Clothing demand in the US and Japan and China's textile exports are improving across the board, and the US income tax relief is a potential catalyst for consumer demand in 2018. Retail sales in the US increased slightly by 0.5% in 2017, an improvement from the 0.2% decline in 2016, benefiting from a positive labor market and rising housing prices. According to historical records, the US income tax relief will clearly stimulate overall consumption in the next two years. China's textile exports also increased 4.5% in 2017, showing their first rise after two years of decline. We tend to think the industry has bottomed out and is likely to accelerate in 2018.
Under the “new retail” framework, brands digitize the supply chain. There is an urgent need for technologization, and high-quality leading suppliers are expected to win more market share. By speeding up the response and speed of operations, brands can sell more, store inventory less, and reduce the amount of discounted sales, so shortening delivery times (from the typical 45-60 days to 25-35 days now) are now their top priority. Nanxuan is a very good manufacturer with excellent “speed”, “quality” and “price” to gain more market share.
NanXuan has strong expertise and R&D capabilities in horizontal knitting, which allows them to explore more room for development, such as WHOLEGARMENT and knitted uppers. Wholegarment and knitted uppers are two advanced products equipped with cutting-edge technology. Their penetration rate in the market is low. Their successful entry into these two fields, which will grow rapidly, is a sign of Nanzuan's superior knitting ability.
Uniqlo's business is recovering well, benefiting from the popularity of innovative products, rapid growth in international business, and continued cold weather this winter (favorable for sweater sales). Uniqlo's recent digital transformation, which began in 2017, has progressed as their innovative products and e-commerce sales performed well from September to December.
We expect FY18E-20E sales compound growth of 20.5% and net profit compound growth of 30.2%.
The driving factors include: 1) more cashmere orders (the market share in Uniqlo will increase), 2) more WHOLEGARMENT orders, and the penetration rate of seamless products manufactured by automated machines will gradually increase, 3) Uniqlo's sales growth (especially overseas business), 4) increased sales contribution from new customers (actively developing new customers from 2014), 5) the gradual release of production capacity in Vietnam, 6) consolidated reports and rapid growth of the knitted upper business.
The initial coverage gave a buy rating, and the target price was HK$4.31. We gave Nanxuan a buying rating for the first time. The target price is HK$4.31. Based on the predicted price-earnings ratio of 17 times in '19, this means there is room for 32.6% to rise. The company's current valuation is only 12.8 times the price-earnings ratio, which is quite attractive. We think the reasonable price should be at least equal to the average of peers (the average of 16.9 times), especially considering that the compound increase in net profit over the 18-20 year period was 30.2% (the industry average was only 10.0%), which implied 0.42 times the 18-20 PEG. The valuation cross-checked with the DCF model was HK$4.57, assuming 9.2% WACC and 1% terminal growth.