Sector: Light industry
manufacturing
Dec. 8, 2010Transformation in progress: Overweight on domestic
sales potential and value of sales channels
—2011 Investment Strategy on Light Industries
Analyst
Zhou Haichen
zhouhc@https://www.doczj.com/doc/244872674.html,
Tu Yiting
tuyt@https://www.doczj.com/doc/244872674.html,
Contact
Liu Li
Tel: (8621) 23297218
liuli@https://www.doczj.com/doc/244872674.html,
Add.：99, East Nanjing Rd. Shanghai Tel: （8621）23297818
SWS Research Co., Ltd.
https://www.doczj.com/doc/244872674.html, ?Overweight on light industry enterprises focused on domestic sales with both
sales channel and brand value. We recommend Markor International Furniture (600337.SH), Shenzhen Fiyta (000026.SZ), and Henan Rebecca Hair Products (600439.SH). We look for the best investment targets in the listed A-Share light industrial companies from the two dimensions of “channel and brand value” and “industry growth rate and room for increased concentration”, and recommend Markor International Furniture (600337.SH), Shenzhen Fiyta (000026.SZ), and Henan Rebecca Hair Products (600439), which have been working hard in the domestic market for many years and enjoy the early bird advantage in terms of brand and sales channels. We believe these companies will benefit the most from the exponential growth and increased concentration of the relevant consumption markets in China. We also believe a period of high performance growth is on the horizon. As manufacturers transform themselves into operators of brands and sales channels, they will enjoy exponential increases in market cap. Investment highlights: Markor International Furniture (600337.SH) (the retail business in China will implement a multi-brand strategy via Markor Home and continue to expand its influence in the domestic market. Private placement will strengthen its edge in sales channels. Overseas sales will gradually recover, with benefits from the favorable policies in Xinjiang. The Company’s new examination policies bring the interest of operators in line with that of investors). Shenzhen Fiyta (000026.SZ) (after the crisis, quick recovery in consumption coincided with exponential growth in the luxury goods sector. The shops built in 2008-2009 begin to bring in returns, with improved cultivation of the sales channels for luxury items and benefits from the inflation).
Henan Rebecca Hair Products (600439.SH) (gradual recovery in exports, rapid promotion of domestic sales development, large-scale expansion of capacity and improvement in upstream and downstream industry chain from proceeds of funded projects.
?Concerns overseas and potential in the domestic market facilitate
transformation of the market. Presently, there are difficulties in the export market, as uncertainties in overseas economies have made operations more difficult, and the original comparative cost advantage of Chinese light industrial companies has shrunk due to changes in labor, exchange rates, prices of resources, and policies.
Meanwhile, macro economic transformation in China will activate the enormous market of domestic demand, providing wide prospects for the transformation of light industrial companies. This has also been proved from the experiences of overseas markets of the same period.
?The essence of transformation is reform in business model. Differentiated from
the external sales model of participating in trade fairs, obtaining orders, and mass production, developing domestic sales emphasizes the increase in the Company’s overall strength in all sections of the industry chain from branding, design, customized production, to control of sales channels. We believe that there are three stages in the transformation currently being undertaken by China’s light industrial companies: (1) market transformation from external sales to domestic sales, (2) strengthening of the two ends of the smiling curve: extension from manufacturing to design and service, (3) change of sales strategy from a single brand to a multi-brand strategy.
