Result Analysis: FY2021 earnings results beat profit alert; potential for spinoff of mid-downstream business and overseas yarn businesses (ex. China & Vietnam)
- Record high FY2021 earnings beating profit alert expectation
- Expect GP margin to come off from record high but volume growth to offset the lower GP margin expectation
- Potential spinoff of mid-downstream business and overseas yarn businesses could trigger re-rating for the company
- Revised up FY22 earnings by 35% to reflect stronger sales volume expectation and more margin stability; Maintain BUY with higher TP at HK$23.8
FY2021 earnings results better than profit alert expectation. Net profit increased to RMB2.69bn, up 419.3% y-o-y, better than the profit alert expectation. Revenue increased by 35.5%, to RMB26.5bn, thanks to strong demand, return of overseas orders, and the increase in ASP. The gross profit margin increased by 8.3ppt to 22.1%, close to its historical high. Net gearing improved to 0.45, vs. 0.52 as at 31 Dec 2020.The board declared a final dividend of HK$0.57 per share with a steady payout ratio of 30% (2020: HK$0.20).
Injecting Jeanswear business to JV should further cement margin stability Texhong reached an agreement with its existing joint venture partner of garment company Hualida Group at the end of 2021. The 15 jeanswear production lines are sold to the Hualida Group. Although jeanswear’s gross margin improved from 9.4% to 13.3% in 2021, we think the group’s decision and its focus on the garment fabric business will further cement its stability and the higher gross margin moving forward.
Potential for spinoff of mid-downstream business and overseas yarn businesses (ex. China & Vietnam). Texhong has been exploring different management restructuring options, including the possibility of a spinoff and separate listing of the group’s overseas yarn operations (excluding China and Vietnam) together with the vertically integrated garment fabric and trading businesses. Nicaragua, Turkey, and Mexico contributed. The mid-downstream business contributed 27% of FY21 sales, while the overseas yarn operations (excluding China and Vietnam) are equivalent to 6% of the total yarn capacity. Exact details of the restructuring options have yet been determined.
Spin-off into “China Yarn” and “Non-China fabrics”. We think the spin-off will benefit Texhong in term of its valuation, business operation and geographical advantage. We think that Texhong is trading at this low valuation mainly due to the volatile margins and high gearing. The spinoff will completely separate the mid-downstream business to form a vertical integrated company, without the most fluctuated margin of the yarn businesses. It will likely attract investors and improve the company’s valuation. Moreover, the garment fabrics are served mostly US customers. A spin off will completely target non-China customers and it will avoid US-China trade tariff or any further negative developments. A vertically integrated operation is also likely to command higher margins and higher valuations. That said we think the potential spinoff could trigger a re-rating for the company.
Expect gross profit margin to come off from historical high and maintain at 20% in 2022 and 2023. We expect the GP margin to lower slightly but remain high vs historical level, at 20% in FY22, thanks to 1) the continuous rise in both domestic and overseas cotton prices, which will continue to provide strong support to the GP margin of the yarn business; 2) the improvement of the downstream business and its increasing contribution to the company’s earnings, which will bring stability and a higher margin for Texhong; 3) the removal of its lower margin jeanswear business; and 4) the commencement of the new garment fabric factory in Vietnam. In addition, we expect Texhong’s GP margin to slightly drop to 19.6% in 2023. We expect begin to normalise afterwards but offset by the improving GP margin of the mid-downstream businesses.
However, expect volume growth to offset the lower GP margin and drive future growth. In Jan-Feb 2022, the company enjoyed a similar business environment to that of 2H21, amid the inflationary environment and strong demand as the world is stepping out of the pandemic. We expect ASP to remain at the current strong level. We expect the company to achieve its sales target of 880,000 tonnes of yarn, 180m metres of woven garment fabrics, and 28,000 tonnes of knitted garment fabrics, which represent a growth of 7.6%, 31.4%, and 57.8%, compared to the sales volumes of 2021. We believe disruptions from lockdowns in Vietnam like last year are unlikely, as the country has already lifted its zero-COVID policy.
Expect total of RMB2.2bn CAPEX in FY22. The CAPEX will be for improving old machinery and equipment for the yarn and garment businesses and purchases of new machines and equipment for the new Vietnam factory. The spending of capex in upgrading the equipment will help lower reliance on labour costs and eventually raise margins. We expect Texhong to further reduce its net gearing ratio to 0.3-0.4 in FY22 and achieve a more stable and low-risk profit growth.
Revised up earnings by 35% for FY22F. Overall, we have adjusted our earnings estimate to reflect the better-than-expected earnings in FY21. We expect earnings to drop 3.6% following the lowered GP margin expectation in FY22. Moving into FY23, we expect earnings to growth 3.7% backed by the expected volume growth. That said, we revise up our TP to HK$23.8, pegged to a lower multiple (reflect recent market de-risking) of 7x FY22F PE, which we think is justified due to its strong performance in FY21, multi-year low net gearing ratio, and stabler gross margin