This article is about China Xiniya Fashion Limited (NYSE:XNY).
We will talk about the company in general, highlighting its strengths and weaknesses. Then we will analyse the financial and economic condition of the company. Finally, we will make an assessment of the stock with four methods: DCF method, relative valuation, NNCAV method and by considering the relationship between ROE and P/B ratio.
China Xiniya Fashion Limited is a New York Stock Exchange listed apparel and accessories designer and manufacturer, based in China. The company designs, manufactures and markets business casual apparel to retail customers through a network of authorized retailers and department store chains managed and supervised by its authorized distributors.
As a leading provider of men's business and casual apparel in China, XNY believes that it is well positioned to capitalize on the favourable economic, demographic and industry trends in this sector. The men's apparel market in China has grown rapidly in recent years primarily due to a) enhanced living standards, b) increased disposable income because of the rapid growth in urbanization and economic prosperity in second- and lower-tier cities, c) a rising level of style and brand consciousness among male consumers.
The men's apparel market in China primarily consists of three major segments, namely the men's business formal segment, the men's casual segment and the accessories segment.
XNY is focusing on a growth strategy that involves the maintenance and expansion of its authorized retail network, which is owned and managed by third parties. It requires close cooperation between XNY and its distributors. XNY believes its business model enables it to achieve growth by leveraging the resources of its distributors, as well as its expertise in retail distribution and management and local relationships.
Short history on xny
The business of the company was originally managed by Shishi Xiniya, a company established in July 2000 and controlled by Mr. Qiming Xu and his father.
Upon the establishment on October 18, 2005 by Fujian Xiniya, Shishi Xiniya ceased to conduct any business relating to the manufacturing and sale of garments and Mr. Xu and his father disposed of their equity interests in Shishi Xiniya to a third party.
Fujian Xiniya was acquired by Xiniya Hong Kong (a limited liability company incorporated in Hong Kong on January 16, 2009) that became the sole shareholder of Fujian Xiniya.
On July 13, 2010 Fujian Xiniya was acquired by China Xiniya (an exempted limited liability company incorporated in the Cayman Islands primarily for the purpose of facilitating its initial public offering).
XNY's ADRs were listed on the New York Stock Exchange on November 23, 2010. Each ADR represents four ordinary shares.
XNY's structure is as follows (you can find a more detailed history about XNY's formation here):
XNY currently offers a wide range of men's leisure and business apparel and accessories that include the following three major types:
Business casual-including jackets, pants, shirts, T-shirts, sweaters and overcoats.
Business formal-including suits, business pants and dress shirts.
Accessories-including ties, bags, belts, shoes and other accessories.
XNY focuses on its business casual collection, which is intended for leisure enjoyment and travel purposes. Its products feature high quality design, high-tech fabrics and craftsmanship that suit its sophisticated yet casual brand image. Among other products, XNY has designed, produced and marketed apparel made out of wrinkle-free, static-free and stain-free fabrics, which complement its customers' business and leisure lifestyle.
Customers and Suppliers
All of XNY's products are sold to customers in China. All of the group's customers are located in the PRC. XNY sells substantially all of its products to its distributors who then resell the products to department store chain operators, authorized retailers, and retail customers through retail outlets managed or authorized by such distributors.
The following diagram illustrates the relationships between XNY, its distributors, department store chains, retail outlets and end consumers.
XNY's target customers is constituted mainly by male professionals between the age of 25 to 45.
The principal raw materials used in XNY's products are fabrics such as cotton, wool, polyester and blended fabrics and accessories, such as zippers and buttons. Unfavourable fluctuations in the costs of the principal raw materials united with the inability of XNY to pass on any increase in raw materials costs to its customers by increasing the suggested retail prices of its products or increasing the sale price to its distributors, XNY's cost of sales and profit margins may be materially adversely affected. XNY obtains all of these materials from domestic suppliers in China. Many of XNY's raw material suppliers are located in Jinjiang City, near the location of the company's recently closed production facility, which allowed XNY to minimize transportation costs in 2011. XNY ceased operation of four of its production lines at its manufacturing facility in Jinjiang City in January 2010 due to its plans to phase out its outdated manufacturing facilities (20-F Form, for year 2011 page 68). The ceased production facility will likely be converted into a warehouse.
