Guotai Junan Securities (Hong Kong) Limited

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1 Code: 0304.HK Industrial Sector Peace Mark (Holdings) Limited Investment Summary March 23, 2001 Year ended March F 2002F 2003F Turnover (HK$ 000) 784, , ,293 1,082,739 1,129,506 YoY Change (%) 5% 10% 20% 4% EBITDA (HK$ 000) 62, , , , ,365 YoY Change (%) 64% 20% 2% 39% Net profit (HK$ 000) 24,073 17,224 33,723 39,161 76,583 YoY Change (%) -28% 96% 16% 96% EPS (HK$ cent) YoY Change (%) -29% 61% 15% 96% PER(x) l With a track record of almost 20 years, the Group has successfully developed its niche in producing high quality, mid-priced fashion and sports watches. In the year ended March 2000, the Group produced about 7.5million pieces of watches and clocks in hundreds of different models. l In 1999, the Group changed its strategy to focus on its core timepieces business. As a result, gross profit margin is expected to increase gradually from 13.76% in 2000 to 15.98% in 2001, and 19.3% in l The Group will focus on developing higher margin, licensed products such as fashion and sports watches in the coming years. l In January 2000, the Group won a three-year license to design and manufacture timepieces under the sports brand name of UMBRO. The Group also plans to distribute these products outside of Europe. l The Group is currently negotiating licenses for three global brands and expects to win them in the near future. l Hong Kong is a leader, together with Japan and Switzerland, in producing watches and clocks for export. In 2000, total exports of timepieces from Hong Kong amounted HK$43.7bn. The major markets for these timepieces were the United States and the European Union, which absorbed 25% and 22%, respectively, of Hong Kong exports in this category in Share price performance LONG TERM BUY Share data Share Price (HK$) mth average daily travel vol (m) Wk H/L 0.223/0.039 Issued shares (m) 3678 Market cap. (HK$m) 162 Free float (%) 73 ROE (%) 6% Debt/asset (%) 33% NAV per share (HK$) Winnie Wong (852)

2 Disclaimer This report has been prepared as part of the normal research activity of Guotai Junan Securities (Hong Kong) Ltd., which may, from time to time, participate as an underwriter, syndicated distributor, or market maker for the stocks mentioned. This report is intended for specific clients and other intended professional users only. Any unauthorized distribution and/or circulation of this report or the copy thereof beyond the intended scope would result in possible violation of pertinent securities laws. The content of this report is neither an offer to buy nor a solicitation to sell any securities referred therein. In compiling this report, we relied on the information and data from the sources we believe to be reliable. However, the accuracy and integrity of the sources have not been independently verified. This report may contain some forward-looking forecasts and statements derived from the assumptions for future political and economic conditions, which are inherently unpredictable and mutable. The opinion expressed is solely of the analysis and personal point of view of the analysts. It should neither be interpreted nor construed as an official position of Guotai Junan Securities (Hong Kong) Ltd. Investment in the stocks herein referred may involve various degree of risks, the readers are advised to consult their own related professionals before doing so. 2

3 Group Background Peace Mark (Holdings) Limited was established in Hong Kong in 1983 as a manufacturer of clocks and watches for export. In February 1993, it was listed on the Hong Kong Stock Exchange. EganaGoldpfeil International Holdings Ltd. subsequently acquired a 30% stake in the Group in 1995 from a substantial shareholder, Mr. Ho Suk Man. EganaGoldpfeil currently holds 16.5% of the Group through its wholly owned subsidiary Glorious Concept Limited. Since 1994, the Group had also participated in distributing Arabica coffee, bakery products, wines and spirits, and manufacturing leather goods. However, due to unsatisfactory operating results, the Group discontinued its food and beverage activities and transferred its leather business to EnganaGoldpfeil in 1999 to concentrate on its core timepieces business. Currently, the Group is primarily engaged in the design, manufacture and trade of watches and clocks on an OEM and ODM basis and for private labels. The Group s management office and R&D team are based in Hong Kong, while its production facilities are located in Shenzhen, China. Group Organization Chart EganaGoldpfeil 100% Glorious Concept Ltd Chau Cham Wong, Patrick 16.5% 10.2% THE COMPANY Design, mft. & sale of clocks & watches Source: Company interim report, GTJAS Research Relative performance Source: Reuters 3

4 Industry Overview Hong Kong is a leader, together with Japan and Switzerland, in producing watches and clocks for export. Swiss manufacturers produce high-end, luxury watches, compared to the low to medium-end products, ranging in price from US$2 to US$200, of manufacturers in Hong Kong and Japan. As a result, Hong Kong faces keen competition from Japan relative to Switzerland. In 2000, total exports of watches and clocks from Hong Kong amounted to HK$43.7bn, representing a growth rate of 4.1% compared with that in The major markets are the United States and the European Union, which absorbed 25% and 22%, respectively, of Hong Kong watch and clock exports in In the past decade, watches have more often been considered as accessories, matching fashion and sport apparel trends in the US and the EU, rather than timepieces. Instead of replacing the battery in a watch, which lasts on average for two years in a casual watch, a watch owner is likely to buy a new watch. Thus, the demand for inexpensive watches is expected to remain strong. We expect the Hong Kong watch and clock industry to benefit from continuing strong demand for its products. This is supported by imports and retail sales in the US, which remained strong in the first two months of 2001despite the economic slowdown. Source: US Census Bureau 350,000 US Total Retail Sales 300, ,000 US$ in million 200, , ,000 50,000 0 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Source: US Census Bureau 4