?Sunshine always comes after the rain. With accumulated efforts, exponential
growth in performance will come. Companies undergoing transformation are enjoying high growth, rise in profitability, and stronger resistance to risks, but they cannot avoid problems such as high expense ratios in the initial stage of
Table of contents
1. Overseas concerns and domestic potentials facilitate market transformation (5)
1.1 Difficulties in the export market (5)
1.2 Domestic demand to be activated. Growth prospects are promising.8
2. Demand for transformation: market transformation calls for reform in business models (12)
3. Process of transformation: sunshine after the rain (14)
3.1 Transformation is about to happen (14)
3.2 During the transformation (16)
4. Transformation map of China’s light industrial companies and recommended companies (20)
4.1 Transformation map of listed light industrial companies (20)
4.2 Recommendations: Markor International Furniture (600337.SH), Shenzhen Fiyta (000026.SZ), Henan Rebecca Hair Products (600439.SH) 21
Figures and Tables
Figure 1: China’s export growth fell with European and American economies in 2008-2009 (5)
Figure 2: Export value of the major products of China’s light industries fell quickly (5)
Figure 3: At the end of 2008, export value of furniture fell for the seventh consecutive month (5)
Figure 4: At the end of 2008, export value of lighters fell for the fifth consecutive month (5)
Figure 5:At the end of 2008, overall export volume bath and shower products such as water taps fell (6)
Figure 6: After 2008, export volume of candles stayed low (6)
Figure 7: In 2008, the hourly wage of China’s manufacturing industry was at a lower level globally (7)
Figure 8: The growth rate in China’s labor wage level is much higher than that in other countries (7)
Figure 9: For A-Share listed light industrial companies, the ratio of labor cost to sales revenue rose YoY (2005-2009) (7)
Figure 10: Degree of increase in minimum wage in the provincial cities in 2010 (7)
Figure 11: Taking a few companies as example, energy makes up 2%-5% of production cost (8)
Figure 12: Since early 2010 to date, the rise in energy and basic raw materials is notable (8)
Figure 13: Appreciation of Renminbi has a significant negative impact on export-led companies (8)
Figure 14: Fall in export tax refund has a significant negative impact on export-led companies (8)
Figure 15: Contributions to China’s GDP in recentyears: mainly depending on investment and export (9)
Figure 16: Ratio of private consumption in GDP in 2009: notably low in China (9)
Figure 17: Realization of “doubling national income”: ratio of labor income in national income rose from 45% to 60% (9)
Figure 18: High growth in Japan’s private consumption: average growth rate was 10% YoY (9)
Figure 19: In 1969-75, amount of consumption on furniture grew rapidly (CAGR 25%) (10)
Figure 20: Household goods industry saw significant gains (10)
Figure 21: During the period of the Three Directions in Korea, ratio of labor income in national income rose from 35% to 50% (10)
Figure 22: Ratio of expenditure on furniture, household goods, and culture and entertainment doubled: 5%-10% (10)
Figure 23: China’s urbanization steadily rises (11)
Figure 24: China’s GDP per capita rises rapidly (11)
Figure 25: Taking the furniture industry as an example, the future growth impetus mainly comes from demand for furniture replacement in urban residential housing, new furniture required, and consumption potentials in rural market due to construction materials going to the rural area (12)
Figure 26: Stages of transformation of China’s light industrial companies 13
Figure 27: Change in the style of IPO of light industrial companies (14)
Figure 28: Stages of transformation of China’s light industrial companies 16
Figure 29: Markor International Furniture (600337.SH): income from domestic sales grew together with the number of Markor Home stores, with 95.2% income CAGR in 2003-2009 (17)
Figure 30: Shenzhen Fiyta (000026.SZ): income from expensive watches grew rapidly with the number of Harmoney chain stores, with 49.9% income CAGR in 2002-2009 (17)
Figure 31: Domestic sales at Henan Rebecca Hair Products (600439.SH) grew 6X in 2007-2009 (17)
Figure 32: Guanfu Household’s (002102.SZ) “1510” brand sawincome growth at 7.5X in 2008-2009 (17)
Figure 33: Markor International Furniture: gross margin for domestic retail is notably higher than that for external sales (18)
Fiugure 34: The Great Wall (300089.SZ): the gap between gross margins for external and domestic sales continues to widen (18)
Figure 35: Fluctuations in export-only listed companies were notable in
2007-2009, while their net profit fell by 35.6% on average (18)
Figure 36: Net profit of doemstic sales companies was basically stable in 2007-2009, while net profit rose by 19% on average in 2008 (18)
