Thursday, July 29, 2010

First Look: XingQuan International Sports Holdings Limited

Puuh...that's a long name. This is my first ever look at the China's related company listed here which have never caught my interest before. One just have to be skeptical to them for few very good reasons:

  1. They are either IPOs or just listed for a year or so. Chances are they might cook the their earnings
  2. Why of all places they pick Malaysia when listings Hong Kong or Singapore generally tend to get better valuation (higher PE)
  3. Chinese companies are known for fraudulent accounting


And I have no answer to any of this question. So it is Unrated. But it is hard to ignore the cheap valuation they are getting: XingQuan (PE 4.62) and Multi Sports (PE 1.92) as the time of writing. XiDeLang is just listed, so I don't have much interest on this one. Sinotop is what we called back door listing, so I'm even more skeptical on them. Multi Sports is pretty much covered ahYap's Blog, so I'll turn my attention to XingQuan who looks to me have a little more history.

If you read The Edge cover story a year back (You can still find it on Google), this business started with initial capital RM255 producing 20 pairs of shoes in the early days.  Then blah blah blah..it has grown to what it is today, listed in KLSE and pretty sizable for Malaysian market as well. XingQuan's factory is located in the province of JinJiang who according to Mr Wu Qing Quan a "City of Shoes" in China which is also known for its sweatshop factory condition. Then the listing story goes blah blah blah...but one thing to take notice though "SC and Bursa have offered some incentives to Xingquan to expedite its listing here" ....."They (SC) had also undertaken to approve our IPO within one month". Okay listing incentives is normal for foreign firms to list here but I'm not quite sure about the one month approval. Sound like confirm approve to me.

Products
They make shoe soles, outdoor/indoor sports and leisure shoes as well as apparels. They started as OEM manufacturer and within 5 years they begins manufacturing for FILA, Spalding and Prince before establishing their very own brand Addnice. Did I say about brand name that doesn't work. Imagine, "Check out my new Nike shoes" or "my new Adidas", my new Addnice? Erm...Adidas + Nike = Addnice? Anyway, most their products are currently marketed in China. I never been to China to check out one of this AddNike, but I presume quality wise they are up to standard considering they're making shoe soles to the likes of FILA, Spalding and Prince. 



Fundamentals
Let's compare XingQuan's fundamental versus their almost direct competitors Multi Sports and against the likes of Nike, Adidas and Li Ning. A look at the sales and earnings growth the Chinese companies do look to live up to their "explosive" reputation. All three of them manage not just double digits growth over the last 4 years but are above 30% while Nike only manages a single digit growth despite its exposure to China's market and Adidas....dismal.



Brand name does seem to play a part on the gross profit margin where all three well-known brands manage higher margin as compare to those two. However when it comes to net profit margin, the little XingQuan and Multi Sports go back to the top by having more than 20% margin over the years. I would guess the "Big Three" despite having a better brand, they are using a lots of money to promote their brand (except for Adidas which seems to have management problem). Another reason why XingQuan has a stronger net operating income ratio is because it has better cost management through its integrated model where 




On the balance sheet, Nike prove to be stronger and more prudent over the years where it gets more than 1 on the super stress test (Current Asset - Inventories - Receivables: Current Liabilities). However, product based companies like these have wider diversification so it is unlikely they'll have too much trouble collecting most of their receivables. In this case, XingQuan has an >1 ratio an even in the Super Stress it is close to 1 in FY2009. So liquidity wise they look okay to me.   



I would have thought all these half sport half fashion company could struggle to turn their inventories into sales especially the lesser brand ones. But I am proven wrong. They turn out better than expected. Both XingQuan inventories turnover take roughly a month and Multi Sport could do it in less than a month where as the Big Three take roughly a month or two. I am guessing their OEM business makes them able to manage their inventories better and whatever they produced would go straight to their customer. That's the reason why we could see Multi Sport takes shorter time than XingQuan because the latter have the brand and products of their own while the Big Three who fully owns their product takes even longer. 

On receivables turnover, if we were to take these 5 as industry standard, XingQuan does look slower than industry average and high on receivables. It is not particularly worrying but it does raise a little bit of concern. They are few reasons that might have contribute to XingQuan quick inventory turnover 1) bi-annual sales 2) they don't operate any retail store. I'm not sure how they are able to do by annual sales without operating a store but what I know is, if they don't do retailing, they don't have the problem of inventories pile up. They just past it to the retailers. 



So all in all, financial wise, Xing Quan is okay. From its gross profit ratio, its management has prove pretty resilience considering they have not just maintain the profit ratio but increase it as well in FY08 when raw material prices hit historical high that time (XingQuan FY ends in June). But all these figures are pre-listing figures except for FY09. Are these a fraud? I'm afraid I can't answer that..




Fraud aside, there is one thing I like about this kind of apparels businesses is that they are able to increase the price without people noticing it. XingQuan annual report tells you why – by introducing new models or range. It is still limited however by the strength of its own and other brand. Targeting only the middle class would not be feasible in the long run, so to break free from this, it has to make its brand to be at least among the Big Boys and there couldn’t be any better opportunity than now. Adinice is not as big as Li Ning yet, but it could leverage on current economic boom in China. Assuming their chairman statement is correct “this segment of middle class is expected to increase to 700 million by 2020”, it’ll not provide both long term and short term growth potential to the industry but also buy time for XingQuan to build a bigger brand name maybe.

So far on its report, it looks to have progress well capturing the middle class market and seems getting more appealing. I've never been to China to check this brand out. So....I'm not sure. 

Their OEM business - not so good. Why? Competition and low barrier of entry. From Multi Sports IPO prospectus, there is an estimated 3000 shoes manufacturer in Jin Jiang. THAT IS 3000! If 10% of them are making shoe soles, that'll be 300. I guess the reason they've not cannibalized each other is because of the current China's market demand. You can see from many reports. It's massive. So it is just a matter of time before that eventually happen. So it'll be interesting to see how XingQuan stands out. 

XingQuan is also tapping into outdoor sports segment competing against the likes of Timberland and Columbia. Perhaps I should do the comparison against them one day. This is a less crowded market but I'm not sure about the size. Despite having the ability to increase the price invincibly, apparels business also has its own problem - fashion and trend. They have to increasingly monitor the current as well as upcoming industrial trend. A miss gives a season of bad sales or worst brand damaging. One thing good however, the market they are targeting is not as headache as the women fashion one. 

The current shoe soles production is already fully utilized at 100%. Although shoe production is not fully utilized, it is limited by by its fully utilized shoe soles factory. So any future sales growth will have to wait for the new factories to operate which is expected to complete by 2011. However, they could still use the existing shoe soles if they ever store any in the inventory. 

All in all, XingQuan has a lot of growth potential not only on the short term but also the longer term. Will I buy into the business now? No - for now. There are still more to look at especially most figures are pre-listing figures. Nevertheless, this company is worth a closer look. I think I'll wait for it to operate for at least couple of years or so before placing it into The List. 

This comment is based on my personal thoughts, opinions and my risk tolerance. It should not be considered as an investment advise. Please consult your financial advisor or do some research of your own before making any decision. You might have your own thoughts. I would love to here from you. You can always place your comments here and or email me privately at luzeeker@gmail.com


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