XNY generally enters into supply agreements with each of its suppliers for a one-year term. For each order, XNY enters into separate purchase contracts that include the terms regarding the price, purchase quantity, delivery terms and settlement terms.
# of RAW MATERIAL SUPPLIERS
Approximately 30.1%, 45.1% and 35.7% of XNY's raw material purchases were from its top five suppliers in the years ended December 31, 2009, 2010 and 2011, respectively.
% of raw materials from XNY's TOP 5 SUPPLIERS
% of raw materials from OTHER minor SUPPLIERS
XNY works with its suppliers on an exclusive basis from time to time to jointly develop innovative materials, such as wrinkle-free and water-proof fabrics, which provide functionality that matches the travel and leisure purposes of its apparel.
Marketing and Sales
In October 2007 XNY established the Xiniya Sales Management Institute in association with China Marketing Institute, a Chinese academic institute specialized in the research and design of marketing strategies. Through this institute, XNY provides systematic training to front-line staff to ensure consistency and quality of store management throughout its retail network.
Thanks to XNY's marketing strategies the number of retail outlets managed or authorized by the distributors increased 35.4% from 2006 to 2011 and a net addition of 72 outlets were added to the sales network as of September 30, 2012 (company presentation).
XNY has conducted multi-channel marketing campaigns to advertise its products to its target customers through television commercials, advertising on indoor video displays, newspapers, magazines, the internet, public transportation and billboards, strategically selecting suitable celebrities as XNY's brand spokesperson. Jacky Cheung, Hong Kong singer-songwriter and actor, is XNY's brand spokesperson.
XNY also markets its products through its consumer loyalty program managed by its distributors.
XNY advertises on Chinese national television channels CCTV-2, CCTV-5 and CCTV-12 to promote its brand.
The men's retail apparel industry is highly competitive in China.
The men's business casual apparel segment in China is relatively fragmented but there are a small number of market leaders. XNY competes primarily with domestic men's apparel brands, including, among others, Lilanz, Septwolves and K-Boxing.
XNY believes the intense competition in China's men's apparel industry will continue in the future.
The main XNY's competitive advantages are:
consumer recognition of XNY's brand name.
XNY's presences in many second- and lower-tier cities in China.
Research and Developments
All XNY's products are designed by its internal design and product development team. The design team and product development consists of designers with an average of over ten years of experience working in the fashion industry in China.The designers are graduates of professional schools of design in China.
By attending fashion shows and meetings with professional suppliers of fashion information, designers are inspired by the styles and trends from all over the world. Even from Japan and Korea, which styles are gaining popularity in China. Participation in fashion shows around the world, meeting with a professional staff of fashion, with suppliers and distributors for the development of innovative materials, with managers and department stores, allows the designer to collect a number of extremely useful information for create designs that are the most suitable for specific markets.
XNY has implemented a centralized system for procurement and inspection of raw materials and ancillary components to help ensure a stable and high quality supply.
In 2010, XNY restructured its authorized retail outlet network by transferring the department store chains as authorized retailers under the management and supervision of its distributors in charge of their respective jurisdictions. XNY believes such change helps to eliminate competition within its distribution network and enhance the overall performance of its network as well as its customer management efficiency. XNY believes that the department store chains will benefit from the restructuring by receiving stronger support from the distributors.
In 2010 XNY decided to close the production facility in Jinjiang City because the plant was outdated. This was done according to XNY's plans to phase out outdated manufacturing facilities. XNY intend to use part of the proceeds from its initial public offering and internally generated cash to increase its own production capacity by building new facilities in China. The company is awaiting approval from the government to acquire land use rights for the facilities. The budget for the facilities, including the land use rights, is expected to be approximately $94M. The facilities will be built in several phases over the next five years (China Xiniya Fashion discusses outlook for new production facility in China).
