CSCI-Textile OEM-Regina Miracle (2199 HK)：Vietnam factory ramp-up boosts operating leverage - 20171201

Vietnam factory ramp-up boosts operating leverage

• Regina Miracle’s (RM) 1H18 YoY net profit rebounded 3.1x YoY, thanks to order recovery from its existing customers and new customer contributions with improvement in margins.
• The Vietnam factory started to contribute to profit in 1H18 and there is further room for improvement in operating efficiency in 2H18E as production is on track to meet its full-year target of 40mn pieces. 
• Although the pace of RM’s recovery seems to be more protracted in FY18E, we expect a substantial pick-up in FY19E once Factory C in Vietnam commences production in 2Q CY18. We will maintain our sales estimates for FY18/19E, but have revised down our EPS for FY18E by 31% after adjusting downwards our net margin estimates. We are keeping the EPS estimates for FY19E (see Figure 2). Accordingly, we have trimmed our DCF-based PT to HKD8.7 (prev. HKD8.8). RM currently trades at 18.5x/12.9x PER on a calendarised EPS basis for FY18/19E. Reiterate BUY.

RM expects sportswear apparel will account for c.10% of total sales in the near future. One of the key parameters of RM’s pace of recovery that we are gauging is how fast it can expand and ramp up its apparel productionto driving up its operating leverage, which is crucial in driving profitability improvement. Revenue from apparel grew from 1% of its total in FY17 to 2.6% in 1H18 and management expects it to grow to c.10%, which we believe to be achievable by FY20E as Factory C in Vietnam will commence trial production after the Chinese New Year in Feb-CY18. Factory C has an annual production capacity of 30mn pieces of apparel, which is target for Uniqlo’s orders.

The Vietnam factory started to contribute to profit in 1H18, with more upside to come as operating efficiency is only two-third of its factory in Shenzhen. Meanwhile, since RM’s factory A in Vietnam has produced c.18mn pieces of bras & intimate wear YTD, we believe RM will be on track to meet its production capacity target of 40mn pieces by the end of FY18E. This suggests that there will be greater room for operating efficiency improvement in 2H18E.

Strong order growth momentum to continue in FY19E. Orders from L Brands (LB US, NR) recovered to a low-teen percentage YoY growth in 1H18E, and such momentum is expected to continue into FY19E. Based on the revenue breakdown geographically, sales from Japan jumped 5.7x YoY, accounting for 6.5% of total revenue in 1H18, versus only 1.5% in 1H17. We believe this was primarily attributable to Uniqlo, as it started to contribute in 1H18. Uniqlo has become RM’s second-largest customer in 1H18.

Maintain BUY, PT trimmed slightly to HKD8.7. We expect protracted recovery for FY18E but anticipate operating leverage to pick up substantially from FY19E. Accordingly, we have trimmed our DCF-based PT to HKD8.7 (prev. HKD8.8). Reiterate BUY.