Maxwell ... Nov11

ZJ Research

Investment Highlights / Summary
• China-based sports shoes OEM and ODM. Located in Jinjiang City, which is dubbed the “Shoes Capital” of the world, Maxwell sells over 11 mln pairs of sports shoes annually. It produces for renowned brands such as Yonex, Mizuno, Fubu, Fila, Diadora, and Hush Puppies, to name a few.

• Design & develop capability differentiates Maxwell from other OEM’s. It develops 1,000 designs p.a. at present and will be increasing to 1,500 designs p.a. going forward. Facility is running at optimal capacity with plans to double in-house production to 16 million over the next two years. Excess demand is currently met by
outsourced contractors.

• Superior profitability. Maxwell generates the highest net profit margin amongst its peers on the local bourse. It registered a historical 4-year revenue and net profit CAGR of 46% and 53% respectively between FY06 and FY10. The Group has no borrowings, with balance sheet backed by NTA/share of 66 sen and net cash/share of 43 sen.

• Risks include potential loss of clients in the absence of long term contracts, quality control issues with its outsourcing and margin erosion from escalating production cost in China.

• Rising consumer spending power in emerging markets will drive Maxwell’s earnings growth forward. We estimate revenue in the next two years to continue expanding at double-digit figures while sustaining net profit margin at the 18%-level.

• Initiate coverage with a Buy recommendation and a fair value of 58 sen, derived by pegging FY11 net profit estimate against 3.5x PER multiple. It also offers attractive net dividend yield of 9.9%. We like Maxwell for its superior profitability track record, earnings growth potential and experienced management. Maxwell is currently trading at an undemanding valuation of 2.1x FY11 PER, which is also below its net cash/share of 43
sen.

OEM and ODM for sports shoes
Maxwell International Holdings Bhd (Maxwell) is an investment holding company incorporated in Malaysia on 3 November 2009, while its only whollyowned subsidiary, Jinjiang Zhenxing Shoes & Plastics Co., Ltd (Zhenxing Shoes) was incorporated in the People’s Republic of China in 1999. The subsidiary is principally involved in the design and manufacturing of sports shoes for the Chinese as well as overseas markets on an Original Equipment Manufacturer (OEM) and Original Design Manufacturer (ODM) basis. It sells in excess of 10 million pairs of sports shoes annually.

Established since1999
Maxwell was listed on the Main Market of Bursa Malaysia on 6 January 2011. The Group’s history dates back to 1999, when founder Madam Li Kwai Chun, through her company Chun Hing Industrial (Hong Kong) Ltd established Zhenxing Shoes to manufacture and sell sports shoes to domestic and overseas customers, which comprise mainly trading houses and brand distributors.

Facility located at Jinjiang City, nicknamed the “Shoes Capital”
Zhenxing Shoes is located in Jinjiang City, Fujian Province, which is dubbed the “Shoes Capital” as the city is renowned as one of the largest shoe manufacturing hubs in the world. Zhenxing Shoes commenced operations in 1999 with only one production line that had an annual production capacity of one million pairs of sports shoes. The business has since grown by leaps and bounds, having expanded from one production line to two in 2000, before adding the third line in 2006 and the fourth line in 2008. With four production lines, the Group currently boasts an annual production capacity of eight million pairs of sports shoes.

Started outsourcing in 2006 to cope with rising demand
In 2006, Zhenxing Shoes also began to outsource some of its production to external contract manufacturers in order to cope with the rising demand. Furthermore, contract manufacturing enables the Group to expand production capability rapidly without incurring heavy capex.

Founders remains hands-on as the Executive Chairman
Today, Madam Li continues to helm the Group in the capacity of the Executive Chairman of Maxwell. A citizen of Hong Kong, she has over 30 years of experience in running businesses across several industries, including footwear, textile as well as arts and crafts. She is aided by Executive Director and CEO, Mr Xie Zhen’an. Mr Xie played an instrumental role in the success of the Group, having been the General Manager of Zhenxing Shoes since inception. The remaining four directors in the 6-member board comprise nonexecutive
directors, of which two are independent directors. We note that the board is well-balanced in that there are three Malaysians (including the two independent directors) in addition to two Chinese national and a Hong Kong citizen.

Substantial shareholders include founder & OSK Technology Ventures

In terms of shareholdings, substantial shareholders in Maxwell are Madam Li and her family with  57.7%-stake, and OSK Technology Ventures Sdn Bhd with 7.2%-interest.

Maxwell, through Zhenxing Shoes, designs and manufactures a variety of sports shoes, including court shoes, running shoes and casual sports shoes for the domestic as well as overseas markets. The Group is an OEM and ODM for various internationally reknowned brands, namely:-
• Brooks,
• Diadora,
• Fila,
• Fubu,
• Hush Puppies,
• Kappa,
• Mizuno,
• Riddell, and
• Yonex.

Customers comprise trading houses and brand distributors
Maxwell’s customers comprise mainly trading houses and brand distributors that are based in China, as it does not usually deal direct with the brand owners. Presently, it has approximately 20 regular customers. These customers in turn export Maxwell’s shoes to overseas markets such as Europe, South and North America, Asia and Africa. We note that the Group’s clientele are quite well spread out, in that majority of customers do not contribute more than 10% to Maxwell’s revenue. We understand Maxwell also exports directly to overseas on a small scale, which is usually less than 10% of its revenue.


