Van Shung Chong (1001)

11 March 2003

5 August 2003

Van Shung Chong

Buy

Stock Code

1001.HK

Price(as at 4/8/03)

HK$1.43

Target Price

HK$2.01

 

Key Data

 

 

Shares Outstanding

312.3M

 

Market Capitalisation

HK$446.6M

 

52 week high/low

HK$1.63/HK$0.192

 

ROA

4.3%

 

ROE

11.6%

 

Current ratio

1.39x

 

Gearing

1.17x

 

Major shareholder

 

 

Mr. Yao Cho Fai

55.72%

Company update: Beyond the target

Significantly improved FY03 results    VSC recorded $60.4M net profit in FY03, surged by almost fivefold from $10.1M in FY02. Turnover was $2755.8M, up 28.9% from $2137.8M. Gross margin improved from 7.19% to 7.95%.

CMG: bottoming out    Price of rebars in Hong Kong has recovered and VSC・s market share was maintained at 40-45%, gross profit should be stable. Upside is possible as the group expands steel distribution in China and performance of JV in Shanghai was encouraging.

CAMP: undergoing rapid expansion Dongguan coil centre posted 70% rise in profit before allocation of corporate overhead to $57M for FY03. Tianjin coil centre commenced operation in July 2003. Riding on the success in Dongguan coil centre, VSC plans to set up at least one coil centre each year. Enclosure systems department is expected to turn around this year and it has recorded over $20M turnover in the first quarter.

Undemanding valuation VSC is trading at 7.1x FY04 and 6.1x FY05 prospective PER. With 30% dividend payout ratio, expected yields in FY04 and FY05 reach 4.7% and 5.5%, respectively. Valuation is undemanding when compared with 10x average of industrial stocks. As VSC has hit our previous target price of $1.54 in a short period of time, we revise our target price upward to $2.01.

As at 31 March (HK$M)

2002A

2003A

2004F

2005F

Turnover

2137.8

2755.8

3031.3

3394.2

Gross Profit

153.8

219.1

254.6

295.3

Net Profit

10.1

60.4

70

81.5

Basic EPS (HK$cents)

2.8

17.4

20.1

23.4

P/E (x)

51.1

8.2

7.1

6.1

Source: Van Shung Chong, Tung Tai estimates

Significantly improved FY03 results

Van Shung Chong (VSC) recorded strong results last year. FY03 turnover grew 28.9% from $2137.8M in FY02 to $2755.8M. Operating profit jumped from about $20M to $77M. Net profit was in line with expectation, surged nearly fivefold to $60.4M, up from $10.1M in FY02. Gross profit margin also improved from 7.19% to 7.95%. Net margin increased from 0.47% to 2.2%.

Turnover breakdown for FY03 was more or less the same as previous year. Construction Material Group (CMG) accounts for 83% of FY03 turnover and China Advanced Materials Group (CAMP) accounts for the remaining 17%.

CMG

Steel stockholding department achieved stable growth

The department recorded $2.28B turnover, in which $2.14B was from steel distribution and $141M was from building products. Steel stockholding department turnover and gross profit increased approximately 10% and 14% respectively. However, gross profit of rebars stockholding decreased 11% because of low-price contract signed previously. During the period, price of rebars in Hong Kong was volatile due to the war in the Middle East earlier this year. At the end of 2002, price of rebars jumped around 40%, followed by a plunge of 20-30% in March due to mass selling by speculators after war. Price has been stabilized at $2,500 per ton, 10-15% higher than before the rise. The group・s market share in Hong Kong steel trading was maintained at 40-45%. VSC also develops steel distribution in China, mainly Shanghai and Shenzhen. The group also plans to introduce environmental friendly piling method by importing machines from Japan. Together with steel supply to iSteelAsia Group, steel distribution business in China amounted to $500M. The purchasing agreement can enable to the group to take advantage of bulk purchase such as cheaper sourcing and flexible delivery schedule.

