First Shanghai: “Buy” rating for Chaoying International

Chaoying International (2111, BUY): revenue growth slows, gross profit drags down 2017 results

Revenue growth of 13.2%, gross profit margins drastically dragged down the results for the financial year ended December 31, 2017, the company recorded revenue of 2.79 billion Hong Kong dollars, an increase of 13.2%. Among the various categories, sports fabric segment revenue increased by 74.9% year-on-year to HK$797 million, while underwear fabrics and lace shipments were affected by weak demand in the underwear market, which recorded a decline of 9.3% and 22,2% respectively, offset by some extent. The increase in revenue; flexible ribbon revenue recorded HK$942 million, an increase of 13.1% year-on-year. During the period, gross profit recorded HK$772 million, down 6.7 percentage points to 27.6%, mainly due to the increase in production expenses due to capacity expansion and the increase in production costs due to strict environmental protection requirements. In addition, the exchange loss caused by the appreciation of the renminbi and the increase in sales expenses reduced the company's net profit to HK$304 million, down 33.5% year-on-year.

Capacity expansion is too fast, entering the capacity digestion period. With the expansion of the Dongguan Phase VI plant and the Vietnam overseas plant production in the third quarter of 2017, the company's annual design capacity of elastic fabrics, elastic webbing and lace reached 110 million meters and 1.669 billion meters respectively. And 24.6 million meters. The rapid expansion of domestic production capacity in the environment of weak underwear demand has caused a big drag on the overall gross profit of the company. In 2018, the company will actively strive for orders and gradually digest excess capacity.

Cooperation with downstream customers to establish JV, long-term profitable company to develop downstream customers. In early December 2017, they signed two joint venture agreements with Brandix and MAS to jointly develop and produce apparel fabrics and establish strategic partnerships. Brandix and MAS are currently the company's major customers, both of which are South Asia's largest exporters of ready-to-wear garments, each with a world-renowned apparel brand customer base. The establishment of JV with the two companies will strategically consolidate the company's fabric supply status, and also shorten delivery time and cost savings, and enhance the company's market competitiveness.

Adjusted the target price of HK$4.92. We bought the rating. We adjusted the company's expansion expectations. At the same time, we adjusted the recent changes in gross profit margin and adjusted the model to adjust the target price to HK$4.92. The target price and the recent closing price have a 19.4% upside. Maintain a BUY rating for 14.6x PE for 2018 forecasted earnings.

The risk indicates that the order growth rate is less than expected; the Vietnam factory climbs for too long; the gross profit margin rises less than expected; the newly established joint venture company squeezes the original market share.