Below there are tables that shows percentages of increase of sales. The increase of sales is compared on a year-over-year basis - from annual performance to quarterly performance.
Please note that at the time we wrote this article we didn't have XNY's financial results yet for fiscal year 2012 and 4th quarter ended on December 31, 2012, but according to the XNY's report for the Third Quarter Earnings of 2012 revenue in RMB for the fourth quarter of 2012 was expected to increase by 4%-7%'' as compared to RMB 482.76 million in 4th quarter of 2011. We assume a 5.5% growth. So CNY 482.76 (4th quarter 2011) + 5.5% = CNY 509.31. Then we can estimate a total sales for the entire year of 2012 of about CNY 1,360.52.
(click to enlarge)
The percentage of the increase of sales is slowing down but we are not concerned about it because XNY is just focusing on opening quality retail outlets at the moment with very good results. As you can see in the graphics below the productivity of outlets is improving even though the percentage of increase of sales is getting smaller and smaller from one period to the next.
The table shows that the store's quality is improving.
With more than 100,000 clothing manufacturers that employ over 10 million people, China has become the largest producer, exporter and consumer of apparel products worldwide. Over the past 30 years the rapid growth of the national economy and domestic demand for clothing have led to the development of Chinese garment. It is making tremendous progress in many aspects, such as the industrial structure, the application of technology, brand development, quality control, profitability and the exploration of the domestic and international markets. This development is also supported by skilled labour force, favourable investment environment and a well-integrated industrial chain.
China's garment industry is mainly located in the Pearl River Delta, Yangtze River Delta, Bohai Sea region south-east and coastal areas. The total production of the five provinces of the eastern coastal area, namely Shandong, Jiangsu, Zhejiang, Fujian and Guangdong, takes over 70% of the total production of the country.
As the industry grows and domestic demand grows, a series of original brands are growing rapidly, making progress in many fields, such as product R&D, management, marketing, collaboration with the home and foreign counterparts and innovations in culture and models. These original brands not only won the recognition by consumers, but also become a major power driving forward the development of the industry.
Now the garment industry in China is undergoing a new wave of upgrading, changing their growth patterns, gaining peace structural readjustment, deepening collaboration and innovation between the upstream and downstream players and building a modern industrial network, to fulfill a better life for all races of people, meet the new requirements of scientific development in the middle and late period of China's industrialization, find its new position in the global economy, create new competitive edge in the international cooperation and competition and grow from a big industry into a strong one through continuous innovations.
Almost all of XNY's assets are located in the PRC and all of XNY's sales are derived from its operations in the PRC. As a result, XNY operations and assets are subject to significant political, economic, legal and other uncertainties associated with doing business in the PRC.
For and against XNY
Small number of leaders in the men's business casual apparel segment in China even though it is higlhy fragmented.
The company is awaiting approval from the government to acquire land use rights for the facilities which construction is expected to be funded with the proceeds from the IPO and internally generated cash.
The labour force is young, well educated and with experience.
Favourable economic, demographic and industry trends.
Internal design and product development team, which designs products that reinforce company's brand image.
The company doesn't have debts. The company is well positioned in the competitive framework in terms of liquidity and profitability.
Reputation Chinese companies.
Country Risk: China.
Increasing price of raw materials.
Any IPO to finance the construction of new production facility increases the number of shares outstanding and reduces the earnings per share and dividends per share might the BoD decides to pay them.
For our financial analysis we will focus on the financials of the last 5 years.
Liquidity and debt
- Current ratio: With regard to the capacity of XNY to fulfill the commitments of short-term, the company has enough liquidity to fund working capital and investment, as can be seen from the following two tables that show the results for the past 5 years from 2007 to 2011 and last quarters.
-quick ratio: the results of the quick ratio are still very good although the latest results fell slightly. Inventory levels should be monitored over time. The company is committed to increase retail sales and reduce inventory levels at the retail channels through investment in training courses for its retail sales and inventory management personnel (China Xiniya Fashion Limited Reports 2012 Third Quarter Earnings).
- Debt to Equity ratio:
If we compare XNY with its industry, we can see that the company is very well positioned in terms of indexes that measure the financial health.