Shanghai BSC posted encouraging results

The 66.7% owned JV with Shanghai Baosteel Group, Shanghai Bao Shun Chang, posted encouraging results during the year. Turnover increased 20.1% to about $497M and net profit contribution before minority interests was about $10M. Given the enormous market potential in China, prospect of the JV is expected to be promising.

To capture opportunities arising from Olympic Games and World Expo, VSC formed a JV with Beijing Shougang

Olympic Games to be held in Beijing in 2008 and World Expo to be held in Shanghai in 2010 will boost demand of construction materials for infrastructure, stadiums, hotels, etc. To capture the opportunities, VSC formed a JV with Beijing Shougang Group for production of colour-coated steel sheets. The JV is anticipated to commence production by the end of 2003. The group invested US$3M for a 7.5% stake with a put option that can be exercised within 2005-07. The group is also able to secure exclusive distribution rights for 50% of the production of colour-coated steel sheets at a discount and the right to supply raw materials if the terms are as competitive as other suppliers. The group considers increasing its stake to about 10%. Though the JV is in its initial stage and the group owns relatively small stake, it enables the group to expand its China steel distribution business.

Operating loss before unallocated corporate expenses of buildings department reduced due to project completion of kitchen cabinet division

Performance of building products department continues to improve. Turnover increased significantly from $55M in FY02 to $141M in FY03. Operating loss before unallocated corporate expenses reduced to $2M, compared with $7M in FY02. It is attributable to completion of three major projects of kitchen cabinet division. The group decides to focus on small to individual projects, instead of huge residential projects, for kitchen cabinet division due to higher profit margin and less human resource deployment. On the other hand, the group will strengthen its sanitary ware division operation. It set up a trading company in Shanghai in April this year and has obtained distribution rights of Toto sanitary ware in Shanghai.

CAMP

CAMP department grew 23% to $472M during the year. Coil centers, enclosure systems, and plastics and machinery account for $277M, $40M, $155M, respectively.

Dongguan coil centre customer base is well diversified and steel coil demand will continue increasing

Dongguan coil centre turnover and profit before allocation of corporate overhead increased by 18% and 70%, respectively, to $277M and $57M. It has a well-diversified customer portfolio that the largest 10 customers account for over 50% of turnover. They are Taiwan or Hong Kong based computer and electrical appliance OEM manufacturers with their products exported to the US and Europe. As corporations there resume their capex, demand for computers and electrical appliances will increase and will boost the demand for steel coil. Given the good performance, VSC added capacity by 30% to 100,000 tons per year early this year. Key value of coil center is customers do not have to keep inventory. In addition, scrap rate can be as high as 50% if steel coil is processed by customers themselves. However, scrap rate is only 5-6% for VSC, so coil centre can enhance cost effectiveness. Profit margin could reach about 25%.

Riding on the success of Dongguan coil centre, VSC plans to set up one coil centre each year

Another wholly-owned coil center in Tianjin, with similar capacity as in Dongguan, commenced operation in July 2003. The group expects some losses may be incurred in the first year of operation, but it targets to break even this year. VSC targets to set up one coil centre each year and it plans to build coil centres in Shanghai and Guangzhou. Capex of a coil centre is around $30-40M. As more coil centres will be built, VSC can purchase raw materials at more competitive prices and thus enjoy a higher margin.   

Enclosure systems department recorded loss before allocation of corporate overhead because of one-off investments in prototyping

Turnover of enclosure systems manufacturing was $40M, when compared with $5.6M in FY02. However, an operating loss before unallocated corporate expenses of about $6M was incurred. It was mainly due to one-off investments in moulds for prototyping. The department・s performance is going to improve given the investments are only one-off and the group has secured over 1000 autoparts supply for Isuzu. The department recorded over $20M turnover in the first quarter. The group targets to have $100M turnover and 20% gross margin this year. Last year・s gross profit margin was 14.4%.

Plastics division turnover was approximately $149M, up 9.4%. The group intends to explore Shenzhen plastic market by establishing a trading company there. Details will be confirmed by the end of this year. Revenue from machinery dropped 11.7% last year. The group may develop new robots to compensate the fall in sales of other machinery.

