CSCI-Textile OEM-Textile Texhong (2678 HK)：A better margin outlook in 2018 - 20180109

A better margin outlook in 2018

• Though we do not expect much to cheer about for its upcoming FY17 core results in Mar-18, we see an improving GPM outlook for 2018.
• The YoY growth rate of the China Cotton 328 Index (CC328 Index) has slowed down to merely 9% in 4Q17 from 10.4% in 3Q17. Meanwhile, the spread between the YoY changes in the CC328 Index and the China Polyester Yarn Index has widened to -25.1% in 4Q17 from -19.0% in 3Q17. Lower raw material input costs together with rising polyester yarn ASP suggest a more favourable margin outlook for yarn producers.
• We expect Texhong to turn a corner in 2018, with improvement in GPM and maiden contribution from its downstream garment segment. Accordingly, we have revised up our EPS estimates by 1.8% for both FY18E and FY19E after adjusting upwards the respective GPM estimates by 0.1%. Hence, we have our upped our PT to HKD13.2 (prev. HKD9.5), still based on 8.2x PER (1-yr fwd historical PER average), rolling over to FY18E. Upgrade to BUY from Hold.

Better margin outlook for synthetic & polyester yarn producers for 2018. We gauge the spread between the changes in cotton prices versus yarn prices as a benchmark for evaluating Texhong’s margins. Since 3Q17, the China Polyester Yarn Index has increased much faster than the CC328 Index, a reversal from the trend in 1H17. The spread between the CC328 Index and China Polyester Yarn Index has widened to -25.1% in 4Q17 from -19.0% in 3Q17. On the contrary, the cotton yarn price seems to be more subdued, as the China Cotton Yarn Index has actually declined 0.5% YoY in 4Q17 from a mild increase of 2.8% YoY in 3Q17. This compares with a 1.9% YoY increase for the CC328 Index in 4Q17 and 10.4% rise in 3Q17 (see Figure 3). In 1H17, cotton yarns accounted for c.49% of Texhong’s total yarn sales volume, whereas synthetic yarns accounted for 17% and denim c.34%.

Downstream contribution starts to kick-in. Texhong completed the acquisition of Nien Hsing Textile in May last year. After consolidating the 12 production lines with its existing facilities in Cambodia, the company’s total number of production lines has reached 22 with a 14mn pairs of jeans production capacity annually. Texhong expects to achieve breakeven in 2018. Moreover, we anticipate the garment JV with Hualida will be an upside catalyst going forward.

Attractive valuation. We expect Texhong to turn a corner in 2018, with improvement in GPM and maiden contribution from its downstream garment segment. We have revised up our EPS estimates by 1.8% for both FY18E and FY19E after adjusting upwards the respective GPM estimates by 0.1%. Hence, we have upped our PT to HKD13.2 (prev. HKD9.5), still based on 8.2x PER (1-yr fwd historical PER average), rolling over to FY18E. Upgrade to BUY from Hold. Texhong currently trades at FY17E/FY18E PER of 8.7x/6.9x, the lowest among its peers (see Figure 5).