Takeaways From Overseas Factory Visit; Optimistic on Client Expansion and Efficiency Improvement In The Long Term
Shenzhou’s vertically-integrated position, strong R&D capabilities and good ESG practices anchor its leading position in the textile industry. We are positive on Shenzhou’s customer expansion and production efficiency improvement in the long term. Raise target price by 6% to HK$85.00. Maintain BUY.
WHAT’S NEW
• We attended Shenzhou International’s Shenzhou) reverse roadshow in Cambodia and Vietnam during 27-29 June, and our key takeaways are as follows.
• Largest supplier for key clients with upside from Uniqlo. Shenzhou contributes 20%/20%/40%/10% of Nike/Adidas/PUMA/Uniqlo’s respective apparel procurement, and is the largest supplier for these four key clients. However, there is still upside for further share gains, especially for Uniqlo, according to management.
• Targeting more new clients. Management aims to secure 10 key clients in the long term. In the near term, management is confident of becoming the largest supplier for Lululemon (currently the second largest supplier), supported by its strong R&D capability on fabrics (50% of the fabrics used for Lululemon’s products are self-produced) and strong quality control. Revenue from Lululemon was US$40m in 2022, and management expects the revenue to double in 2023.
• Expanding fabric production capacity. Management expects to further expand its fabric production capacity in Vietnam by establishing a new fabric plant to catch up with the garment capacity expansion, but no clear timeline has been provided.
• Expanding overseas capacity in the mid term. Shenzhou aims to further expand overseas capacity, which will contribute 70% of its garment production and two-thirds of fabric supply (currently 50% of overseas capacity for both garment and fabric) in 3-5 years. In the next 1-2 years, the company aims to add 3,000-4,000 operators in both Cambodia and Vietnam. Although production efficiency of overseas factories is only 80% of that of its China factories, management sees upside potential given enhanced automation in overseas factories.
• Localisation management. Shenzhou aims to strengthen the localisation management of
its overseas factories, in order to improve management efficiency and stability. Currently,
Chinese management accounts for 3% of its total staff in overseas factories.
• Expects turnaround to happen in 3Q-4Q23. Management saw sequential improvement on its orders in 1H23, and expects a turnaround to happen in 3Q-4Q23, after key customers complete the destocking process.
• Marvel garment factory. Marvel garment factory is located in Phnom Penh, Cambodia, with total area of 60 hectares and total investment of around US$300m. The factory commenced production in Sep 20. Currently, it has 14,370 employees, of which 14,000 persons are local operators. Management expects the total number of operators to reach 18,000 in the next 1- 2 years. Capacity of the Marvel garment factory has continued to ramp up since commencing operation, with total output reaching 45.3m pieces in 2022. By destination, 69% of the output is exported to Europe, given the Everything Buy Arms (EBA) preferential tax policies granted to Cambodia, and 24%/4%/3% is exported to Middle & North America, Asia, and other areas respectively. By brand, 74%/13%/13% of the products go to Nike, Ralph Lauren, and Lululemon respectively. Management expects total output to reach 60m pieces (standardised terms) in 2023 (66%/17%/17% for Nike, Ralph Lauren, and Lululemon), and 80m pieces in the next 1-2 years. Latest capacity utilisation stands at around 95-100%, and management saw better utilisation in 2Q23 than in 1Q23.
• Gain Lucky fabric & garment factory. Gain Lucky factory is located in Tay Ninh, Vietnam, with total area of 150 hectares and total investment of around US$600m. The factory’s fabric and garment plants commenced production in Nov 14 and Mar 19 respectively. Gain Lucky factory has around 18,000 employees (3,000 for knitting, 7,500 for dyeing and finishing, and 7,500 for garment production). Gain Lucky’s fabric capacity is 400 tonnes per day, satisfying 50% of the fabric demand for Shenzhou’s garment production. Garment capacity is 200,000 pieces per day, for key clients Uniqlo, Adidas, Nike and PUMA.
• Worldon garment factory. Worldon factory is located in Ho Chi Minh, Vietnam, with total area of 83 hectares and total investment of around US$360mn. The factory commenced production in Mar-15. Currently, it has around 15,000 employees, and management expects to add 3,000 – 4,000 operators in 2024. Worldon’s capacity is 7mn pieces per month, and key clients are New Balance, Uniqlo, Adidas, Nike and Puma.
STOCK IMPACT
• Turnaround to drive re-rating. We hold a long-term positive view on Shenzhou, given its customer expansion and production efficiency improvement. In the near term, we believe only the clear signs of a turnaround (normalised orders visibility and domestic capacity utilisation) will drive the re-rating of the stock. A pivot point may approach in 4Q23 for Shenzhou, in our view, as we expect that: a) major brand customers’ orders will gradually normalise by 3Q23 and they begin to stock up for the upcoming winter season, and b) gross margin will gradually recover, driven by improvement of domestic capacity utilisation.
EARNINGS REVISION/RISK
• No changes to earnings estimates.
• Risks: Brand customers’ slower-than-expected destocking process; weak demand for the upcoming winter season.
VALUATION/ROCOMMENDATION
• Maintain BUY, and raise target price by 6% to HK$85.00. We revise up our long-term FCFF forecasts, to reflect Shenzhou’s: a) increase in new clients, b) overseas capacity expansion, and c) improvement of overseas production efficiency. We maintain WACC of 10.9% and terminal growth rate of 2% unchanged. Therefore, our target price is raised by 6% to HK$85.00. Maintain BUY. Our target price implies a 25.8x 2023F PE. Shenzhou currently trades at 22.7x 2023F PE, 1SD below the five-year average.