Income statement: gross margin, operating margins and net profit margin: in terms of profitability, the company recorded higher values than the average sector and industry. This means that the business is going very well. The company is developing markets and increasing sales.
Even the index that measures the investment return is very high and above the sector and industry ratios. This means that the use of capital in the business is done efficiently by the management.
We will value XNY's stock using the discounted cash flow method. We will use the free cash flow approach to determine the "fair value" of XNY.
We determined in 5 years the period we projected cash flows because XNY is a company based on a strong balance sheet, operates as leading company even though in highly fragmented segment, operates with advantage such as multi-channel marketing campaigns to advertise its products to its target customers and recognizable brand name.
Growth: XNY has grown revenues at 40.12% CAGR for the past 5 years (from 2007 to 2012. Taking into consideration revenue's growth expectations for the 4th quarter of year 2012). Frost & Sullivan estimated a growth for the men's apparel market at a CAGR of 16.1% from 2010 to 2015. Instead according to a report released by RNCOS, a leading industry research and consultancy firm, the Chinese apparel sector is expected to grow 23% CAGR during 2012-2015. We then decide to set a steady revenues growth rate for XNY at 20% for the first 2 years and then 15% for the last 3 years. It seems being fair enough to us.
Future Operating Costs: A good place to start when forecasting operating costs is to look at the company's historic operating cost margins. The operating margin is operating costs expressed as a proportion of sales.
For 5 years period (2007-2011), XNY has generated an average operating cost margin of 70.25% (geometric mean). In other words, for every CNY 1 of sales, the company incurs CNY 0.7025 in operating costs.
The trend got worse as you can see from the table below that shows operating expenses as % of sales through the last 5 quarters. The company has generated an avg operating cost margin of 76.66%. For every CNY 1 of sales, XNY incurs CNY 0.77 in operating costs.
If we compare each of the 3 quarters of 2012 with corresponding ones of 2011, we can se from the table below, that on avg XNY's operating cost margin increased 7.10% or 11.33% (it depends on your preference for the average or the median value) in each quarter from the corresponding previous year.
Furthermore in view of the fact that a) up to today the company has demonstrated its ability to pass price increases of raw materials to the retail price of the products and protect gross margin (20-FORM FY 2011, PAGE 10 and 2012 company presentation page 22), b) the production outsourced is more expensive than its own (20-F, fy 2011, page 49), c) a significant increase in labour costs is expected (20-F form for FY 2011, page 13); d) the total operating costs will also increase because of 'expected' depreciation charges on new production facilities that will be build over the next 5 years; we decided to set a percentage for operating cost margin of 70% for the first 2 years, 75% for the third and fourth year and 78% for the last year.
XNY spent CNY 17.67 in 2011 on capital expenditures, with depreciation of CNY 1.65, giving net investment of CNY 16.02, or 1.36% of total revenues. But in the 4 prior years, the company's net investment was practically zero as a % of sales.
XNY expects that its current levels of cash and cash equivalents and cash flows from operations will be sufficient to meet its anticipated cash needs, for both working capital and capital expenditures, for the foreseeable future (20-F, for FY 2011, page 12). XNY expects to fund the construction of new production facilities with the proceeds from the IPO and internally generated cash. The budget for the facilities, including the land use rights, is expected to be approximately $94M. Let say about CNY 584.60 M according to the exchange effective on the day we wrote this article (March 29, 2013). The facilities will be built in several phases over the next five years.
