8,021)

(10,441)

Profit from operating activities

55,840

41,504

107,854

@157,123

Finance costs

(10,917)

(9,958)

(10,000)

(7,000)

Shares of losses of:

 

 

 

@

Jointly-controlled entities

(529)

(489)

3,000

@6,000

Associates

(360)

-

-

@-

Amortisation of goodwill arising on acquisition of

 

 

 

@

jointly-controlled entities and associates

(420)

(6,532)

(9,000)

@(9,000)

Profit before taxation

43,614

24,525

91,854

147,123@

Taxation

(6,015)

(2,793)

(8,266)

(17,655)

Profit before minority interests

37,599

21,732

83,588

129,468@

Minority interests

-

2,095

(8,359)

(25,894)

Net profit attributable to shareholders

37,599

23,827

75,229

@103,574

Dividend

-

7,113

22,569

@31,072

Earnings per share (HK$cents)

 

 

 

@

Basic

4.52

2.22

5.88

@7.14

Diluted

N/A

2.19

@5.50

6.72@

Source: U-right International, Tung Tai estimates

Consolidated Balance Sheet

As at 31 March (HK$'000)

2002

2003

Non-current assets

 

@

Fixed assets

91,971

125,230

Investment properties

12,980

11,940

Goodwill

-

19,998

Interests in jointly-controlled entities

19,921

86,058

Interests in associates

32,719

-

Investment securities

71

-

Deposit fro acquisition of long term assets

12,000

37,336

Rental deposits

7,328

6,890

@

176,990

287,452

Current assets

 

@

Inventories

59,675

87,176

Trade receivables

51,171

69,801

Prepayments, deposits and other receivables

29,262

60,278

Amounts due from jointly-controlled entities

7,254

1,534

Amounts due from associates

9,958

-

Other investments

980

980

Pledged bank deposits

52,880

-

Bank and cash balances

22,353

108,327

@

233,533

328,096

Current liabilities

 

@

Trade and bills payables

28,595

25,428

Accruals and other payables

13,290

14,195

Provision for taxation

28,487

18,090

Interest-bearing borrowings

69,190

98,209

Finance lease payables

4,581

8,054

@

144,143

163,976

Net current assets

89,390

164,120

Total assets less current liabilities

266,380

451,572

Non-current liabilities

 

@

Interest-bearing borrowings

19,858

92,857

Finance lease payables

2,931

7,280

 

22,789

100,137

Minority interests

-

(2,383)

Net assets

243,591

353,818

Capital and reserves

 

@

Share capital

94,604

110,658

Reserves

148,987

243,160

Shareholders' funds

243,591

353,818

Source: U-Right International 2003 annual report

Consolidated Cash Flow Statement

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

2002

2003

Cash flows from operating activities

 

@

Profit from operating activities

55,840

41,504

Adjustments for:

 

@

Depreciation

12,971

20,271

Interest income

(882)

(565)

Deficits on revaluation of leasehold land and buildings

157

576

Deficits on revaluation of investment properties

70

240

Gain on disposals of subsidiaries

-

(10,326)

Gain on disposals of fixed assets

(22)

-

Write off of fixed assets

1,289

-

Bad debts written off

213

-

Unrealised loss on other investments

35

71

Amortisation of goodwill

-

6,651

Impairment loss on interest in a jointly-controlled entity

-

1,921

@

 

@

Operating profit before working capital changes

69,671

60,343

(Increase)/ Decrease in inventories

5,314

(27,501)

Increase in trade receivables

(9,448)

(18,496)

Increase in prepayments, deposits and other receivables

(16,126)

(27,942)

Decrease/(Increase) in amounts due from jointly-controlled entities

(7,254)

5,720

Decrease/(Increase) in amounts due from associates

(9,958)

9,958

Decrease in trade and bills payables

(12,438)

(6,748)

Increase in accruals and other payables

2,167

785

Increase in trust receipt loans

6,764

15,336

Cash generated from operations

28,692

11,455

Interest paid

(10,604)

(9,242)

Interest element on finance lease rental payments

(313)

(716)

Taxes paid

(1,413)

(2,870)

Net cash (outflow)/inflow from operating activities

16,362

(1,373)

Cash flows from investing activities

 

@

Purchases of fixed assets

(27,382)

(39,878)

Proceeds from disposals of fixed assets

22

-

Deposit paid for establishment/acquisition of a subsidiary

(8,877)

(37,336)

Purchases of other investments

(1,015)

-

Purchases of investment securities

(60)

-

Increase in other receivable

-

(13,520)

Capital contribution to a jointly-controlled entity

(2,450)

(42,000)

Acquisition of associates

(33,499)

-

Acquisition of subsidiaries

(22,000)

(12,899)

Proceeds from disposals of subsidiaries

-

12,000

Decrease/(Increase) in pledged bank deposits

(9,484)

(52,880)

Interest received

882

565

Net cash outflow from investing activities

(103,863)

(80,188)

@

 

@

Cash flows from financing activities

 

@

Proceeds from issue of shares

83,268

88,444

Expenses on issue of shares

(2,425)

(1,144)

Drawdown of bank loans

44,776

160,123

Repayment of bank loans

(32,865)

(74,431)

Cash inflow from sales and leaseback transactions

6,183

-

Capital element of finance lease rental payments

(2,336)

(6,447)

Dividend paid

(11,000)

-

Net cash inflow from financing activities

85,601

166,545

@

 

@

Net increase/(decrease) in cash and cash equivalents

(1,900)

84,984

Cash and cash equivalents at beginning of year

22,164

20,264

Cash and cash equivalents at end of year

20,264

105,248

@

 

@

Analysis of the balances of cash and cash equivalents

 

@

Bank and cash balances

22,353

108,327

Bank overdrafts

(2,089)

(3,079)

@

20,264

105,248

Source: U-Right International 2003 annual report




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