Fuxing China (“Fuxing”) piques my interest as analysts have ascribed an average target price of $0.27. This represents a whopping 69% potential upside (from its last close price of $0.16 on 4 Nov 2010). Dividend yield is around 4.3%. Below is a summary of Fuxing:
Description of Fuxing China
Fuxing is located in Jinjiang City and commands an estimated 4% market share in the PRC zipper industry, lagging behind the industry leader Fujian SBS with a 5% market share. Except for the colour dyeing process in zipper chains and electro-plating process in zipper sliders, Fuxing is a vertically integrated zipper manufacturer and the 2nd largest in the PRC.
Fuxing’s clientele includes manufacturers of apparel and footwear products (such as Peak, Anta), camping equipment, bags and luggages (such as Samsonite), upholstery and furnishings, trading companies as well as other zipper manufacturers in the PRC and overseas markets.
a) Improving utilization rates in 3Q, up another 40-50% from 2QFY10
According to NRA Capital, 2QFY10 average utilization rate climbed to 58% from 42% in 1QFY10. Lim & Tan mentioned that utilization rates in 3QFY10 are likely to be up another 40-50% from 2QFY10. Conservatively speaking, average utilization rates in 3QFY10 should be around 80%. This should bode very well for Fuxing’s 3Q results. If utilization rates can maintain at this level, FY10 results should also be very strong.
b) Turnaround in Shanghai and Qingdao operations in FY11
According to DMG, management hopes to turn around its Shanghai and Qingdao operations on a gross profit level on a monthly basis by end of 2010. These operations were set up to target foreign brand customers who are still using YKK zippers, a market leader with an estimated 70-80% market share in high end zipper product). To put into perspective, Qingdao facility generates a RMB5M loss in 1HFY10 out of Fuxing’s 1HFY10 net profit of around RMB25.9M.
It is also noteworthy that losses in Shanghai and Qingdao operations cannot be offset against Fujian-based profit for tax purposes, resulting in effective tax rates of >30%.
Thus, if company manages to turn around both Shanghai and Qingdao operations, it should have some meaningful contribution to FY11 net profit.
c) Super durable zipper (“SDZ”) – the next growth driver
Management indicated that SDZ can be produced at a lower cost than metal zippers and with a longer product life. SDZ also commands higher gross margin of >40%. Company targets to increase the production capacity by 10% by acquiring 100 sets of machinery (to produce SDZ) by year end. This should start to contribute in FY11 with more significant contribution in FY12.
d) Backed by $0.14 of cash
One of the most attractive aspects of Fuxing is its significant cash pile. As of end June, it has a net cash of RMB600M which represents about $0.14 per share. This means that if I were to invest in the company at current price of $0.16, I will be paying $0.02 for its business which generates earnings and $0.14 for its cash. Based on this aspect, it does not seem to be expensive.
e) Trading at 0.6x P/BV
As at end Jun 10, Fuxing’s net asset value per share stood at approximately $0.25. Thus, Fuxing is trading below its net asset value which limits the potential downside.
a) Contribution from SDZ still unknown
Although management is optimistic on the prospects of SDZ, it has not produced significant results on this segment yet. Thus, I do not have a concrete idea on how much contribution this will add to its FY11 results. Furthermore, as Fuxing is the first to introduce this product in China, it requires customer trial and acceptance before mass production can begin next year.
b) Cash pile – drag on ROE
Fuxing’s significant cash pile drags down its performance as cash generates very little returns. Nevertheless, management has outlined some uses for its cash, viz. i) Capital expenditure – to increase production capacity in view of potentially higher orders ; ii) Acquisition – may acquire companies with both dyeing and electro-plating capabilities so as to be a fully integrated zipper manufacturer; iii) Share buybacks and dividend distribution of not less than 40% of its net profit.
c) Margins may be pressured due to rising labour cost
Management indicated that the Group is still facing a tight labour supply, despite hiking wage rates for its workers. This is likely to have a downward pressure on its margins.
Conclusion – KIV list
If management succeeds in generating strong sales for SDZ, then company is likely to generate some good returns in the next few years. Till then, this is a good company to keep in view and perhaps to punt on its results release on 9 Nov. Results should be strong due to improving utilization rates and a low base in FY3Q09.
This writeup is an amended version of the original writeup which was sent to clients over the weekend.