Figure 37: Expense ratio of Markor International Furniture rapidly increased after 2003. High expenseratio dragged down the company’s performance (19)
Figure 38: Expense ratio of Henan Rebecca Hair Products rose rapidly after 2003, which dragged down performance (19)
Figure 39: At the final stages of transformation, multiple factors push up ROE (20)
Figure 40: Transformation map of China’s light industrial companies (21)
Figure 41: Demonstration of “Markor Home” showroom (23)
Figure 42: Product showcase of MHF Home (23)
Figure 43: High growth in China’s luxury goods market: 2004-2008 CAGR 43%, with 12% growth in 2008-2009 (24)
Figure 44: Shenzhen Fiyta’s (000026.SZ) income and profit maintain rapidgrowth (24)
Figure 45: Export recovery and bottoming out of gross margins for Henan Rebecca Hair Products (600439.SH) (26)
Figure 46: The number of stores in China for Henan Rebecca Hair Products (600439.SH) grows significantly (26)
Table 1: Major differences between external and domestic sales (13)
Table 2: Proceeds from IPO or additional offerings of light industrial companies in 2010 mostly went to the two ends of the smiling curve (15)
Table 3: Markor International Furniture’s (600337.SH) domestic sales continue to rise, and external sales are at a turning point (23)
Table 4: Earnings forecasts of furniture and household light industries26
Table 5: Earnings forecasts of paper and packaging and printing industries (27)
1. Overseas concerns and domestic potential facilitate market transformation
1.1 Difficulties in the export market
1.1.1 Increased risks in operating in overseas economies
Increased risks of operating in overseas economies. Impacted by the 2008-2009 financial crisis, demand in overseas markets have shrunk severely, which has made China’s export growth fall rapidly with the European and American economies. Major products of light industries were also impacted: for example, the products of major listed companies in the light industries sector such as furniture, lighters, water taps, and candles, showed drastic decreases in export volume at the end of 2008. Despite some recovery in export value after the crisis, the shadow of the financial crisis still looms, as most orders received by companies are short-term and pricing is difficult. With ever increasing trade protectionism, external uncertainties faced by export-led light industrial companies have increased .
Figure 1: China’s export growth fell with European and American economies in 2008-2009
Figure 2: Export value of the major products of China’s light industries fell quickly
Source: CEIC: Bloomberg; SWS Research Source: NBS; SWS Research
Figure 3: At the end of 2008, export value of furniture fell for the seventh consecutive month
Figure 4: At the end of 2008, export value of lighters fell for the fifth consecutive month
Source: NBS; SWS Research Source: NBS; SWS Research
Figure 5:At the end of 2008, overall export volume fell for bath
Figure 6: After 2008, export volume of candles remained low
and shower products (such as water taps)
Source: NBS; SWS Research Source: NBS; SWS Research
1.1.2 Comparative advantage of export companies gradually shrinks
Comparative advantage of export companies gradually shrinks. In the 1980’s to 1990’s,
China’s manufacturing industry enjoyed cost advantages with cheap labor, a stable
exchange rate, cheap resources, and all kinds of supporting policies, and took over the
transfer of manufacturing from Europe, America, Japan, and Korea. “Made in China”
became world famous. Now, with changes in labor cost, exchange rate, prices of resources,
and tax refund policies on exports, the cost advantage that export-led light industrial
companies once relied on, is gradually shrinking.
Cost of labor is rapidly rising, causing immense cost pressure. The enormous population
base and the imbalance in urban-rural development once provided China’s manufacturing
industry with abundant cheap labor. From a static point of view, the wage level of China’s
manufacturing industry is still far below that of the world’s major countries. In terms of time
series, the growth in China’s wage level tops the world. From 1999 to 2007, taking out the
price level increase, real wages grew at 12.95%. The rise in labor cost is also demonstrated
in listed A-Share paper manufacturers: from 2005 to 2009, cost of labor to sales revenue
gradually increased from 7.7% to 10.1% in 2009. As the provincial cities moved up the
minimum wage level in 2010, this trend is expected to continue going forward. The rise in
labor cost is not just a short-term phenomenon, it is a long-term trend. According to SWS’s
forecast, under the mixed influence of economic development, change in population
structure, and policies, the annual growth in wage level is likely to reach 20% over the next
five years.
