Important disclaimer: Maxwell International is a 7.2%- owned investee company of OSK Property PP10551/09/2011 (028936) Management which is a wholly-owned subsidiary of OSK Ventures International Berhad 14 Jun 2011

MALAYSIA EQUITY ` Investment Research


Trading Idea

The Research Team +60 (3) 9207 7688 [email protected] Maxwell International

A Stock That Deserves Better

The share price of Maxwell has languished alongside the rest of the M-chips since its BUY  listing in January this year. Despite general investor concerns the sector, Maxwell Fair Value 0.90 posted FY10 results that were in line with our IPO note forecasts, with revenue and Price 0.50 net profit rising 12% and 10% to RM335.9m and RM67.1m respectively. Having met CONSUMER our profit forecasts, we feel that Maxwell is trading at a ridiculously low PER of 3.0x, Maxwell International is an original equipment and see value in the company given its forecast double digit growth. A good manufacturing and original design investment idea for deep-value investors and generally a good trading idea for manufacturing company that designs and everyone else, we believe Maxwell deserves at least a FY11 PER of 5x, which gives manufactures sports . the stock an indicative fair value of RM0.90. Stock Statistics Bloomberg Ticker MAXWLL MK Different from its competitors. Listed in January 2011, Maxwell is a pure China based Share Capital (m) 400.0 original equipment manufacturing (OEM) and original design manufacturing (ODM) Market Cap 200.0 52 week H | L Price 0.62 0.46 company involved in the manufacture and design of sports and casual sports shoes for 3mth Avg Vol (000) 16.6 China’s domestic and export markets. Unlike its competitors, Maxwell does not need to YTD Returns N/A spend heavily on advertising and promotions and hence can channel more funds to design Beta (x) N/A and development (D&D). We believe that the OEM business is more resilient as the smaller Major Shareholders (%) orders from a weaker brand owner will be buffered by the higher volume of orders from a Li Kwai Chun 54.6 stronger brand. Moreover, brand owners which outsource their production to third parties OSKTV 7.2 usually own leading brands that are less susceptible to changes in consumer demand.

Double digit revenue growth to continue. Maxwell is in the midst of acquiring 4 new production lines to boost its annual production capacity to 16m pairs in 2HFY12. Share Performance (%) Riding on a strong sales force, the extra capacity is expected to benefit Maxwell as the Month Absolute Relative 1m -2.0 -2.3 company can serve a larger customer base and wield more control over the quality of its 3m -5.7 -8.7 products. We are forecasting for the group to achieve sales of RM375.6m and RM422.5m 6m N/A N/A 12m N/A N/A in FY11 and FY12 respectively.

5-month Share Price Performance Summer sales galore. As with most China-based Malaysian-listed companies, or

commonly known as M-chips, Maxwell is trading at a ridiculously cheap 3.0x PER. 0.58 Considering the current market PER of some 15x to 16x and Maxwell’s double-digit profit 0.56 growth, as well as factoring in the perceived risk of having its operations offshore in China,

0.54 we feel that there is significant value in the company just from the valuation viewpoint alone. We believe that Maxwell makes a good Trading Idea (not under our regular 0.52 coverage) and value the stock at a very conservative FY11 PER of 5x, which translates into 0.50 a FV of RM0.90. This extremely low price means that the company’s 3.35 sen dividend 0.48 payout for FY10 translates into a dividend yield of 6.7%, which is reasonable for this still Jan-11 Feb-11 Mar-11 Mar-11 Apr-11 May-11 growing company.

