Net profit for 2023 was in line with expectations, but sales fell short of expectations. Sales in 2023 fell 10.1% year on year, and net profit remained flat at 4.6 billion yuan year on year, in line with market uniform/BOC International expectations. Due to improved orders in the fourth quarter, the year-on-year decline in sales in the second half of 2023 narrowed to -5.5% from -15% in the first half of the year, while increased capacity utilization also helped the gross margin to rise from 22.4% in the first half of the year to 25.8% in the second half of the year. The payout ratio was raised to 60.3% (previously 54.9%), and the dividend ratio was 3.1%. Given the 40% year-on-year increase in net cash (HK$8.4 per share, or 13% of the share price), we expect the dividend ratio to remain as high as 60%.
Orders are strong, and the capacity utilization rate of all plants has reached 100%: Management said that orders were strong in the first quarter of 2024, and sales volume for the whole year are expected to increase by no less than 15% year over year, and the average sales price (USD) will increase by 1-2%.
The boom in business is reflected not only in the recruitment plans of the Vietnam/Cambodia factory, but also in the recruitment plans of the Ningbo factory (the utilization rate of the Ningbo factory in the first quarter of 2024 was 100%, up from 95% in the fourth quarter of 2023). As far as customer orders are concerned, Nike's growth is relatively low, and orders may remain flat or grow slightly, but management expects orders from other core customers (Uniqlo, Adidas, Puma) and Chinese sportswear brands (Li Ning, Anta, Tep) to increase by more than 10%, while orders from new customers (such as Lulu Lemon) are expected to increase by another 40-50%.
Increased capacity utilization is expected to drive a sharp rise in gross margin: although management did not provide guidance on gross margin, we expect gross margin to reach 28-29% in the first quarter of 2024, as gross margin reached 26-27% in the fourth quarter of 2023 despite a low capacity utilization rate (95%) in China.
Market focus: Nike's weakness; US election year; huge capital expenditure: Some investors are worried that new tariffs may be imposed on the textile supply chain after the US election, not only on Chinese exports, but even on Vietnamese exports. We have noticed that Shenzhou's shipments to the US are low, accounting for only 16%, so the impact is manageable. Nike's recently issued conservative sales guidelines also did not affect management's confidence, as Shenzhou's share within Nike continues to expand. Since Shenzhou's expansion in Indonesia will be carried out in stages, it is estimated that the capital expenditure for the next few years will be 2 billion yuan per year, which is not very high compared to historical levels.
Reiterate the purchase and raise the target price to HK$116: As orders fully resume and production capacity is fully utilized, we expect a positive response from the stock price. We raised our earnings per share to reflect the bottoming rebound in Shenzhou's order growth and optimistic order volume expectations. The target price was raised to HK$116 (previously HK$95.5), based on 21.5 times the 2024-25 average price-earnings ratio (previously 21.0 times 2024E price-earnings ratio) and 0.9 times PEG.