Shenzhou International kicks off roadshows in Japan

China''s largest knitwear manufacturer banks on vertically-integrated model to tempt investors.

In an unusual move, Zhejiang-based Shenzhou International launched its roadshow for its November Hong Kong IPO in Japan yesterday (October 12). Shenzhou - China's largest knitwear manufacturer on a net income basis - chose to kick off in Japan because it represents the company's biggest export market.

Pre-greenshoe, it is hoping to raise $101 million to $115 million based on the sale of 300 million new shares, which are being marketed on a price range of HK$2.63-HK$2.99 per share. BNP Peregrine Paribas is lead manager and sponsor of the deal.

The final free float will represent 25% of the company's share capital, resulting in a market cap of around $400 million to $460 million. Shenzhou International is 75% owned by 41-year old Ma Jianrong, who took over the core knitwear operations from his father in 1989. Ma has some 20 years experience in the knitwear business.

Based on the indicative range, Shenzhou is being marketed on a valuation of 9.5 to 10.8 times 2005 earnings - a discount to sector comps, which average roughly 11.8 times. Its lower valuation is the result of the need for an IPO discount and fact that the sector has been hit by trade disputes.

Shenzhou is China's biggest knitwear exporter to Japan. (Knitwear is a stretchy fabric made up of cotton and artificial fabrics used, for example, in football jerseys). Last year, for example, Shenzhou produced 68 million garments, of which 60 million went to Japan.

There have also been unconfirmed rumours that the company's biggest customer, Japanese retailer Uniqlo, has taken a strategic stake in the company. Uniqlo is one of the world's largest retailers of fashionable, low-priced clothing and recently opened stores in Hong Kong, Shanghai and New Jersey.

In addition, the company is well known to Japan's trading companies and sourcing agents. Specialists say the company's long-standing relationships with its Japanese customers is an attractive feature, especially as Japan does not impose quotas on knitwear from China.

In contrast, the Chinese textile industry's trade with the EU and the US has been hit by fierce quota disputes this year. This may benefit Shenzhou relative to its main listed comps, which primarily export to the US.

Shenzhou's non-Japan customers include Adidas, New Balance, Converse and Itokin. In 2004, the company produced 33,000 tons of fabric, most of which it used in-house, making Shenzhou China's leading vertically-integrated knitwear company.

The compan is said to be involved in every stage of the knitwear manufacturing process, from helping customers design the fabric to the actually knitting, dying and cutting and sewing. Knitwear is harder to sew than pure cotton and hence require special machinery.

The vertical integration reduces the time the company needs to get its products to the market by ensuring that production problem are resolved quickly on-site. The company's main products are casual wear and sports wear, but Shenzhou is shifting its focus from casual wear to higher-priced sports wear.

Casual wear costs Rmb25-35 per item, while sports wear costs Rmb35-45. The industry average for sports wear is around Rmb 20. Specialists say the difference is that higher margins can be charged in Japan.

Rough comparables include Texwinca, Fountain Set, Weiqiao Textile and Luen Thai. However, Texwinca, Fountain Set and Weiqiao Textile have a predominantly upstream presence, focusing on producing the yarn to make the cloth and fabrics used further downstream.

Luen Thai, although it does help customers source fabrics, focuses more on downstream operations than upstream. Last year, Shenzhou had revenues of Rmb2.1 billion ($260 million), with revenues of Rmb2.4 billion forecast for this year.

Net profits came in at Rmb308 million in 2004 (or Rmb588 million if the sale of some land is included), with Rmb345 million forecast for 2005. Revenue CAGR reached 30% between 2002 and 2004, while net profit showed CAGR of 56% for the same period.

Shenzhou's gross profit margins were around 22% last year, with 23% forecast for this year, compared to 17% for Weiqiao Textile and 26% for Texwinca (including Texwinca's retail higher-margin operations). Luen Thai scored 17.6%.

As China's largest knitwear company, Shenzhou is said to benefit from favourable government treatment. The mainland government is keen on consolidation, especially as the smaller mills have a worse environmental record than the larger ones. (The textile industry is a major polluter, because it requires large amounts of water, much of which is then expelled from the factory without being treated).

Shenzhou, which has advanced water cleaning facilities, recently got a quota share of five million garments out of a total quota of 8.5 million to the EU to July 2006. This means that Shenzhou has a golden opportunity to expand into the European market, point out specialists. It is likely that the company will be equally favoured when the government issues new quotas to the US.

IPO proceeds will be used to reduce the company's debt to equity ratio from 130% to roughly around 30%. Debt was incurred during the construction of a new 500,000 square metre factory in Zhejiang province. The factory is the new principal production site.