Figure 7: In 2008, the hourly wage of China’s manufacturing industry was at a lower level globally Figure 8: The growth rate in China’s labor wage level is much higher
than that in other countries
Source: CEIC
Source: CEIC
Figure 9: For A-Share listed light industrial companies, the ratio of labor cost to sales revenue rose YoY (2005-2009)
Figure 10: Degree of increase in minimum wage in the provincial cities in 2010
Source: SWS Research
Source: SWS Research
The rise in prices of resources, appreciation of Renminbi, and reduction in export tax refund, etc…create pressure on company profits. Under the direction of energy saving and emission reduction, as well as price reform of production factors, prices of resources including water, electricity, gas, and oil, etc… have been rising continuously in 2010. As industry structure is upgraded and the economy intensifies, price reform of resource production factors will continue. With regards to exchange rate, the pressure on appreciation of the Renminbi will also become increasingly noticeable (1-10M10, accumulated appreciation of Renminbi against USD was 2.2%). With the government’s intention to adjust the way the economy grows and the industry structure, further reduction in the already high export tax refund is highly likely. For the average export-led company, the rise in prices of resources, appreciation of Renminbi, and reduction of export tax refund will all create pressure on profits. Leading companies may benefit from increased industry concentration, but the fall in cost advantage in international competition will be inevitable.
Figure 11: Taking a few companies as example, energy makes up 2%-5% of production cost Figure 12: Since early 2010 to date, the rise in energy and basic raw materials is noticeable
Source: IPO prospectus; SWS Research Source: SWS Research
Figure 13: Appreciation of Renminbi has a significant
negative impact on export-led companies
Figure 14: Fall in export tax refund has a significant negative impact
on export-led companies
Source: IPO prospectus of Yotrio Group; a calculation based on
export revenue of USD 250 mn
Source: IPO prospectus of Yotrio Group; a calculation based on
export reimbursement rate decline of 1%
1.2 Domestic demand to be activated. Growth prospects are promising
The mode of economic development changes from being led by export and investment to
being driven by internal demand. In recent years, the growth in China’s GDP was mainly
driven by export and investment, whereas the consumer market remained sluggish. In 2009,
the export market faced a shock, contributing -3.7%, while the contribution of investment
rose to 8.7% and contribution from consumption remained the same as in 2008. Laterally,
private consumption made up 35% of China’s GDP in 2009, noticeably lower than the major
countries in the world. The problems of relying on export and investment are increasingly
notable, such as over-capacity, high energy consumption, and imbalance in internal and
external development, etc... Looking ahead, consumption is an important engine that will
drive sustainable and healthy economic development in China.
Figure 15: Contributions to China’s GDP in recent years: mainly depending on investment and export Figure 16: Ratio of private consumption to GDP in 2009: particularly low in China
Source: CEIC; SWS Research Source: CEIC; SWS Research
We chose the period from Japan and Korea’s development, where the GDP per capita was
similar to China’s current situation. As national income grows rapidly, consumption of
household-related light industries enjoys rapid growth.
Japan’s plans to double national income in 1965: national income grew rapidly, and the
corresponding segments of domestic demand experienced exponential growth. From the
perspective of GDP per capita, China’s current development is similar to Japan’s plans of
doubling national income in 1965. In terms of development, there are similar problems such
as insufficient effective demand, large disparity between regional economies, industries
needing to be upgraded, etc... Both governments adopted economic stimulus measures
such as tax reductions, increasing infrastructure building, strengthening social security,
encouraging private investment, and developing regional economies. During this period,
Japan’s national income grew at a high rate: contribution of labor income to national income
rose from 45% to 60%, while private consumption maintained high growth of 10% YoY.
