Sheng Nuo 16's first-half results were lower than we expected because of the higher-than-expected cost of acquiring Dormeo and opening a US plant. The group is still in transition in fiscal year 16, and group profits are expected to rebound strongly when new US plants are fully put into production in fiscal year 17, boosting sales. We expect Sheng Nuo to continue to grab market share from US competitors. Re-buy, based on a price-to-earnings ratio of 10 times forecast earnings for fiscal 17, the target price was lowered to HK $0.94.
The acquisition of Dormeo and the opening of US plants have dragged down the performance as expected.
Shengnuo 16's first-half results were weaker than expected, with net profit down 58 per cent year-on-year to HK $40 million. Driven by export sales in the United States and Europe, earnings in the first half of 16 increased by 11% year-on-year to HK $1.534 billion. Gross profit margin shrank 1.2 percentage points year-on-year to 27.3%. Due to the consolidated accounting for the newly acquired subsidiary Dormeo for three months during the period, and the one-time cost of opening a plant in the United States, the ratio of operating expenses to revenue in the first half of the year rose 2.5 percentage points to 20.2% from 17.7% in the same period last year. Excluding the loss recorded by Dormeo and the one-time setup cost of the US plant, the adjusted net profit in the first half of 16 decreased by 16% year-on-year to HK $80 million, due to higher staff costs and sales expenses. The Group declared an interim dividend of HK0.6 cents per share (first half of 15: HK1.5 cents).
Us earnings are expected to accelerate
In Sheng Nuo's performance, investors mainly focused on when Dormeo will turn into a profit and the prospect of the export market. We expect Dormeo to continue to report losses in the second half of 16 and break even in FY17 with the increase in new products and strict cost control. With the deepening penetration of the beneficiary channels and the commissioning of the second phase of the US plant, we expect exports to be a major source of revenue growth from the beginning of fiscal year 17. During this period, we believe that Sheng Nuo is still in transition in the second half of 16, and the Group needs to: first, increase investment to increase its US market share; and second, implement cost controls to enable Dormeo to turn losses into profits. However, we believe that our main investment argument for Sheng Nuo remains the same, and when the new plant in Tennessee is fully operational in fiscal year 17, the Group has sufficient strength to seize market share from US competitors.
Re-buy with a target price of HK $0.94
We lowered Sheng Nuo's profit forecast for fiscal year 16-18 by 28% Murray 52%, mainly due to an increase in operating expenses forecast. However, we expect net profit in fiscal year 18 to rise 79% to 20% from the same period last year, driven by increased orders from new customers in the United States and the recovery potential of the retail business. Based on a price-to-earnings ratio of 10 times for fiscal 17, compared with a previous forecast of 10 times for fiscal 16, the target price was lowered from HK $1.1 to HK $0.94. The potential devaluation of the RMB and the rebound in oil prices are expected to further boost Sheng Nuo's earnings and profits. The main risks are the deterioration of the retail market in Hong Kong / China and the higher-than-expected cost of expansion in the US.