Champion on the Cheap

03/09/2010 12:42 pm EST


Ryan Irvine


Sportswear maker Zungui Haixi is poised to score with increasingly affluent Chinese consumers, writes Ryan Irvine in KeyStone's Small-Cap Stock Report.

Zungui Haixi Corp. (Toronto: ZUN.V) is principally engaged in the manu­facture and sale of athletic footwear, apparel, accessories, and ca­sual leather footwear. [Its products] are marketed in the People's Republic of China (PRC) under the well-recognized ZUNGUI brand.

Zungui is a play on the strength of the Chinese economy and growth of the domestic consumer. [From] 2004 to 2008, China's nominal GDP per capita more than doubled from approx­imately US$1,490 to approximately US$3,267.

Zungui distributes its products through three corporate-owned retail outlets and 47 dis­tributors, who in turn sell [into] an extensive network of 1,716 retail outlets. Zungui is currently the PRC's eighth largest domestic sportswear brand by revenue.

At present, the company is focused on gaining market share in the large and growing Chinese market. In 2008, the sportswear industry was a US$7.7 billion market, demonstrating a 32.2% compounded annual growth rate from 2004 to 2008.

[Over the next 12 months, it plans to open] an additional 100 corporate-owned and -managed re­tail outlets, [which] offer higher margins than sales through distributors.

To increase manufacturing capacity and improve produc­tion scales and efficiencies, Zungui is planning to replace and update its five existing production lines. Zungui also intends to build an additional six-floor, 9,000-square-meter manufacturing facility in Shishi City, which is expected to be completed in 2010, [and to] install two additional production lines [there]. Management believes that these new and updated production lines will increase the internal production capacity by over 40%. Gross margins should show improvement in 2011 when the new production ca­pacity comes online and outsourcing is reduced in favor of higher mar­gin in-house manufacturing.

While it may take a couple of solid quarters for Zungui to garner significant attention in the broader financial market, its current valuations are fairly compelling. The company's trailing diluted price/earnings ratio is just above [seven times], its ratio of enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) is a low 3.7x, and the company has zero debt. Couple this with $58 million, or 94 cents per share, in cash in the bank and the fundamentals are indeed solid.

Growth did slow in its most recent quarter and gross margins slid a bit, but with the [recent initial public offering], management has positioned itself to ramp up growth following its seasonally slower (impacted by the Chinese New Year) current quarter and on into 2011. The addition of further pro­duction capacity should also help boost margins or at least curtail their erosion in 2011.

We are initiating coverage on the stock with a Buy rating and placing the company on our Focus Buy list. As a new listing, the stock remains rela­tively illiquid and we would place limit orders in the range of C$2.95 to C$3.35 over the near- to mid-term. [Shares closed at C$3.13 in Toronto Monday—Editor.]

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