Financial Highlights
Maxwell has been chalking up commendable revenue and net profit growth over the last several years. The Group registered a 4-year revenue and net profit Compounded Annual Growth Rate (CAGR) of 46% and 53% respectively between FY06 and FY10. In FY10, it posted a net profit of RM65.1 mln on the back of RM335.9 mln turnover, translating into a net profit margin of 19.4%.

For a manufacturing entity, Maxwell’s profitability is certainly impressive with its double-digit net profit margin. Management explained that its healthy net profit margin is a result of its business practice of accepting only orders which yield a minimum gross margin of 25%. In essence, it works on a “cost plus” business model. Its bargaining power is bolstered by its D&D capability and proven track record of quality products and on-time delivery of orders.

From the historical financials, we note that Maxwell managed to grow its business considerably without sacrificing profit margin, thanks to its “cost plus” model. This is evident in its ability to sustain Gross Profit (GP) margin in excess of 27% despite production volume rising threefold to 11.3 mln pairs between FY06 and FY10. In fact, Maxwell’s GP margin had generally been trending up, rising from 27.2% in FY06 to 29.4% in FY10.

On a per pair basis, the average selling price (ASP) increased steadily from RM18.43 in FY06 to RM29.81 in FY10. Management attributed the rising ASP to increasingly complex shoe designs as well as higher raw materials costs. Meanwhile, average GP (AGP) per pair too, expanded to RM8.75 from RM5.01 during the same period.

Earnings Outlook
The global sporting goods industry is expected to expand in tandem with the projected 3%-4% annual global GDP growth in 2011 and 2012. We believe the growth in spending for sporting goods is weighted towards the emerging markets such as China and other Asian countries, bolstered by the rising consumer income in these economies.

In 2009, the per capital annual spending on footwear in the US was USD173, four times more than its counterpart in China. With the growing affluence of the Chinese consumers and rising brand awareness, Maxwell’s prospects appear to be bright over the next few years. The Group is certainly seizing the
opportunities with its planned expansion in production output and design capabilities in order to drive its earning growth going forward.

We project Maxwell FY11 revenue and net profit to climb 10.5% and 2.7% yo- y to RM371.3 mln and RM66.9 mln respectively, on the assumptions of a 2% increase in sales volume and a 5% hike in ASP. Considering that 1HFY11 net profit is currently at RM27.0 mln, our projection reflects our expectation for
a more robust performance in 2HFY11, which is usually the case. 1H results are historically weaker as there are fewer working days in 1Q due to the Chinese New Year celebrations, while orders in 2H are traditionally stronger as customers place more orders ahead of the year-end festive seasons when consumer spending is higher.

We note that the FY11 net profit included one-off listing expenses amounted to RM2.5 mln which dragged profitability down. For FY12, we forecast net profit at RM74.2 mln (+10.9% y-o-y) on the back of RM408.7 mln turnover (+10.1% y-o-y).

We expect the growth in production output in the next two years to come mostly from outsourced portion as in-house production has reached the optimal level, with new production lines to gradually commence only from 2012 onwards.

Investment Risks
Absence of long term contracts. Maxwell does not have long term contracts with its customers (i.e. the trading houses and brand distributors) and jobs are received via purchase orders from them. We understand that this is a common industry practice and is not specific to Maxwell. Customers therefore, in theory, could switch manufacturer as and when they desire. However, this usually does not happen unless Maxwell fails to deliver quality products on time or is uncompetitive in pricing, as the Group has established good and strong relationships with its customers. At present, approximately half of its business are derived from repeat customers.

Reliance on outsourcing. Outsourcing could be considered as a doubleedged sword. On one hand, it enables Maxwell to scale up productions rapidly to meet demand without heavy capital outlay. On the other hand,
however, there are risks that the Group’s reputation and financial performance may suffer if the external contract manufacturers fail to deliver the orders on time or fail to adhere to the required quality, specifications and designs. Should this happen, the adverse impact could be material considering outsourcing constitutes approximately half Maxwell’s total output.

Nevertheless, management clarified that as there are over 3,000 shoes manufacturers in Jinjiang City and that there is no shortage of good contract manufacturers.

Rising production cost. Prices of some of Maxwell’s raw materials move in tandem with the crude oil price. Raw material costs made up 71% of total cost in FY10, up from 63% in FY06 largely due to the rising crude oil price. The other major component is labor cost, which is also on the uptrend. Labor cost contributed about 11% of total cost in FY10. In mitigation, management explained that it is able to source raw materials at competitive prices due to availability of a large pool of suppliers in Jinjiang City. More importantly, it has
been able to pass the cost increases to customers, as shown in the rising ASP over the years.

Recommendation

We initiate our coverage on Maxwell with a Buy recommendation and a fair value of 58 sen, which translates into a potential share price upside of 61%. We like Maxwell for its superior profitability track record compared to its peers, earnings growth potential, high net cash/share as well as hands-on
and experienced management team.

Maxwell’s current valuation, at prospective FY11 PER of 2.1x, is undemanding and does not reflect its earnings growth potential in our opinion. Furthermore, it also offers very attractive net dividend yield of 9.9%, assuming a 20% payout from net profit as per management guidance. Given management’s active initiatives to enhance investors’ perception and confidence toward the Group, interests in the counter may gradually pick up going forward as it delivers its earnings stream.

Moderating factors include possible profit margin erosion from higher-thanexpected escalation in production cost, muted sales growth arising from worse-than-expected slowdown in the Chinese economy, and reputation damage from quality issues arising from outsourcing. Meanwhile, emergence of more alleged financial irregularities in foreign-listed Chinese firms may also prolong the tepid response by investors.