We suppose that there will be completed production facilities to be entered in the balance sheet for a value of CNY116.92M at the end of 2013. These plants will be used starting from the following year 2014. The depreciation charge for year 2014, as a cost for the year, will be approximately equal to CNY16.70. We assume the useful life of the assets will be 7 years (approximately 14.28% as depreciation charge's percentage according to the Straight Line Depreciation Method). In the second year (2014) other production facilities for a value of CNY 116.92 will be carried out and entered in the balance sheet at the end of 2014. So the total value of plants at the end of 2014 will be CNY 116.92 plus CNY 100.22 (= 116.92 - 16.70). For a total net value of CNY 217.14. Plants completed in 2014 will be used from 2015 onwards. The total value of depreciation charge for the year 2015 is equal to CNY 33.40 (2nd depreciation charge of plant completed in 2013 plus 1st depreciation charge on plants completed in 2014). And so on. See table below:
Change in Working Capital:
Since we did not yet know the amount of working capital for 2012 because XNY had not released its full 2012 year's financial results yet when we were writing this article, we decided to estimate the working capital for 2012 by observing the working capital turnover over the past 5 years (2007-2011) and 5 quarters. As you can see from the table below, the last trend of working capital turnover is around 1 (see years 2010 and 2011 and geomen of 3 quarters 2012 per 4 months). So we decided to consider a working capital amount equal to total sales for the period from 2013 to 2017. When we compute the working capital we take into account even the cash the company is expected to use to fund the construction.
Finally the table below shows FCF forecasted for the 5 years period:
(click to enlarge)
Then we've determined our estimated free cash flow for our forecast period.
Risk Premium: 5.38%
Beta: 1.43 (as of March 29, 2013. Data gathered from Yahoo Finance).
XNY's Re = 0.04% (return on US T.Bills as of March 29, 2013) + 1.43 x 5.38% (MRP) = 7.73%. Plus 1.05% for Country risk premium = 8.78%
The company doesn't have debt, furthermore XNY expects that its current levels of cash and cash equivalents and cash flows from operations will be sufficient to meet its anticipated cash needs, for both working capital and capital expenditures, for the foreseeable future.
Discount rate: 8.78%
We assume that XNY's cash flows will grow in perpetuity by 6% per year.
XNY's Terminal Value = CNY 52.87 M * 1.06 / (8.78% - 6%) = CNY 2,015.91M.
XNY's Enterprise Value = (CNY 94.72 M/1.0878) + (CNY 14.06 M/(1.0878)^2) + (CNY 45.05/(1.0878)^3) + (CNY 81.03M/(1.0878)^4) + (CNY 52.87 /(1.0878)^5) + (CNY 2,015.91M/(1.0878)^5) = CNY 1,550.04
CNY 1,550.04M / 231.11M = CNY 6.71 per share.
1 CNY = 0.1609 USD as of March 29, 2013. Then 1 XNY's share = $ 1.08. Since 1 ADR = 4 ordinary shares, 1 XNY's ADR = $4.32
If we set XNY's cash flows perpetuity growth at 5% per year, the value of 1 XNY's ADR is about $ 3.32.
We can also perform a relative valuation for XNY's stock using P/E ratio. As of March 29, 2013 the PE of Textile - Apparel Clothing industry is 22.00. XNY's EPS (TTM) is $0.64 per ADR.
So XNY's ADR value = 22.00 x 0.64 = $ 14.08.
We can even compute XNY's NNCAVPS as below and compare it with the ADR's price.
As of September 30, 2012 XNY's total current assets is equal to CNY 1,755.03 M. and its total liabilities is equal to CNY 432.54 M.
The difference of CNY 1,322.49 divided by 231.11 M. of shares outstanding will give us a NNCAVPS equal to CNY 5.72. That is $ 0.92 per share according to the currency exchange as of March 29, 2013. Since 1 XNY's ADR = 4 ordinary shares, so 1 XNY's ADR = $3.68 according to this valuation method.
As of March 29, 2013, XNY's ADR market price is $1.32. So the current price of XNY's stock is cheap compared to the values that came out from our valuation.
We can also make an assessment whether the stock is either overpriced or underestimated by the relationship between its ROE and P/B ratio according to the table below.
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The first column shows XNY's ratios, the second shows Industry ratios and the third column shows the sector's ratios:
As of March 29, 2013:
a) XNY's ROE : 18.77% (it is higher than Industry and Sector ROE).
b) XNY's Price/Book Value (mrq): 0.35 (it is lower than Industry and Sector P/B).
a) + b) = XNY is at the moment underestimated by the market.
Remember that we are talking about an entity with a small market capitalization that operates in China.