Household-related light industries, closely related to the domestic demand market, also
experienced exponential growth: from 1969 to 1975, the amount of consumption on
furniture grew rapidly per household at an annual average growth rate of about 25%. In the
capital markets, the household goods industry also saw significant gains.
Figure 17: Realization of “doubling national income”: ratio of labor income in national income rose from 45% to 60% Figure 18: High growth in Japan’s private consumption: average growth rate was 10% YoY
Source: CEIC Source: Datastream
Figure 19: In 1969-75, amount of consumption on furniture grew rapidly (CAGR 25%)
Figure 20: Household goods industry saw significant gains
Source: Datastream
Source: Datastream
The period of The Three Directions in Korea: national income increased, and ratio of consumption of household-related light industries increased. From the perspective of GDP per capita, China’s current development is similar to Korea’s Three Directions in 1985. Between 1981 and 1988, Korea implemented the “Three Directions”, which was aimed at stabilization (avoid blind investment and strive for reasonable allocation of resources), opening (introduce overseas capital and technology) and self-discipline (move from government-led to market-led) to reform the overall economic development strategy. In this period, the ratio of Korea’s labor income in GDP rose from 35% to 50%. The consumption structure also showed significant changes during this time: proportion of basic living expenses dropped from 72% to 56%, whereas the ratio of expenditures on furniture, household goods, and culture and entertainment doubled from 5% to 10%.
Figure 21: During the period of the Three Directions in Korea, ratio of labor income in national income rose from 35% to 50%
Figure 22: Ratio of expenditure on furniture, household goods, and culture and entertainment doubled: 5%-10%
Source: Datastream Source: Datastream
Similar to Japan and Korea, China’s consumption is about to enter the golden decade of
exponential growth, segments of household-related light industries will also benefit a great
deal. Reform in income allocation will further boost the rise in income per capita,
transforming potential consumption demand into effective demand. In addition, the rise in
the level of urbanization, education and consumption awareness will also become the driver
of China’s consumption growth, so that the corresponding segments of internal demand
industries will also benefit. Take household-related light industries as an example, the
driver for the next decade of growth comes from: 1) rise in the level of per capita income
and the awareness of more individualized consumption of furniture, leading to demand for
replacing furniture for the current 17.4 billion m2 of residential area in all of China. 2)
Urbanization is estimated to rise from 46% in 2009 to 60% in 2020, and residential area per
capita is estimated to rise from the current 28 m2 to 35 m2, generating demand for new
furniture for the increase of 13.7 billion m2 in urban and rural residential housing. 3)
‘Construction materials going rural’ drives consumption in rural markets. In 2010, the
central government issued “Document No. 1”, which put forward that as rural housing
construction was growing rapidly and construction materials were well supplied,
opportunities should be grasped to make supporting rural housing construction a major
measure in expanding internal demand, adopt effective measures to promote “construction
materials to the countryside”, and encourage farmers to build self-used housing in
compliance with the law. It is estimated that this measure will bring RMB550-600 billion in
new consumption to the rural furniture materials market every year.
Figure 23: China’s urbanization steadily rises Figure 24: China’s GDP per capita rises rapidly
Source: CEIC; SWS Research Source: CEIC
Figure 25: Taking the furniture industry as an example,the future growth impetus mainly comes from demand for furniture replacement in urban residential housing, new furniture required, and consumption potential in rural markets due to construction materials going to rural
Source: SWS Research
2. Demand for transformation: market transformation calls for
reform in business models
We believe that the transformation from external to domestic sales, is in essence, a reform
in business model.
External sales depend on “quantity”. In the external sales market, light industrial companies
participate in trade fairs, contact foreign trading companies and overseas distributors to
obtain orders, organize large-scale production, and face overseas markets indirectly. The
competitive edge for companies mainly lies in the scale of production capacity and
production management.