Business was temporarily affected by SARS, but returned to normal in June

The group・s business was affected by the SARS epidemic in April and May as customers slowed down their orders. However, orders picked up again in mid-June before the peak season and returned to the level before SARS.

At present, VSC does not have any concrete plans after the signing of CEPA

The group does not have any concrete plans at the moment regarding CEPA. According to CEPA, certain metal products made in Hong Kong can enjoy zero tariffs for exports to the PRC. Currently, they are subject to 4-10.5% tariffs. The group will see which categories of steel products are under the scheme and then make appropriate decisions.

China was the largest rolled steel importer and producer last year

Future demand for steel in China will remain strong. China has become the largest importer of rolled steel last year. According to a report by the China iron and Steel Industry Association, China imported 24.49M tons of rolled steel last year, 42.23% more than that of 2001. 28.63% of rolled steel was imported through processing trade, representing approximately 7M tons of steel. The report also revealed China remained the world・s largest steel producer that total output was 182.24M tons, up 20.67%.

There exist competitors in steel processing market 

VSC estimates that rolled steel demand in Guangdong area is in excess of 1M tons p.a. and the group targets for 10% share. Since the market is large, the group still has the potential to grow. Nonetheless, there are competitions from other coil centres, which are set up by Japanese, domestic and other Hong Kong firms. Japanese coil centres are less competitive in price. Other Hong Kong firms are weaker in cash flows and have smaller scales. However, domestic firms are major threats as they are flexible in production. VSC has an advantage over them, which is the group being the first mover. In addition, as VSC will establish a chain of coil centres, economies of scale can be achieved.

Conclusion

Gearing (interest bearing short-term borrowings and long-term bank loan over shareholders・ equity) surged from 0.5 in FY02 to 1.17 in FY03 as a result of a few factors. First, short-term borrowings increased by more than double, which is in line with rise in steel trading turnover. Second, the group borrowed a $23M three-year long-term loan for funding of its investment in Beijing Shougang JV. Third, the group repurchased shares in Jan 2003 and reduced shareholders・ equity. Since the gearing grows with turnover and given the group・s operations are mainly cashflow businesses, depending on the exact time of calculating the gearing ratio, there can be a wide fluctuation. In addition, as the group relies heavily on short term bank financing for its steel distribution and processing businesses, with strong banking support and cashflow management, the group・s financial position is still healthy. Cash-in-hand is about $70M.

We expect the group to eventually consider raising capital in short to medium term. Proceeds raised are expected to fund the set up of a metal service centre in Tianjin, which involves about $100M capex. The factory will be in the form of JV with Japanese automobile manufacturers and details will be confirmed by the end of 2003.

Steel trading in Hong Kong has stabilized and with the enormous PRC market potential, we expect FY04 turnover will grow by 10% to $3031.3M and net profit will increase to $70M. There was a $6.6M write-back from a JV that was written off previously and a $4-5M further write-back in this year is expected. VSC is trading at 7.1x FY04 and 6.1x FY05 prospective PER. The group will maintain 30% dividend payout ratio. Expected yields in FY04 and FY05 reach 4.7% and 5.5%, respectively. Valuation is undemanding when compared to 10x average of industrial stocks. VSC has hit our previous target price of $1.54 in a short period of time. Added by the strong results, we revise the target price upward to $2.01.

Consolidated Profit and Loss Account

For year ended 31 March (HK$M)

2002A

2003A

2004F

2005F

Turnover

2137.8

2755.8

3031.3

3394.2

Cost of sales

(1984.1)

(2536.7)

(2776.7)

(3098.9)

Gross profit

153.7

219.1

254.6

295.3

Other revenue

9.2

11.7

9

-

Selling and distribution expenses

(13.8)

(17.1)

(21.2)

(23.8)

General and administrative expenses

(130.5)

(135.1)

(151.6)

(169.7)

(Deficit)/Surplus on revaluation of investment properties

1.2

(1.5)

(1.5)

-

Operating profit

19.9

77

89.3

101.8

Finance cost

(7.9)

(11.1)

(13.5)

