Maxwell, First IPO for 2011 Written by Insider Asia 05 January 2011
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Maxwell, first IPO for 2011 Written by Insider Asia 05 January 2011 China-based sports footwear designer and manufacturer, Maxwell International Holdings is slated to be the first initial public offering (IPO) listing on Bursa Malaysia this year. The stock will make its debut on the local bourse tomorrow. A slightly different shoe manufacturer Maxwell is the seventh China-based company to be listed on the local bourse and the fifth that is related to the footwear industry. As with its peers, Maxwell’s factory is located in Jinjiang, Fujian province, which is the footwear hub for China. The industry is extremely fragmented and highly competitive. Statistics indicate at least 3,000 shoe manufacturers in the vicinity ranging from small- scale cottage industries to large-scale automated production lines. However, Maxwell differs slightly in that it focuses on the OEM (original equipment manufacturer) and ODM (original design manufacturer) segments of the sports shoe market. Its products are primarily court sports shoes (for soccer, tennis, skateboarding, basketball, badminton, baseball) and casual sports shoes (boots, shoes for children, hiking, retro and leather). As an OEM, the company manufactures sports shoes according to the specifications and designs provided by customers. Should it be required to, it can also design, develop and manufacture products for its customers (ODM). Maxwell counts well-known global brand names such as Yonex, Diadora, Kappa, Brooks and FILA as its end- customers although the company deals primarily with trading houses and brand distributors that represent these brands. By contrast, K-Star Sports, XiDeLang and Xingquan International are primarily own brand manufacturers (OBM) — that is their products are marketed and sold under proprietary brand names and distribution networks. For instance, K-Star Sports’ footwear is sold under the “K- Star” and “Dixing” brands via almost 850 retail outlets in China. The company recently expanded its product range to include apparels under these brand names. Whilst it does undertake OEM and ODM — for international sports brands such as Umbro, Diadora, Kappa, Le Coq Sportif as well as homegrown brands like Double Star — this segment of the business accounts for just about 23% of total revenue. Similarly, Xingquan markets its products (shoes, apparels and soles) under the brand name “Addnice” that are distributed through more than 2,000 retail outlets across the country. It does some OEM for international and local brands such as Xtep, China Peak, FILA, Spalding and Lotto, but these make up little over 5% of its revenue in 2009. XiDeLang, meanwhile, is a pure OBM. Its “XiDeLang” products (shoes accounted for roughly 65% of sales while apparels and accessories make up the balance) are distributed through 2,481 retail outlets at end-2009. One other China-based footwear company, Multi Sports Holdings manufactures only shoe soles and is thus, not directly comparable with Maxwell’s operations. Pros and cons of OEM/ODM Product differentiation through the creation of proprietary brand names usually allows companies to earn better margins compared to the contract manufacturing business, which is highly competitive. On the other hand, focusing on OEM-ODM means Maxwell does not have to spend on building and marketing its own brand name, which carries a certain degree of risk. In particular, as China opens up to the rest of the world, rapid growth and rising per capita income is expected to translate into greater competition from global brands like Nike and Adidas. Indeed, with a more diversified product range and clientele, Maxwell’s earnings may well be more resilient than an OBM operating in a fickle consumer market. Interestingly, Maxwell has managed to achieve slightly better net profit margins, on average, than its listed peers over the past few years. The company typically prices its contracts on a cost plus basis, which would buffer it against rising costs. This means Maxwell will be better positioned to protect its margins compared with OBM, which may have to partially absorb higher costs to maintain market share. Once an order and pricing has been confirmed, Maxwell will source for raw materials from the numerous suppliers from within the city. As such, it does not need to carry much inventory, which reduces working capital requirements and perhaps more importantly, the risks of obsolescence and stock writeoffs. Nevertheless, we do not rule out the possibility of gradual margins erosion. As mentioned above, the OEM business is highly competitive and has relatively low barriers to entry. Earnings sustainability is dependent on the company’s ability to retain existing customers, which is often a function of its relationship with clients, and secure new ones. This could mean greater business volatility. For instance, Maxwell operates on a per order basis. There are no long-term contracts. Maxwell has established track record Positively, Maxwell has a good track record and relationship with key clients. Revenue grew at an annual compounded rate of almost 54% between 2006 and 2009 — increasing from 160 million yuan to 584 million yuan. Roughly 53% of revenue in 1H2010 was derived from repeat customers. Volume sales increased from four million pairs of shoes to 11 million pairs over the same period. This is more than the company’s total production capacity of eight million pairs as Maxwell outsources some of its orders to smaller contract manufacturers. Outsourcing allows it greater flexibility in coping with surges in orders while limiting the downside risks — in terms of fixed overheads and salaries — on unexpected demand drops. Margins for both in-house production and outsource are about the same. The company intends to use part of its IPO proceeds to expand production capacity — to 16 million shoe pairs — as well as bolster its design and development unit. The latter, at present, churns out over 1,000 shoe designs annually, roughly 80% of which end up in commercial production. With additional computer software equipment and staffing, Maxwell can ramp this up to 1,500 designs per annum. IPO priced at 3.4x estimated 2011 earnings with net yield estimated at 5.9% Net profit expanded from 25.9 million yuan in 2006 to 118.7 million yuan in 2009. Earnings totalled 62 million yuan in 1H2010. We estimate net profit to total roughly 127 million yuan for 2010 and increasing to 136 million yuan this year — equivalent to roughly RM59 million and RM63 million for the two years at the prevailing exchange rate of 1RM=2.14 yuan. Thus, at the IPO price of 54 sen per share, the stock is being priced at P/E multiples of 3.6 and 3.4 times for 2010-2011. In addition, Maxwell expects a minimum 20% dividend payout, which translates into roughly 3.2 sen per share for the current financial year. That will earn shareholders a fairly attractive net yield of 5.9% based on the IPO price. Negative vibes for China-based company listings It is understandable for investors to be wary of China-based companies listed on the local bourse. Shares of K-Star Sports, Xingquan, XiDeLang and Multi Sports have not fared well since their debut, currently trading 22%-41% below their IPO prices. Investor confidence was affected, in part, by the selling down by some pre-IPO investors, for the earlier listings. Even though a six-month moratorium was subsequently imposed on K-Star Sports, it did not prevent its share price from falling sharply after the moratorium period. Investor perception of the quality of these companies was also hurt by accounting irregularities involving some China-based companies listed in Singapore. Furthermore, with their operations based on unfamiliar foreign soil, it is difficult for local investors to “see” for themselves how brand names like XiDeLang and Addnice are faring in the market terms of consumer demand, preferences and brand loyalty. Will time change investors’ perception? As a result, these footwear stocks are currently trading at well below market average valuations — ranging between 2.4 and 3.7 times forward earnings. Ironically, most of these companies have not done badly, earnings-wise. For example, K-Star Sports’ revenue and net profit were both up 14% in 2009. Although earnings dropped 14% year-on-year (y-o-y) in 1H2010, business picked up momentum in 3Q2010, with net profit growing 27% y-o-y. At this pace, earnings growth for the full year should remain in the black, albeit slower than that in the previous few years. Meanwhile, Xingquan reported solid 23% and 17% revenue and net profit growth, respectively in 1QFYJune 2011 over the previous corresponding period. This followed a 21% earnings growth in FY2010 on the back of 51% expansion in topline sales. Perhaps given more time for the companies to prove their underlying fundamentals, investors may become more confident in picking up these stocks. With valuations this low, a re-rating would offer pretty smart returns. This article appeared in The Edge Financial Daily, January 5, 2011. .