Domestic sales depend on “quality”. Faced with the more dispersed and complicated
domestic sales market, light industrial companies need to raise their overall
competitiveness in all sections of the industry chain from brand building, design capability,
customized production, control of sales channels, etc… Differentiated from the production
method for external sales, which was mainly OEM, companies engaged in domestic sales
need to discover demand, build up their own brand and channels, gradually build up
consumers’ trust and loyalty to the brand, and establish the brand’s fame and reputation. To
open up sales for products, companies must investigate and research and even create
market demand proactively to direct the public’s consumption habits. In organizing
production for internal sales, changes in the individual demand of end users need to be
considered, and uncertainty is greater. Therefore, there is a higher demand on the
company’s flexibility in production. Companies must actively work with distributors on all
levels, or build their own channels to fully penetrate the market.
Table 1: Major differences between external and domestic sales
External sales
Domestic sales
Competitive
edge
Demonstrated in sections of production: Product quality, productivity, cost control
Demonstrated in sections of industry chain:
Brand design, customized production, control of channels,
logistic support
Product
Single product, emphasis on sales volume Complete product line
Production control
Take production orders, produce according to orders
Large quantities, reliable production plan
Consider demand and end consumers:
Coordinate inventory and systematic production, flexible
production plan
Branding
Mainly OEM with others’ brands Create own brands Channel
Relatively simple and straightforward
Join trade fairs, contact foreign trading companies and
overseas distributors
Relatively complex
Look for domestic distributors themselves or build their
own channels
Market grasp Lower requirement
Higher requirement: proactively investigate and research
demand, create demand
Source: SWS Research
Transformation of light industrial companies can be divided into three stages. Rome was not built in one day. We think that the process of transformation can be divided into three stages: 1) first is the market transformation from external sales to domestic sales, 2) second is the strengthening of the two ends of the smiling curve: extension from manufacturing to brand design and channel service, adopting the operation model of light assets, inputting limited resources into sections with higher added value, and outsourcing production sections that have lower added value; 3) third is migration from a single brand to a multi-brand operational strategy, a process which highlights the brand effect with the enrichment of product types and the extension of the industry chain.
Figure 26: Stages of transformation of China’s light industrial companies
Source: SWS Research
Single brnd
Multi-brand
cluster
Transformation 3.0
Transformation on brand strategy
3. Process of transformation: sunshine after the rain
3.1 Transformation is about to happen
Change in the style of IPO of light industrial companies: key words of listed light industrial companies have changed from “export” and “manufacturing” to “domestic sales”, “design”, and “channel”. In 2005-2007, the A-Share listed light industrial companies mostly focused on manufacturing and the export market. In the past two years, light industrial companies with their own brand and channels directed at the domestic market, have started entering the A-Share market.
Source: SWS Research Note: According to the company definition when issuing public offerings, Guanfu Modern Household Wares (002102) partially converted its role to a channel provider.
From the flow of proceeds from capital raising activities, IPO and additional offerings of light industrial companies in 2010 were mainly spent on extending design and channels:
Companies that have already been transformed, build up their brands further and strengthen their hold on end user channels: for example, Markor International Furniture (600337.SH) plans to open 16 directly operated Markor Home chain stores and 33 MHF Home Style shops selling household products. Shenzhen Fiyta (000026.SZ) will implement the development and reform project on the “Harmony” watch chain stores. Henan Rebecca Hair Products (600439.SH) expects to develop a directly operated sales network (3 flagship stores + 10 concept stores + 30 directly operated shops).
More companies are on the road to transformation. In 2009, Guangdong Yihua Timber Industry (600978.SH), which had 99% export, set up 16 Yihua Global Home Experience
Centers all over China, based on which, 500 partnership stores were created, officially
entering the domestic market. Similarly, in 2009, The Great Wall (300089.SZ), which had
88% external sales, created a domestic distribution network with proceeds from the IPO:
opening of the Great Wall Shijia Direct Flagship Store with 200 distributors in different
provincial cities. Guanfu Household (002102.SZ) used the “1510” brand to build up an end
user retail brand, moving from the original manufacturing and distribution to channels.
