BUY (Initiation)
Closing Price S$0.135
Target Price S$0.191(+41.5%)
From the time ADAM took a bite of the forbidden fruit, the textile industry was born. From the main purpose of covering up one’s modesty, textile production has evolved to satisfy Man’s vanity. Beside aesthetic appeal, the textile industry has also evolved in its own right to offer a greater variety of selection that caters to different usages, not just on clothing. Today we have functional fabrics that boast of properties such as water resistant, UV protection, air breathability and many more. I’m sure DAVID would have preferred a pair of tight fitting hotpants made of breathable material to a fig leaf.
Contrary to popular belief, the PRC textile industry is a growing but competitive industry. Sales revenue from 2003 to 2010 registered a CAGR of 19.0% while net profit had a CAGR of 27.4%. Number of enterprises also grown from 25,803 to 55,391 in end 2010, highlighting the attractiveness and ease of entry. Annual loss making enterprises ratio approximates 15% going downtrend. Key catalyst to the industry is growing domestic consumption. As such, we think it is not difficult to survive, as in; stay out of the red. But it takes a bit of innovation and distinction to achieve outperformance.
Foreland is a vertically integrated manufacturer of normal and functional fabric. The core strength of the company lies in its expertise in producing functional fabrics. It currently offers a range of 19 functional fabrics to customers and the company aims to introduce at least 2 new products annually. We believe offering high quality functional fabric is the distinction to achieve outperformance. Normal fabric competes on price, functional fabric competes on quality. We estimate functional fabric can achieve 10ppt higher in gross profit margin.
Reasons why we are featuring the stock:
- An inflexion point was observed in 1Q10, profitability since then has rebounded strongly. Future earnings are premised on strong demand for functional fabrics.
- Current entry point looks attractive relative to 2 previous batches of placees. 1st batch paid $0.1235, 2nd batch paid $0.16.
- A top 10 customer took a 3.9% stake in the company at $0.16, signifying confidence in a long term business relationship
We price Foreland at 4.35x FY11E earnings. This represents a hefty 70% discount to broad market PE of around 14.5x. Reasonable considering a 50% (we are cautious too) S-chip “may-go-bust-anytime” sentiment discount, 10% small cap discount and a further 10% for the laughable bid-ask spread of $0.001. This gives us a target price of $0.191.
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