EUR 850.00 For Business Accounts Only

Morningstar | Strong Sportswear Sales Bode Well For Shenzhou; FVE Lifted to HKD 76, Shares Remain Overvalued

We are impressed with how strong global demand for sportswear has been in 2018. Solid results coming out of Nike and Adidas will translate into higher order volume for tier one suppliers like Shenzhou. Thus, we are raising the valuation of narrow-moat Shenzhou International to HKD 76 from HKD 68 per share for stronger near-term sales volume growth. Even with the increase in our fair value estimate, shares of Shenzhou still appear fundamentally overvalued to us.

While we continue to like Shenzhou's competitive positioning and believe it should generate excess returns over its weighted average cost of capital, or WACC, over the next 15 years, we also think the market is currently being overly optimistic in the company's long-term prospects. The labor-intensive nature of garment production means plants must consistently be moved to low labor cost countries. As Chinese wages rose over the past years, Shenzhou has opened new factories in lower-cost countries such as Vietnam and Cambodia. While Shenzhou will most likely be able to leverage its entrenched relationships with apparel giants and its solid track record in reliability on many fronts to consistently generate above-WACC returns wherever they move, we are seeing several sportswear retailers starting to explore automation technology in manufacturing.

New technologies in areas such as automation and 3D printing will drastically reduce the labor component of garment manufacturing and ensure production stays close to customers. By producing onshore/nearshore, brands can drastically reduce supply chain lead times and react quickly to consumer demands. Our 7% midcycle sales growth assumption reflects what we believe the business will do on a normalized and sustainable level, given the improvement in automation technology moving some production volume back to developed countries like the U.S.