Shenzhen Comix Stationery (002301.SZ) set up 40 city-level sales distribution branches,
100 Comix office equipment 5S flagship stores, and 30,000 end retail stores in an effort to
build up a model as the comprehensive supplier of office-related products: to become the
brand builder and supplier with R&D, production, and sales. Alpha Animation (002292.SZ)
and Guangdong Huafei (002502.SZ) not only invested capital to improve the end user
channels, but also actively developed the upstream production of animation and films, using
popular cartoon images to promote a hot sale for a product.
Table 2: Proceeds from IPO or additional offerings of light industrial companies in 2010 mostly went to the two ends of the smiling curve
Listed company
Planned
investment
Direction of capital Remarks
Markor
International Furniture (600337) 700 mn yuan
Open “Markor Home” chain stores: open 16 directly operated
chain stores with total planned area of 26,460 m2; open 33 “MHF
Home Style” household product chain stores.
Furniture and household products:
Transforming from external to
domestic sales/ OEM to self-own
brand/ manufacturing to design
and service
Guangdong Yihua
Timber Industry (600978) 84.85 mn yuan
Set up 16 Yihua Global Home Experience Centers in the country,
and 500 partnership stores
Furniture industry: transforming
from external to domestic sales
Fujian Guanfu
Modern Household Wares (002102) 282.90 mn
yuan
Set up 150 “1510” household products chain stores (93 in East
China, 35 in North China, and 22 in South China)
Household goods industry:
Transforming from manufacturing
to brand and channels
The Great Wall Group (300089) 59.64 mn yuan
Build up a domestic sales system, invest in building a
multi-function sales headquarters in Shenzhen and a domestic
distribution network
Household goods industry:
Transforming from manufacturing
to brand and channels 418.25 mn
yuan
Network development and reform of the Harmony watch chain
stores
Shenzhen Fiyta
Holdings (000026)
40 mn yuan Shenzhen Fiyta (000026.SZ) brand promotion project Watch making and sales industry: Transforming from manufacturing to brand and channels
Henan Rebecca
Hair Products (600439) 70.95 mn yuan
Build up a domestic sales system, a new sales network of 43
directly operated stores (3 flagship stores, 10 concept stores, 30
directly operated stores)
Hair product manufacturing
industry:
Transforming from external to
domestic sales / production to
service
Shenzhen Comix
Stationery (002301) 50 mn yuan
Build up the domestic sales network: 40 city-level sales
branches, 100 Comix office equipment 5S flagship stores, and
30,000 stationery end retail stores
Stationery industry:
Transforming from manufacturing
to brand and channels 205.02 mn
yuan
Industrialization of animation and film production and derivative
products
Guangdong Alpha
Animation and
Culture (002292) 75.52 mn yuan Improvement and upgrade of market channels and reform and
technological reform projects
Toy industry:
Transforming from manufacturing
to brand and channels
Guangdong
Huawei Toys Craft
81.44 mn yuan Animation production and sales network building projects
(002502)
Source: SWS Research
Figure 28: Stages of transformation of China’s light industrial companies
Source: SWS Research
3.2 During the transformation
Transformation contributes to new areas of growth in performance. In the process of
transformation, as the building of network expands, income from the new operating model
grows exponentially, giving companies new areas of growth in performance. This is
demonstrated in Markor International Furniture (600337.SH) and Shenzhen Fiyta
(000026.SZ), which have been transforming for 7-8 years, as well as Henan Rebecca Hair
Products (600439.SH) and Guanfu Household (002102.SZ), which have just started
changing their model to domestic retail. The number of stores of Markor International
Furniture (600337.SH) was 34 at the end of 2009, with revenue CAGR up to 95.2% in
2003-2009. At the end of 2009, Shenzhen Fiyta (000026.SZ) had 119 Harmony stores, and
income from prestigious watches also grew rapidly, with revenue CAGR up to 49.9% in
2002-2009. Henan Rebecca Hair Products (600439.SH) managed to build up the
consumption market for wigs while strengthening itself with the two brands “Rebecca” and
“sleek”, using the model of direct operation + partnership stores. Guanfu Household’s
(002102.SZ) income grew 7.5X over 2008-2009 depending on the “1510” retail brand. The
number of its stores is estimated to reach 150 in 2010.
