While scrolling through the approximate 800 plus stocks listed on the SGX based on potential capital upside, Eratat Lifestyle (“Eratat”) came up to be one of the stocks which provide the highest potential capital upside. Average consensus target price is around $0.44 which represents a whopping 120% potential capital upside from the closing price of $0.20 on 10 Dec 10.
Is the market missing out on Eratat or the market knows something on Eratat that the analysts are unaware of? This piques my interest and spurs me to take a deeper look into this counter.
Description of Eratat Lifestyle
Eratat Lifestyle designs, manufactures and distributes lifestyle fashion footwear. It also designs and distributes lifestyle fashion apparel under its proprietary brand “ERATAT” (“鳄莱特”). It sells its products to distributors located in 22 provinces across China. It has the largest presence in Guangdong and Shanxi with 11.8% and 10.5% of 1HFY10 sales respectively.
Investment merits
Focus on brand equity
Eratat focuses on brand building and this is evident in their management of distributors. Firstly, distributors are allowed to open specialty stores at new locations subject to Eratat’s approval. Eratat’s belief is that to have a strong and positive brand impression to customers, the stores have to be opened and sustained for a number of years.
Secondly, Eratat has a model specialty store at its sales office. Here, it would impart distributors on the “standard look and format” of Eratat store layout so that each Eratat specialty store would provide a similar shopping experience to consumers, despite carried out by different distributors.
Thirdly, Eratat requires their key distributors to directly own the specialty shops progressively so as to cultivate their ownership and loyalty to the brand.
Fourthly, Eratat also pays attention to advertising and promotion in order to create brand awareness. It has appointed celebrity Wang Lee Hom as brand spokesman and Eratat also collaborates with CCTV5, Anhui TV etc to promote their brand.
Order book visibility
Typically, Eratat attended two large scale trade fairs, namely Autumn / Winter Season (to be delivered from July to December) and Spring / Summer season (to be delivered from January to June.) annually. In the recent 2011 Spring / Summer season held in August, Eratat announced confirmed sales order amounting to RMB477m, up 23% over 2010 Spring/Summer Season. These orders are non cancellable. This means if distributors are unable to clear all of their stock, the balance would not be returned back to Eratat. Nevertheless, Eratat would check with other distributors to see whether the goods can be sold there. If this can be done, Eratat will link the distributors together.
According to SIAS research, Eratat has recognised about 53% of its Autumn / Winter Season as sales in the quarter ended Sep. The balance of RMB236m, together with any additional restocking by distributors and contribution from third party footwear would be recognized in the coming quarter. Coupled with the RMB477m orders won (to be delivered from January to June), this lends earnings visibility up to 1HCY2011.
Successful reposition as a casual lifestyle wear manufacturer
Since 2008, Eratat has started to slowly steer its growth path from a sports shoe maker to a casual lifestyle wear manufacturer. Naturally, this takes time as the company’s focus changes and also as a result, its gross margins dipped from 30.1% in FY09 to 28.8% in FY10. (Company’s year end was previously in March but management will be changing it to Dec from end 2010 onwards.). However, there are a couple of signs which indicate that the company’s repositioning is bearing fruits. Firstly, gross margins have rebounded to a record 32.2% in the latest quarter. Secondly, Eratat announced that their 2011 Spring / Summer season raked in an order book of RMB477m with 51% contribution from apparel and the rest from footwear (2010 Spring / Summer: 43% and 57% respectively). It is noteworthy that apparel carries higher margins than footwear.
Proactive in creating investor awareness
Eratat has been very active in engaging the investment community which should bode well for Eratat’s share price in the long term. Besides attending CIMB corporate lunch talks, it has also given presentations at other brokerages and even Invest Fair.
Conservatively managed
Since its listing, Eratat has not done any rights issue or shares placement via issuance of new shares since its IPO in April 2008. Furthermore, according to the latest available financials, it is debt free. It has been utilizing its internal resources for expansion and working capital.
Valuations – cheap vs. peers
With reference to Table 1, Eratat’s valuations are cheaper than China Hongxing but seem to be in line with China Sports. However, China Sports does not have much growth in the near term due in part to the continual competitive landscape of the sports shoes industry, whereas Eratat faces healthy growth rates underpinned by its strong growing orderbooks.
Table 1: Eratat Lifestyle vis-à-vis its peers
|
Ticker
|
Short Name
|
Lcl Cur
|
Last Px
|
Analyst TP
|
Adj Mkt Cap
(S$m) |
FY09 PE
|
FY10F PE
|
FY11F PE
|
ROE (%)
|
Fwd Div Yield
(%) |
|
ERAT SP Equity
|
Eratat Lifestyle
|
SGD
|
0.20
|
0.44
|
85.1
|
4.5
|
3.4
|
3.1
|
19.8
|
6.2
|
|
CHHS SP Equity
|
China Hongxing
|
SGD
|
0.155
|
0.18
|
434.0
|
31.6
|
17.1
|
15.7
|
3.2
|
1.5
|
|
CSPORT SP Equity
|
China Sports Int
|
SGD
|
0.105
|
NA
|
101.0
|
7.2
|
3.6
|
3.1
|
14.3
|
3.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average ex Eratat Lifestyle
|
|
|
|
|
19.4
|
10.3
|
9.4
|
8.8
|
2.6
|
|
Source: Bloomberg (as of 10 Dec 10)
Investment risks
Long cash conversion cycle
Eratat’s cash conversion cycle increased from 104 days as at 31 Mar 10 to 126 days as at 30 Sep 10. This trend is likely to persist as Eratat strives to motivate their distributors by owning the specialty shops through extending longer credit terms to them. Eratat prefers to extend credit terms, instead of providing sales discounts or rebates or renovation subsidies (unlike its peers) as this would affect Eratat’s margins.
Still in a competitive landscape
Although Eratat has repositioned itself as casual lifestyle wear manufacturer, clients have to be aware that this industry is also very competitive and there is also a limit to how much Eratat can raise its average selling prices to improve its gross margins. Furthermore, a casual lifestyle wear manufacturer also has to constantly keep abreast of fashions (as fashion comes and goes), in order to make apparels attractive to the consumers.
Conclusion – May see re-rating if company continues to deliver
Against average analysts’ target price of $0.44, Eratat offers a potential capital return of 120% and a potential dividend yield of 6% for a one year horizon period. Company is likely to see re-rating if it continues to deliver on its results.
This is an amended version of the write-up which I sent to my clients recently.
Disclaimer
The information contained herein is the writer’s personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied. In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials
The information contained herein is the writer’s personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied. In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials
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