CSCI-Textile OEM-Shenzhou International (2313 HK)：Increasingly a cash cow, solid growth intact - 20180123

Increasingly a cash cow, solid growth intact

• We believe Shenzhou (SZ) will enter into a golden harvest period in the coming years, as its fabrics plant in Vietnam gradually builds up, while further expansion of the garment plants would require minimal capex. We see SZ turning into a cash cow.
• Solid growth remains intact for 2018, as initial customer orders indicate a DD percentage YoY growth, with majority of the upside to come from the casual wear segment.
• For the upcoming FY17E results, we expect upside surprises from below the line items, while GPM will still be under slight pressure. Accordingly, we have fine-tuned our EPS estimates for FY17/18E by -1.7% and -0.1% respectively (see Figure 1). Meanwhile, we have revised up our PT to HKD94.2 (prev. HKD72.4), after changing our valuation basis to DCF from PEG, as we believe it is a better method to value SZ’s long-term value, on the belief that it is turning into a cash cow. Our PT represents 25x PER for FY18E. 

Entering into a golden harvest period. Given the gradual build-up of SZ’s Vietnam special fabric and garment project from 2014-2016, we believe SZ has already passed its peak investment period, with annual capex anticipated to return to a normalised level of c.RMB1bn in FY18-FY20E, versus c.RMB2bn in FY16. Further expansion of its garment plant would require limited capex. We estimate SZ’s operating cash inflow to come in at >RMB4bn p.a. in FY17-19E, while capex will drop, effective tax rate will be reduced subsequent to growing profit contribution from Vietnam and interest expenses to decline with the full conversion of its CB last Sept. We expect SZ to generate an average FCF of >RMB3.5bn p.a. for FY17-19E, which makes it especially favourable during the interest rate reflation cycle. We also expect SZ will likely raise its dividend payout going forward from the current level of c.60%.

Order outlook remains strong in 2018, especially casualwear. Management has provided more clarity on the YoY sales order growth outlook for 2018, with NIKE expected to rise 20%, Uniqlo +15%, Adidas +10% and Puma flat, versus +30%/+8%/+10%/+37.7% in our estimates for FY17E respectively. ASP is expected to grow at a LSD percentage YoY, from product and material upgrades.

What lies ahead in 2018? We expect raw material cost to be a major challenge for SZ in 2018, as synthetic and polyester yarn prices in China had risen by a DD percentage in 2H17, given the rebound in the global crude oil price. Whereas, FX challenges will be minimal as RMB should remain rather stable in 2018. On the positive side, SZ will continue to reap benefits from production automation, lower operating costs and tax savings from its Vietnam plant.

Valuation and earnings revision. Accordingly, we have just fine-tuned our EPS estimates for FY17/18E by -1.7% and -0.1% respectively (see Figure 1). Meanwhile, we have revised up our PT to HKD94.2 (prev. HKD72.4), after changing our valuation basis to DCF from PEG. Our PT represents 25x PER for FY18E.