FYE Dec (RMm) FY08 FY09 FY10 FY11f FY12f Revenue 218.1 301.0 335.9 375.6 422.5 Net Profit 41.7 61.2 67.1 71.5 78.8 % chg y-o-y 66.0 46.9 9.5 6.6 10.2 Consensus EPS (sen) 10.4 15.3 16.8 17.9 19.7 DPS (sen) 3.4 3.6 3.9 Dividend yield (%) 6.7 7.2 7.9 ROE (%) 45.0 40.2 19.2 17.1 16.0 ROA (%) 28.1 31.6 17.3 15.6 14.6 PER (x) 4.8 3.3 3.0 2.8 2.5 BV/share (RM) 0.21 0.34 0.52 1.04 1.23 P/BV (x) 2.2 1.3 1.0 0.5 0.4

OSK Research | See important disclosures at the end of this report 1


Maxwell at a glance. Maxwell is a China-based OEM and ODM company involved in the manufacturing and designing of sports and casual sports shoes for China’s domestic and export markets. It manufactures leading brands such as Yonex, , , Brooks and . The group was founded in 1999 when Chun Hing Industrial Ltd, which is owned by the Chairman, Li Kwai Chun and her husband Li Chun Tak, set up Zhenxing Shoes in Zhushuxia Industrial Zone, Jinjiang City in China’s Fujian province. Through Mrs Li’s well established relationship with various footwear trading houses and brands distributors, Maxwell managed to secure sports shoe orders and started with a single production line and an annual production capacity of some 1m pairs of sports shoes. Today, with increasing orders as the group manufactures for more customers, its production capacity has swelled to 12.0m pairs (as of FY10).

Figure 1: Group structure



Zhenxing Shoes

Source: Prospectus

Figure 2: History

1999 Established Zhenxing Shoes Started with one production line with annual production capacity of circa 1m pairs of sports shoes Set up design and development department Secured contract to produce shoes for US sports brand Riddell 2000 Added 2nd production line to expand production capacity Secured contract for US Polo 2002 Secured contract with another US brand – Fubu 2005 Secured contracts with Japanese brands Mizuno and Yonex 2006 Added 3rd production line Secured contract with Kappa 2008 Became member under SATRA Attained ISO9001: 2000 status Added 4th production line Secured contracts with US and Italian sports brand Brooks and Diadora respectively 2009 Awarded Quanzhou Famous Trademark 2010 Secured contract with Italian brand Fila

Source: Prospectus

OSK Research | See important disclosures at the end of this report 2


OEM, a resilient business model. Although Maxwell has its brand, Sodeng, the group is putting this branding initiative on hold given the strong competition from established local brand names and to focus on OEM. While the original brand manufacturing (OBM) business usually commands higher margins and bargaining power owing to its integrated business model, we believe that the OEM business is more resilient than OBM since the smaller order volume from a weaker brand would be buffered by the higher orders from a stronger brand owner. Furthermore, brand owners which outsource their production to third parties are usually leading brand which are less susceptible to changes in consumer demand.

Figure 3: OEM and OBM brands

OEM brands Riddell US Polo Fubu Mizuno Yonex Kappa Brooks Diadora Fila

Own brand Sodeng

Source: Prospectus, OSK

Quality is the best policy. The ability to secure contracts from leading brands such as Yonex, Diadora, Kappa, Brooks and Fila is a testament to the quality of Maxwell’s products. In fact, Maxwell conducts quality checks on all the products manufactured and implements quality controls at every process. As Maxwell also outsources to third parties due to capacity constraints, to ensure the quality of its outsourced products, the group also sends its personnel to conduct on-site inspection on the appointed external contract manufacturers’ factories. As another step towards reinforcing its commitment towards continuous improvements and maintaining product quality, the group joined SATRA in March 2008. SATRA is the world’s leading research and technology centre and a leading authority on international legislation and testing, as well as the technical aspects of a wide range of consumer products. Its accreditation and awards program is widely used worldwide as a mark of commitment to high and consistent product and service quality.

Good product quality, strong D&D capabilities and timely delivery. While Maxwell does not sign long-term contracts, the group has established a track record and strong relationships with its customers. In FY09, some 53.2% of Maxwell’s sales came from repeat customers. This we believe is due to its consistent product quality, strong D&D capabilities and timely delivery, which have stood it in good stead to secure more OEM contracts from brand owners over the past few years. We also note that due to rigid outsourcing requirements in relation to product quality and the trustworthiness of OEM manufacturers, it is unlikely for customers to switch from one OEM to another without serious consideration. Having said that, the loss of a major customer would severely impact Maxwell given that its top 8 customers account for 43.8% of the group’s 1HFY10 sales.

