Sheng Nuo Group is a leading manufacturer and retailer of memory sponge bedding. We cover it for the first time and give it a buy rating with a target price of HK $1.1 (up 29%). The company's retail business faces resistance in the short term, but thanks to strong sales in the US, we forecast a compound annual growth rate of 16 per cent for real net profit for three years. Sheng Nuo's valuation is attractive and is now trading at 8 times forecast earnings for fiscal 16, well below Minhua's 14 times and US listed peers'16 times.

First-line bedding brand

Sheng Nuo is a manufacturer and retailer of memory sponge pillows and mattresses, with a leading position in the United States, Hong Kong and China. The company's sales channels include exports to the United States and the opening of retail stores in Greater China. Frost & Sullivan estimated in 2013 that Sheng Nuo was the second largest supplier of mainstream memory sponge products in the United States and the largest supplier in both the Hong Kong and Chinese retail markets.

Export sales-driven growth

We predict that the increase in new customer orders, including Costco, is expected to drive strong export sales growth in FY16. Sheng Nuo's new plant in Tennessee, USA, began trial production on May 16, and we believe that it will be beneficial for the company to grab market share from competitors. In addition, the devaluation of the RMB and the rebound in oil prices further benefit Sheng Nuo's revenue and earnings. The company's export sales accounted for 46-50% of total revenue in fiscal year 15-18. Driven by capacity expansion and new customer orders, we forecast export sales to grow at a compound annual growth rate of 23% in fiscal year 15-18.

Retail is down, but the sponge business is strong

The retail market in Hong Kong is weak and we believe that Sheng Nuo's retail business will be adversely affected in the short term. However, due to the high brand awareness of the company and the leading position of the memory sponge bedding market in Hong Kong, we remain optimistic about the company's long-term prospects. Benefiting from the increased health awareness of Chinese consumers and the increased demand for high-quality furniture, we predict that Sidney's sponge products business will maintain solid and steady growth in the 16-18 fiscal year.

Attractive valuation and steady earnings growth

Shennuo's business is much smaller than Minhua's and its listing period is shorter, but we expect its recurrent net profit growth to be similar to Minhua's, about 16 per cent in fiscal year 15-18. Our target price is HK $1.1, based on a price-to-earnings ratio of 10 times forecast earnings for fiscal year 16, or about a 25% discount to Minhua's forecast price-to-earnings ratio for fiscal year 17. The current price of the stock is equivalent to 8 times the forecast price-to-earnings ratio for fiscal 16, which is a sharp discount to 16 times the average price-to-earnings ratio of more Minhua and its US peers. The main catalyst is the company's increased production capacity in the United States.