(14)

Share of loss of associates

(0.1)

-

-

-

Profit before taxation

11.9

65.9

75.8

87.8

Taxation

(0.8)

(2.2)

(2.5)

(3)

Profit after taxation but before minority interests

11.1

63.7

73.3

84.8

Minority interests

(1)

(3.3)

(3.3)

(3.3)

Profit attributable to shareholders

10.1

60.4

70.0

81.5

Dividends

(9.2)

(18.1)

(23.3)

(27.2)

Earnings per share (HK$cents)

 

 

 

@

Basic

2.8

17.4

20.1

23.4

Diluted

2.8

17.3

20.1

23.4

Source: Van Shung Chong, Tung Tai estimates

Consolidated Cash Flow Statement

For the year ended 31 March (HK$M)

2002

2003

Operating activities

 

@

Net cash inflow generated from operation

130.1

29.3

Interest received

2.7

4.9

Interest paid

(7.9)

(11.1)

Hong Kong profits tax paid

(6.1)

(2.8)

Hong Kong profits tax refunded

-

10.1

Mainland China enterprise income tax paid

(0.2)

(0.8)

Net cash inflow from operating activities

118.6

29.5

@

 

@

Investing activities

 

@

Additions of property, plant and equipment

(42.3)

(23.4)

Proceeds from disposal of property, plant ad equipment

2.4

0.5

Acquisition of additional interests in a subsidiary

-

(1.9)

Proceeds from disposal of a subsidiary

-

0.5

Acquisition of a long-term investment

-

(25)

Acquisition of a business

(19.7)

-

Receipt of return from a joint venture

6.5

6.6

Dividend received from a long-term investment

-

0.2

Translation adjustments

0.08

0.03

Net cash outflow from investing activities

(53)

(42.4)

@

 

@

Financing activities

 

@

Proceeds from issue of shares

0.001

4.1

Repurchase of shares

(0.3)

(53.1)

New bank loans

56.7

47

Repayment of bank loans

(36.2)

(2.4)

New other short-term loans

-

37.8

Capital contribution by minority shareholders of a subsidiary

0.9

3.6

Dividends paid to a minority shareholder of a subsidiary

(0.3)

(0.3)

Dividends paid to shareholders

(88.1)

(2.8)

@

 

@

Net cash inflow/(outflow) from financing activities

(67.3)

34

Increase/(Decrease) in cash and cash equivalents

(1.7)

21.1

Cash and cash equivalents, beginning of year

50.2

48.6

Cash and cash equivalents, end of year

48.6

69.6

Source: Van Shung Chong

Consolidated Balance Sheet

As at 31 March (HK$M)

2002

2003

Non-current assets

 

@

Property, plant and equipment

123.2

125.8

Investment properties

32.5

31

Investment in associates

0.002

0.002

Long-term investments

32.6

45.7

Goodwill

6.5

4.6

Total non-current assets

194.8

207.1

Current assets

 

@

Inventories

217.8

381.5

Gross amount due from customers for installation contract work

1.9

19

Prepayments, deposits and other receivables

41.4

79.5

Accounts receivable

470.9

655

Loans receivable

10.8

6.9

Pledged bank deposit

3

8

Cash and other bank deposits

45.5

61.7

Total current assets

791.4

1211.6

Current liabilities

 

@

Short-term borrowings

263

590.7

Accounts and bills payable

152.6

212

Receipts in advance

6

29.8

Accrued liabilities and other payables

34

27.9

Gross amount due to customers for installation contract work

-

4.6

Taxation payable

2.4

6.1

Total current liabilities

458.1

871.1

Net current assets

333.3

340.5

Total assets less current liabilities

528.1

547.6

Non-current liabilities

 

@

Long-term bank loan, non-current liabilities

-

20.5

Deferred taxation

0.25

0.25

Total non-current liabilities

0.25

20.7

Minority interests

4.6

6.5

Net assets

523.3

520.4

Share capital

35.5

31.2

Reserves

487.8

489.2

Shareholders' equity

523.3

520.4

Source: Van Shung Chong




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