Intensifying sales and marketing activities. Other than improving on basic communication tools such its website, Maxwell will expand its sales force to further beef up sales by penetrating new markets. To reach out to potential customers more effectively, the group also intends to participate in more transnational trade fairs such as the Harbin border trade fair and other international trade fairs in Russia and Europe.

OSK Research | See important disclosures at the end of this report 3

OSK Research Ramping up production capacity. Currently, Maxwell’s manufacturing facilities in Zhushuxia Industrial Zone in Jinjiang City has the capacity to produce up to 8m pairs of sports shoes per year. The group intends to acquire 4 new production lines to increase its annual production capacity to 16m pairs to cater for future demand. Apart from producing in-house where the utilization rate has not reached full capacity, the group also outsources some activities to third parties in order to free up capacity during the peak season. While the details of its development master plan to centralize production have yet to be finalized, Maxwell plans to build a new factory with an estimated production floor area of approximately 50,000 sq m at an estimated RMB75m. As the construction of the new plants would only be completed after 2QFY12, any substantial increase in sales would only be felt after FY12. However, as Maxwell may still benefit from the extra production capacity in 3Q and 4QFY12, our forecasts conservatively include this impact (we estimate that total output will increase by 7.44% from 12.1m to 13.0m pairs only).

Figure 4: Production capacity and utilization rate

FY09 FY10 FY11f FY12f (1) Production capacity (m pairs) 8 8 8 8 + 8 Output (m pairs) 6.2 6.2 6.2 6.2 + 1.5 Utilization rate (%) 77.3 78.0 77.5 77.5 / 48.1

Outsourced production 5.0 5.0 5.9 5.3 Total 11.2 11.2 12.1 13.0

(1) The effects of the increase in production due to the completion of the plant after 2QFY12 has been factored into the output production estimate

Source: OSK, Bloomberg

Raw material price spike will not significantly hit earnings. As Maxwell is an OEM player, it has been able to pass on higher costs to its customers without significantly impacting earnings. Also, most of Maxwell’s suppliers are primarily located close to its manufacturing facility. As there are many raw material suppliers based in Fujian, Maxwell does not rely on any particular supplier and hence is able to keep in check suppliers’ pricing power.

A potential corporate action? Maxwell’s net cash position swelled by some 160.7% from RM53.3m in FY09 to RM139.0m in FY10. In its quarterly report for 1QFY11, it had stated that its net cash strengthened further by RM36.9m to RM175.9m. This fortifies the group’s position to embark on acquisition exercises should the opportunity arise. On the other hand, given the company’s ownership of other manufacturing businesses in China, we believe that there is high possibility of an asset injection in the future.

OSK Research | See important disclosures at the end of this report 4


Good showing in FY10; results spot on with our forecasts. Maxwell’s FY10 results were almost spot on with our IPO earnings forecast, with only a small 2% deviation. For FY11, we raise the previous revenue forecast as per our IPO Note by 9.5% from RM343.0m to RM375.6m to account for an increase in average selling prices and sales. For FY12, we forecast revenue of RM422.5m, which conservatively factors in the benefits arising from the completion of the 4 new production lines as well as management’s confidence in securing contracts with new customers. From FY10 to date, management has raised the average selling prices of its products by more than 5%. Figure 5: Revenue (RM m) Figure 6: Net Profit (RM m)

450.0 422.5 90 78.8 400.0 375.6 80 71.5 335.9 350.0 70 67.1 301.0 61.2 300.0 60

250.0 50 218.1 41.7 200.0 40

150.0 30

100.0 20

50.0 10

0.0 0 2008 2009 2010 2011f 2012f 2008 2009 2010 2011f 2012f

Source : OSK, Prospectus Source : OSK, Prospectus

Figure 7: Revenue breakdown by Figure 8: Average selling price and geographic region production volume

