New World markets another China retail play

New World Department Store aims to raise about $300 million from its Hong Kong IPO.
Investors who failed to get their desired allocations of BelleÆs heavily oversubscribed initial public offering last month, will get another chance to add to their China retail portfolios through New World Department Store ChinaÆs upcoming IPO of about $300 million.

The company, which is a wholly-owned subsidiary of Hong Kong-listed New World Development, is currently pre-marketing the issue and will launch a formal roadshow on June 25.

The offering, with is jointly arranged by Deutsche Bank and HSBC, will comprise 25% of the enlarged share capital, equivalent to 406 million new shares. Of the total, 5.6% will be reserved for existing shareholders of New World Development, 84.4% will go to the institutional tranche and 10% will be earmarked for retail investors. There is also a clawback mechanism that could increase the retail tranche to as much as 50% in case of heavy oversubscriptions.

The price range will be set closer to the launch of the institutional roadshow with the final price expected to be determined on July 5. The trading debut is scheduled for July 12.

Having opened its first department store in 1994, the companyÆs growth model is closely linked with ChinaÆs economic expansion as rising incomes and a growing number of ônouveau richeö spenders continue to drive consumption û particularly with regard to luxury goods.

According to China Association of Branding Strategy, 175 million or 13.5% of the countryÆs population can now afford a variety of luxury brands and roughly 13 million of these people are also active buyers on a regular basis. Syndicate research projects that Chinese department store sales will accelerate from a compound annual growth rate of 8.4% in 2001 to 2005, to 11.5% in 2006 to 2010.

The trading performance of Hong Kong-listed Parkson Retail Group and Golden Eagle Retail, which are competitors as well as close comparables of the listing candidate, does give an idea of how enthusiastic investors are about the countryÆs department store sector.

Both stocks have more than doubled since their respective listings in November 2005 and March 2006. Parkson, as the first-mover and the larger of the two, reached a closing high of HK$57.90 in April - 490% above its IPO price of HK$9.80 û before edging slightly lower over the past couple of months. Yesterday it closed at HK$52.05.

Golden Eagle gained 119% last year from a March 2006 IPO price of HK$3.15. Since then, however, it has been on a slight declining trend, closing yesterday at HK$6.45.

New World Department Store operates 16 self-owned and 12 managed stores in 16 provinces or municipalities in Greater China, ranking fifth in terms of revenues and second to Parkson on geographical reach. More than 60% of its stores are located in the most prosperous cities in the country.

Analysts say the operatorÆs net profit could double to HK$426 million ($54.5 million) in the fiscal year to June 2009 from HK$207 million in fiscal 2007. Net profit more than doubled to $19 million in fiscal 2004 to 2006, while sales rose 60% in the same period. The department store operator also recorded a gross profit margin from direct sales of 25% in calendar 2006, which was the highest in the sector, exceeding ParksonÆs 16.6% and Golden EagleÆs 18.8%.

One syndicate research report estimates a fair value market capitalisation of HK$6.9 billion ($883 million) to HK$9.9 billion, which is equal to 25 to 37 times its estimated earnings for fiscal 2008. Parkson and Golden Eagle are currently trading at estimated 2008 price-to-earnings multiples of 32.4 and 24.3 respectively.

Store expansion will be a key growth driver for New World Department Store with projections that it will increase its total operating sales area by 95% from fiscal 2006 to 2009. This could boost direct sales by 106% during this three-year period to HK$178 million, while commission revenues could increase by 131% to HK$1.4 billion.

ôThe operator has a tight plan of department stores acquisitions going forward. Proceeds from the IPO are going to be used for further expansion,ö says a source. ôRegarding access to land bank for department store network built-out, it has an edge over its competitors by being close to New World Development, which develops property in China through New World China Land.ö

New World Department Store enjoys a first right of refusal to acquire any of the 12 stores it manages but doesnÆt currently own and has options to acquire four of them. It is also believed that New World Development is likely to invite the operator to manage department stores that it will build at its new sites. As the operator seeks to get more stores under managed and new management contracts come on line, its management fees are expected to reach HK$187 million by fiscal 2009, more than a triple the amount received three years earlier.

ChinaÆs retail sector was opened by the end of 2004 in connection with the countryÆs accession into the World Trade Organisation, permitting full business ownership for foreign retailers. Among the potential risks related to this are increasing competition from both local and foreign players, which in the long run could trigger a drop in sales and shrinking profits.

For instance, KoreaÆs largest retailer Lotte Shopping plans to enter the Chinese market in 2008 through a joint venture in Beijing. Parkson and Golden Eagle are both going to carry out expansion plans this year, while other local competitors such as Wangfujing are also moving upmarket. The rapid development of local shopping malls is likely to pose risks to the operatorÆs client base and loss of concessionaire partners, which generate commission incomes accounting for 80% of its self-owned storesÆ total net turnover.

With the highest rental cost to sales ratio among it peers at 28%, the operator is also facing persistent rental pressure. And this is likely to get worse as the company is currently searching for new store sites, while retail rents are surging. The research report estimates its operating lease costs will increase 93% to HK$453 million in fiscal 2009 from fiscal 2006.

WomenÆs shoe manufacturer and retailer Belle International attracted a mind-boggling $120 billion worth of orders for its $1.1 billion IPO in May. On the retail side the demand translated into an order value of HK$446 billion ($57.3 billion), which was higher than the HK$423 billion committed for Industrial and Commercial Bank of ChinaÆs world record-breaking $21.9 billion IPO and made Belle the most popular retail offering in Hong Kong ever.

It is also the largest Chinese retailer listed in Hong Kong with a market capitalisation of about $8.6 billion.
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