Shenzhou International Ltd – Strategic Expansion Amidst Challenging Market Conditions

Shenzhou International Ltd (HKEX: 2313): Capitalizing on Global Expansion and Operational Efficiency

Recommendation: BUY

• Target Price: HKD 95.00
• Date of Recommendation: September 2, 2024
• Broker Company: OCBC Investment Research

Investment Thesis:

Shenzhou International Ltd, the world’s largest vertically integrated knitwear manufacturer, continues to demonstrate resilience in a challenging market environment. Despite facing headwinds such as lower average selling prices (ASP) and inventory risks, Shenzhou has managed to achieve robust earnings growth driven by strong operational efficiency and strategic capacity expansion.

Key factors driving this investment opportunity include:

• Robust Earnings Performance: In 1H24, Shenzhou’s net profit surged by 37.8% year-on-year to CNY 2.9 billion, significantly beating market expectations. This was primarily due to a stronger-than-expected gross profit margin (GPM), which improved to 29.0% from 22.4% in the previous year. The improvement was attributed to full production utilization rates in both domestic and overseas facilities, as well as enhanced operating efficiency at new overseas factories.
• Strategic Capacity Expansion: Shenzhou is targeting a 30%+ capacity expansion over the next three years, focusing on its overseas operations in Vietnam and Cambodia. By increasing its production capabilities in these regions, the company aims to support future growth and improve its margin profile, leveraging lower labor costs and favorable trade agreements.
• Diversified Client Base: The company’s long-standing relationships with major global brands such as Nike, Adidas, Puma, and Uniqlo provide a stable revenue stream. In 1H24, Uniqlo emerged as the best performer with a 34% year-on-year increase in sales, while Nike’s sales saw a decline of 6% due to weaker demand in key markets.

Financial Performance:

• Revenue Growth: Shenzhou reported a 12.2% year-on-year increase in revenue to CNY 13.0 billion in 1H24, although this fell short of market expectations due to an 8% decline in ASP. The growth was driven by a more than 20% increase in sales volume, reflecting the company’s ability to ramp up production and meet demand from its key clients.
• Gross Profit Margin: The company’s GPM improved significantly to 29.0%, supported by better product mix, higher production utilization rates, and improved operating efficiency at new facilities. This margin expansion was a key factor in the company’s strong earnings performance.
• Dividend Increase: Shenzhou declared an interim dividend of HKD 1.25 per share, up 31.6% year-on-year, reflecting a payout ratio of 58.3%. This highlights the company’s commitment to returning value to shareholders while maintaining a strong balance sheet.

Valuation and Catalysts:

The target price of HKD 95.00 reflects Shenzhou’s robust earnings growth, strong operational efficiency, and strategic capacity expansion. Despite near-term challenges such as weaker demand and inventory risks, the company’s diversified client base, focus on expanding its high-margin product segments, and proactive management of costs position it well for long-term growth. Investors should consider this stock for its potential to deliver strong returns as the global economy stabilizes.

Potential Catalysts:

• Stronger-than-expected Sales and Volume Growth: Shenzhou’s ability to exceed its volume growth targets could drive further upside in earnings.
• Recovery in Garment Capacity Utilization: The ramp-up of new capacity in Vietnam and Cambodia could boost margins and support higher ASPs.
• Easing Inflationary Pressures: A reduction in input costs and favorable foreign exchange movements could further enhance profitability.

Investment Risks:

• Supply Chain Disruptions: Any disruptions in the supply chain, particularly in its overseas operations, could impact production and earnings.
• Weaker End-Market Demand: A downturn in demand from key clients, particularly in the sportswear segment, could negatively affect order flows.
• Rising Labor and Input Costs: Increases in labor costs and raw material prices could pressure margins if not effectively managed.

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