100% 70.0 14.0 98% 60.0 12.0 96% 50.0 10.0 94% 40.0 8.0 92% 30.0 6.0 96.9% 96.0% 96.0% 90% 95.0% 20.0 4.0 92.0%

88% 10.0 2.0 Productionvolume(m) Average selling(RM) Averageprice 86% 0.0 0.0 FY08 FY09 FY10 FY11f FY12f FY08 FY09 FY10 FY11f FY12f

Domestic Asia America Europe Africa Average selling prices (RMB) Average selling prices (RM)

Production volume (m)

Source : OSK, Prospectus Source : OSK, Prospectus Sturdy margins. Maxwell commands strong margins, with gross profit margin hovering at 28.4%, 29.7% and 29.3% respectively from FY08 to FY10. The stable margins are mainly attributed to improving average selling prices, the introduction of new designs that command higher margins, greater economies of scale and efficient cost management. Although production cost is on the rise due to spiraling oil prices and labor costs, Maxwell has so far been able to pass on the cost to its customers. In tandem with the margin improvement in the past 4 years, its net profit CAGR remained strong at 54.0% from 2006 to 2010. We see Maxwell’s gross profit margin remaining strong at above 27% for FY11 and FY12. The slight decrease is attributable to an increase in sales, labour and raw material costs. We maintain our net profit forecast for FY11 of RM71.5m and expect its FY12 net profit to perk up by 10.2% to RM78.8m, including the contribution of the 4 new production lines after 2QFY11.

Robust balance sheet and strong cash flow. Maxwell has a strong balance sheet with net cash of RM53.3m and RM139.0m for FY09 and FY10 respectively. Its recent quarterly report for 1QFY11 stated that the company’s net cash position had strengthened to RM175.9m, translating into RM0.44 cash per share as at 31 March 2011. The quality earnings give Maxwell room for M&As as well as to distribute dividends.

Strong growth in the domestic region. By geographic region, the bulk of revenue is generated from the domestic China market. Management believes that the domestic market’s contribution to sales will be steady at above 96% for FY11 and FY12. This bodes well for Maxwell as it reduces the group’s exposure to foreign currency risk given the strengthening of the yuan.

OSK Research | See important disclosures at the end of this report 5


Highly dependent on executive directors and key management. The success of Maxwell’s business depends to a significant extent on the continuity of the services of its Executive Director and Chairman Li Kwan Chun, who is responsible for formulating and implementing growth, and her small management team. The company’s reliance on a small management team poses significant risks as any loss of their services will adversely affect the confidence of investors. Also, the fact that its Executive Director and Chairman own more than 54% of the company may limit the ability of minority shareholders to influence the outcome of corporate decisions requiring the approval of shareholders.

Reliance on recurring customers. One concern is that the company is reliant on recurring customers. Another is that Maxwell does not have any long-term contracts with its customers, which place purchase orders. Hence its ability to retain customers is essential to the continued success of the company.

Buyers’ bargaining power. The shoe industry is highly fragmented. There are approximately 3,000 shoe manufacturers in Jinjiang alone. This, together with the low barriers to entry for new players, means that should Maxwell be unable to compete or fail to adapt to the ever changing and competitive market environment, its business and financial health may be adversely affected.

High equity risk premium. Being a China company listed on Bursa Malaysia, the stock’s valuation is subject to a huge discount although the company’s fundamentals are strong. There is no assurance that this perception will change in the near future. This negative perception, should it persist, could adversely affect the share’s price performance in spite of Maxwell’s compelling growth story.

