China Hongx Research Report

by CIMB-GK (15 Oct)

IN MID-NOVEMBER 2007, China Hongxing Sports placed out 400 million new shares at S$1.18 each to raise net proceeds of 2.3 billion yuan (S$493 million). The money was meant to fund its expansion plans.

Hongxing set aside 1.3 billion yuan from the proceeds to aid its distributors with the opening of 420 mid-sized stores from Q4 2007 till Q4 2008. The rationale for this was to secure key retail locations.

Under these arrangements, Hongxing secures leases for the distributors, who are obliged to pay first-year rentals in instalments over 12-15 months. After the first year, the leases are transferred to the distributors. These advancements are recorded as prepayments on Hongxing's balance sheet.

As at end-Q2 2008, Hongxing had advanced 962 million yuan to distributors to facilitate the establishment of 319 mid-sized stores. It had also collected 34 per cent of the 227.5 million yuan advanced in Q4 2007, in line with the 12-15 month repayment period. The last advancements to distributors will take place in the second half of 2008. Management says that the collection of advancements has been smooth.

Although we project negative free cash flow (FCF) for Hongxing for FY2008 due to the spike in its working capital and capital expenditure, we expect its FCF to turn positive in FY2009-2010, as the group starts to reap benefits from its expansion.

We project capital expenditure of around 480 million yuan over FY2008-2010, to be partly funded by placement proceeds. We believe that concerns over its negative FCF have been overplayed, given that it is still in a net cash position of about two billion yuan.

Earnings for the rest of the year should be bolstered by a strong order book of 1.5 billion yuan. Our TP remains based on eight times CY2010 PE, the lower end of its historical band.

-Research Report by CIMB-GK (15 Oct)