Company Reports

Shenzhou International's revenue for the second half of 2023 fell slightly behind our expectations, but operating profit was broadly in line. Even with a revenue downturn, the company still managed to improve profitability, suggesting effective cost-control measures and operational resilience that could bode well for future financial performance. There is no exact guidance for 2024, but management conveyed a positive outlook, saying "We are very optimistic for 2024." This optimism leads us to anticipate that revenue growth could very well hit the midteens percentages in 2024, and profitability recovery could come faster than we previously expected. As a result, we raise our fair value estimate by 8% to HKD 124, and view shares as materially undervalued.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by: 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.

We lower our fair value estimate for Shenzhou International by 18% to HKD 115 from HKD 140 to account for a weaker sales outlook. We expect Nike and Adidas, two of Shenzhou’s largest clients, to replenish inventory at a slower pace, translating to more moderate revenue growth for Shenzhou. While we have reduced Shenzhou’s long-term revenue growth assumption, we expect Shenzhou's outlook to brighten following a challenging 2023, which was pressured by issues such as inventory surpluses, an intensified promotional climate, and clients shifting production away from China. We anticipate the sportswear market will work through excess inventory in 2024 and this is supported by strong January sales data reported by manufacturing peers. We believe that Shenzhou's current share price represents an attractive investment opportunity for investors.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by: 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by: 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.

Narrow-moat Shenzhou’s first-half results were below our and Refinitiv consensus expectations, but the improving gross margin is an encouraging sign for a return to long-term earnings growth. Management struck a cautious tone for growth in the fourth quarter and beyond, supporting our forecast for double-digit sales growth and a return to normalized profitability in 2024. We keep the bulk of our assumptions unchanged and maintain our fair value estimate of HKD 140. We continue to be of the view that the current share price presents an attractive buying opportunity for long-term investors.

We see Shenzhou International's second-half 2022 results as a mixed bag. On the positive side, revenue growth remained healthy despite operating under a challenging industry environment. With key clients reporting a gradual recovery in China, we think Shenzhou's demand outlook will gradually improve. On the negative side, profitability fell more than our expectations as capacity utilization rates fell, and this headwind will likely remain in the first half of 2023. We are maintaining our HKD 140 fair value estimate for the narrow-moat company and see the shares as materially undervalued from a long-term perspective.

2023 will be a better year for Chinese sportswear manufacturers and retailers, and we see some attractive buying opportunities. These firms have struggled with many issues in 2022, including sporadic lockdowns in China, excess inventories, a more promotional environment, logistical challenges, and tough comparisons against 2021. But as China scraps its zero-COVID-19 policy, stores will reopen, and easing income pressure and an improving consumer mood will also lead people to spend more on discretionary items. This means consumption demand for sportswear will increase, and inventory levels should improve.

Investors have forsaken apparel manufacturers and retailers, which we believe present numerous attractive opportunities. These firms have struggled with many issues in 2022, including higher inventories, lower operating margins, inflation, logistical challenges, tough comparisons with 2021, low international travel, and an extremely strong U.S. dollar. However, we see positive signs. In recent weeks, shipping has shown signs of normalizing, and gas prices have dropped. Moreover, we anticipate inventory levels will improve as manufacturers cancel shipments and sales increase in the holiday season (as is typical). In 2023, we anticipate the benefits of investments in supply chains and other operations by many apparel firms will become more apparent. Consequently, despite widespread pessimism in the market, we believe now is a good time to consider the many apparel stocks trading well below our fair value estimates.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.

Narrow-moat Shenzhou reported first-half results above our and Pitchbook consensus expectations, but near-term guidance was disappointing. Management struck a cautious tone for the growth in the second half as its key clients (Nike and Adidas) have reduced orders due to weak demand in China. That said, we expect new orders to recover when channel inventory has stabilized, which we expect by the end of 2022, and this should support double-digit top-line growth and a much better profitability in 2023. Despite near-term challenges, Shenzhou demonstrated its competitive advantages by gaining market shares in the first half of the year within clients' supply chains. Therefore, we maintain our fair value estimate of HKD 140 and view ongoing destocking concerns as a buying opportunity for this narrow-moat company.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.

Adidas’ second-quarter results suggest we were too optimistic about supplier Shenzhou’s 2022 outlook, and we are lowering our near-term revenue and margin estimates accordingly. After adjusting our models, we lowered our Shenzhou fair value estimate to HKD 140 per share from HKD 171, but we still think shares are undervalued.

As already anticipated in a previous profit warning, narrow-moat Shenzhou reported weak second-half results. The company also lowered its revenue guidance for 2022, affected by an ongoing hiring freeze that was put in place to prevent new workers from bringing the COVID-19 virus into the factory bubble. Nevertheless, we think this guidance is on the conservative side, considering Cambodia's ramp-up, efficiency improvement, and low base from last year. Therefore, we see slight upside to management's guidance and believe the current share price weakness provides opportunistic entry points for long-term investors. Our forecasts assume that suspensions in Southeast Asian plants do not repeat in 2022, and China plants will resume hiring in the second half—leading to higher capacity utilization and better margins.

We maintain our fair value estimate at HKD 171 despite Shenzhou’s profit warning ahead of full-year 2021 results. The company blamed a net profit decline on several factors that are all COVID-19 related, except foreign exchange losses. We would treat volatility in the stock as opportunistic entry points, but we acknowledge further production suspensions could lead to downward revisions to our near-term estimates. That said, our base case assumes that suspensions in Southeast Asian plants do not repeat and margins will recover as operating leverage comes back. Shenzhou shares are trading at about a 28% discount to our fair value estimate.

Our fair value estimate remains unchanged despite 16 delta variants reported at the Third Department workshop of Shenzhou’s Ningbo factory. Based on the assumption of an average seven-day quarantine period for all Ningbo workers, we estimate earnings impact is capped at 3% for the year. Even if the quarantine period is to lengthen, we still expect negative financial impacts to be limited to first half of 2022. Given Shenzhou’s rock-solid balance sheet, the firm can comfortably weather an extended shutdown. After an 8% sell-off, we now view Shenzhou shares as undervalued, as they trade at a 19% discount to our fair value estimate of HKD 171.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.

Shenzhou's 2021 first-half earnings were below our estimates, due to a number of non-operating factors. We think ongoing focus should be on: 1) potential of further downside risk in the rest of 2021; and 2) more importantly, what long-term demand will look like once Vietnam gets COVID-19 under control. We trim assumptions for 2021 to reflect weak first-half earnings, and extended COVID-19-related factory shutdowns in the second half, but lift our longer-term forecast to factor in Shenzhou’s recent Lululemon order win. After these adjustments, our fair value estimate rises to HKD 171 from HKD 138. We now expect the firm to record five-year revenue CAGR of 20% (previously 14%) and five-year net profit CAGR of 23% (from 16%). We believe recent bearish sentiment around COVID-19-induced factory shutdowns have created a good buying opportunity for narrow-moat Shenzhou.

We have a strong conviction in Shenzhou’s ability to continue serving as the dominant supplier for global apparel giants. The firm is well-positioned for growth, thanks to the combination of its strong R&D capabilities and entrenched relationships with leading brands. Shenzhou’s business expansion will be driven by 1) growing demand for sportswear globally; and 2) brands' efforts in further consolidating their supplier bases. Efficiency improvements at existing plants and capacity expansions at new plants will enable the company to accept more orders, especially those from fast-growing brands like Lululemon.