OSK Research | See important disclosures at the end of this report 6


Undervalued, with potential upside. As with the other China-based companies listed in Malaysia (M- chips), Maxwell’s share price has languished since its listing, having fallen by 6.48% from 5 Jan 2011. The stock is currently trading at a PER of 3.0x, which is the mid range of the other China-based shoe companies. Given the current market PER of 15x – 16x and the fact that the shares of small cap companies have enjoyed a good run-up so far this year, we find the pricing of Maxwell and other M-chips unrealistically cheap, which make them good candidates for eventual privatization. In view of the company’s double digit profit growth forecast for the next few years, we are applying a conservative FY11 5x PER to derive a fair value of RM0.90. With an almost 80% upside, Maxwell is a sound investment idea for investors looking for deep value and a good trading idea for others as well. In addition, stripping out the net cash per share of RM0.44, the company is trading at an extremely low PER of 0.36x, which is undeniably a very good bargain.

Commendable dividend payout. In line with its intention to distribute dividends, Maxwell has declared its first and final single tier dividend of 3.35 sen per ordinary share for FY10. The proposed dividend will be subject to shareholder approval at the company’s forthcoming second AGM. This translates into a yield of 6.7%, which is commendable compared to its peers listed on Bursa Malaysia. The management is expected to continue paying dividends of no less than 20% in the future. Apart from its cheaper valuation vis-à-vis its peers, Maxwell’s dividend yield is also more appealing.

Figure 9: Maxwell and peers’ revenue, net profit and PE ratio for FY10 Company Revenue Net profit Cash per share DPS PE (X)(1) (RM m) (RM m) (as at latest (sen) financial results) Maxwell 335.9 65.1 0.44 3.35 3.00 Xinquan 1,274.9 216.6 0.54 2.5 3.47 Xidelang 465.1 77.9 0.18(2) 1.0 2.78 Multi Sports 291.8 66.1 0.30 2.5 2.96 K-Star 319.1 42.0 0.37 1.6 2.30

(1) Data as of 24 May 2011 (2) Data as of 31 Dec 2010 (results for 1QFY11 has not been released) Source : OSK, Bloomberg

OSK Research | See important disclosures at the end of this report 7


FYE Dec (RMm) FY08 FY09 FY10 FY11f FY12f Turnover 218.1 301.0 335.9 375.6 422.5 EBIT 56.4 82.7 90.5 95.3 105.1 PBT 55.9 82.3 90.1 95.3 105.1 Net Profit 41.7 61.2 67.1 71.5 78.8 EPS (sen) 10.4 15.3 16.8 17.9 19.7 DPS (sen) 3.4 3.6 3.9

Margin EBIT (%) 25.9 27.5 26.9 25.4 24.9 PBT (%) 25.7 27.3 26.8 25.4 24.9 Net Profit (%) 19.1 20.3 20.0 19.0 18.7

ROE (%) 45.0 40.2 19.2 17.1 16.0 ROA (%) 28.1 31.6 17.3 15.6 14.6

Balance Sheet Fixed Assets 33.0 31.4 29.4 28.6 29.6 Current Assets 112.6 160.2 356.5 428.7 507.6 Total Assets 148.0 193.9 388.3 459.9 539.7 Current Liabilities 55.4 41.5 38.3 41.9 46.8 Net Current Assets 92.7 152.4 350.1 418.0 492.9 LT Liabilities 0.0 0.0 0.0 0.0 0.0 Shareholders Funds 92.7 152.4 350.1 418.0 492.9 Net Gearing (%) Net cash Net cash Net cash Net cash Net cash

OSK Research | See important disclosures at the end of this report 8

OSK Research

OSK Research Guide to Investment Ratings Buy: Share price may exceed 10% over the next 12 months Trading Buy: Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain Neutral: Share price may fall within the range of +/- 10% over the next 12 months Take Profit: Target price has been attained. to accumulate at lower levels Sell: Share price may fall by more than 10% over the next 12 months Not Rated (NR): Stock is not within regular research coverage

All research is based on material compiled from data considered to be reliable at the time of writing. However, information and opinions expressed will be subject to change at short notice, and no part of this report is to be construed as an offer or solicitation of an offer to transact any securities or financial instruments whether referred to herein or otherwise. We do not accept any liability directly or indirectly that may arise from investment decision-making based on this report. The company, its directors, officers, employees and/or connected persons may periodically hold an interest and/or underwriting commitments in the securities mentioned.

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