Figure 29: Markor International Furniture (600337.SH): income from domestic sales grew together with the number of Markor
Figure 30: Shenzhen Fiyta (000026.SZ): income from expensive watches grew rapidly with the number of Harmoney chain stores, Source: Company Report; SWS Research Source: Company Report; SWS Research
Figure 31: Domestic sales at Henan Rebecca Hair Products (600439.SH) grew 6X in 2007-2009
Figure 32: Guanfu Household’s (002102.SZ) “1510” brand saw
income growth of 7.5X in 2008-2009
Source: Company Report; SWS Research Source: Company Report; SWS Research
Transformation raises profitability. Business transformation helps companies move towards the higher end of the value chain, giving them more power for price negotiation over the upstream, as well as better pricing power to the downstream. The profitability of companies can thus be raised to new highs. Take Markor International Furniture (600337.SH) as an example, in the last three years, gross margins of external sales have remained near 20%, whereas gross margins of domestic sales gradually rose to around 60%. The disparity between the gross margins for external and domestic sales for The Great Wall (300089.SZ) has also been widening.
Figure 33: Markor International Furniture: gross margin for
Fiugure 34: The Great Wall (300089.SZ): the gap between gross
Source: Company Report; SWS Research Source: Company Report; SWS Research
Transformation is the performance stabilizer. During the financial crisis in 2008-2009,
export-led companies saw noticeable fluctuations in their net profit. Faced with recession in
external demand, manufacturing companies lacking brand and channel control were
particularly passive and saw the largest fall in performance. In 2008, listed export
companies saw their net profit slide by 35.6% on average. In contrast, listed companies
directed at the domestic market had stronger resistance to cyclical fluctuations in profits.
With the help of stable domestic demand, net profit remained stable. In 2008, their net profit
still rose by 19% on average.
Figure 35: Fluctuations in export-only listed companies were notable in 2007-2009, while their net profit fell by 35.6% on average. Figure 36: Net profit of doemstic sales companies was basically stable in 2007-2009, while net profit rose by 19% on average in 2008
Source: Company Report; SWS Research Source: Company Report; SWS Research
Trouble with growth – high expense ratio impacts performance. The road of transformation
is not all smooth. Different from the focus on “quantity” in trade fairs, “quality” for domestic
sales is not achieved overnight, but is rather an accumulation of channel and brand over a
long period of time. This process inevitably involves a large amount of cost and expenses. Fees of rental, advertising, staff and opening shops that come with domestic sales, have made the expense ratio high for listed companies (that are undergoing transformation) for a prolonged period, dragging down performance. Take Markor International Furniture (600337.SH) as an example, in 2003, the first year of its domestic sales, the overall expense ratio was 21.6% (of which, the sales expense ratio was 11.1%), and in 2009, the overall expense ratio rose drastically to 34.1% (of which the sales expense ratio was 20.4%), making the operating profit just 5.7%, although the overall gross margin reached 39.8% that year.
Figure 37: Expense ratio of Markor International Furniture rapidly increased after 2003. High expense ratio dragged down the Company’s
Source: SWS Research
Figure 38: Expense ratio of Henan Rebecca Hair Products rose rapidly after 2003, which dragged down performance
Source: SWS Research
At the final stages of transformation, multiple factors can boost ROE to increase. It is estimated that at the final stages of transformation, the further expansion of the sales network, particularly the opening of access in tier-two and tier-three cities, will allow domestic sales companies to get into contact with a wider group of consumers. As the
brands become more well-known, effectiveness per store is likely to rise significantly,