Morning Bulletin from Kim Eng dated 21 July 2008 

1. China Hongxing – Company Update (Pauline Lee, DID: 64321453)

Previous Day Closing price: $0.49

Recommendation: BUY (maintained)

Target price: $0.87 (maintained)

Grass is greener at home

The group’s leading domestic franchise in the PRC will mitigate external shocks. Retail sales in China jumped by 23% Y/Y in June, reflecting the still buoyant domestic consumption. CHHS has an extensive distribution network of 3440 point of sales (POS) as at 1Q08, trailing behind Li Ning (5676 POS) and Anta (4716 POS) which are more than double its size in terms of market capitalisation. CHHS’s brand ‘Erke’ is gaining traction and is ranked 139th out of 500 top brands in the PRC at the fifth world brand summit, with an estimated brand value of RMB5.3bn.

Strong cashflow position assures smooth business expansion

The group’s strong net cash position of RMB2.6bn or S$0.19 per share will facilitate its expansion plans. Its placement of 400m new shares in November 2007 raised approximately RMB2.3bn, and will be mainly used for the expansion of its sales and distribution network and for advertising and promotional activities. The rental loans given to distributors for the mid-size stores are being repaid according to schedule with no signs of default.

Gross margin to see short-term weakness

While raw material costs are rising (approximately by 5-10% Y/Y), the group is confident about improving gross margin through better product mix, economies of scale (vis-a-vis in-house production), and rising ASPs along with new footwear/apparel designs. However, gross margin in FY08 is likely to stay flat at around 41% due to the product discount program which will last till 1Q09. The group is confident of reverting to a 2%-point annual increase in gross margin by FY09.

Same-store sales growth in the pink of health

According to the management, same-store sales have been growing faster than the targeted growth rate of 15% Y/Y. The group expects to add at least 600 new stores a year in 2008 and 2009. Each new mid-size store typically takes 6 months to operate at a normalized sales level and progress has been encouraging so far.

Shoes for sale!