5 Business Analysis The Group s major business is the manufacture of OEM and ODM timepieces. In addition to procuring the exclusive right to manufacture mini clocks under the trademarks of Dugena and Pierre Cardin, the Group has won the license to manufacture and distribute watches under the world-renowned sports brand name UMBRO. In the year ended March 2000, the Group recorded total turnover of HK$821mn. North America, Europe and Asia (including China) comprised HK$493mn (60%), HK$292mn (35.6%) and HK$36mn (4.4%), respectively, of total turnover. Turnover divided by geographical markets in 2000 Europe 36% Asia 4% North America 60% Source: Company data Focuses on producing high quality, mid-priced fashion and sports timepieces Over the almost 20 years it has been in operation, the Group has successfully developed its niche in producing high quality, mid-priced fashion and sports watches. In the year ended March 2000, the Group produced about 7.5million pieces of watches and clocks in hundreds of different models. Prices of the Group s products range widely, from US$3 to US$300; however, sales volume peaks at an average price of about US$15. Most products selling at this price level are fashion and sports watches, which are in strong demand in the US and Europe. The Group s R&D team comprises seven professionals, who are capable of designing popular timepiece styles to meet customers specific requirements. The team presents new designs on a weekly basis. The high quality of the Group s products is well recognized by the industry. Pursuant to obtaining ISO 9001 accreditation in 1999, the Group was awarded the Hong Kong Productivity Council Certificate of Merit in Productivity in We believe the Group s high quality products and strong in-house R&D team are capable of supporting future business growth. Efficient production The Group presently has 14 production lines manufacturing traditional watches and clocks, and one production line specially fitted to produce metal mini clocks. The total annual production capacity is approximately 10.5 million pieces. 5

6 Production output and percentage of usage Fiscal Year Turnover Average Production Percentage of (HKD Million) Output (mn of pieces) Usage % 2001F % 2002F % 2003F % Sources: Company data, GTJAS estimates We estimate that 89% of the Group s production capacity will be utilized in the next two years. Therefore, the Group is capable of supporting rapid turnover growth under no further pressure to build new production facilities, or increase capex. Strong OEM distribution network provided by parent company The Group s parent company, EganaGoldpfeil is an active player in the jewelry and watch market in Europe, where it has a large and efficient distribution network. The Group assembles watches for EganaGoldpfeil s OEM customers while EganaGoldpfeil refers OEM customers to the Group, which avoids having to develop its own OEM sales network in Europe. Given this cohesive relationship, we expect the Group to continue to benefit from this distribution model for its OEM products. Gross profit margin to expand from business restructuring Following its decision to focus on its core timepieces business in 1999, the Group achieved a high degree of vertical integration by acquiring and installing new machinery to manufacture stainless steel cases and bands. It also leased a building in Shenzhen to set up an electroplating factory, which will start operation in mid As a result, we estimate the Group s gross profit margin to increase gradually from 13.8% in 2000 to 16.0% in 2001 and 19.3% in Business divisions Timepieces manufacturing Existing core business with 19,260squ.m production areas in Xixiang, Shenzhen Watches 14 production lines, annual products 10.5mn pieces Mini clocks 1 production line Stainless steel cases and brands Expended in 1999 Electroplating Expected to fully operate in mid 2001 with 5,600squ.m production areas in Songgang, Shenzhen Licensed timepieces distributing Expected to start in mid 2001 Food and beverage Discontinued in 1999 Leather business Disposed in 1999 Sources: Company data, GTJAS Research Sales of higher margin products expected to increase Currently, the average gross margin of the Group s timepieces is approximately 19%, compared to 17% for ODM and 15% for OEM products, and about 40% for licensed products. In January 2000, the Group won a three-year license to design and manufacture timepieces under the sports brand name of UMBRO, which is popular in the UK. The Group also has the right to distribute these products in markets other than Europe. The Group plans to establish its own distribution networks to sell this brand in Asia. It will spend approximately HK$30mn on the marketing and promotion of the brand at the World Cup Soccer tournament to be held in Korea and Japan in

7 With a focus on developing licensed products such as fashion and sports watches, the Group s negotiations on licenses for three brands are expected to be completed in the near future. Thus, we estimate turnover from licensed products will increase from 14% in 2002 to 18% in Key assumptions 2001F 2002F 2003F Turnover breakdown by business ODM 80% 69% 66% OEM 20% 17% 16% Umbro 14% 18% Total 100% 100% 100% Gross profit margin breakdown by business ODM 16% 17% 17% OEM 16% 15% 17% Umbro 40% 40% Total 16% 19% 21% Net profit margin breakdown by business ODM 3.7% 3.2% 2.9% OEM 3.7% 3.2% 2.9% Umbro 5.8% 25% Total 3.7% 3.6% 6.8% Source: Company data, GTJAS estimates 7

8 Investment concerns Cash position Even though the Group currently has approximately HK$100mn on hand, its trust receipt loans and bank overdrafts balances are high, totaling about HK$200mn. Moreover, as a result of major capex on acquiring fixed and intangible assets for the year, we therefore estimate the Group s total cash and cash equivalents will be a negative HK$109mn at the end of March Furthermore, with the Group s investment in securities as a liquid asset, we expect its net debt to equity ratio to be 14% in 2001 and 27% in Expenditure on sales network will squeeze net profit margin We estimate the Group s gross profit margins at 16%, 19% and 21% respectively for 2001, 2002 and 2003 compared with net profit margins of 3.73%, 3.61% and 6.78% in those years. Net profit margin is expected to decrease in 2002, with the Group s plan to invest about HK$30mn to promote its UMBRO brand products in Asia, and rise as its sales network becomes more developed. Peer comparison In FY 2000, the Group s net profit margin was 2%, a satisfactory level compared to competitors in Hong Kong and Japan which recorded losses or had lower profit margins. Trading at a 7.6x PER, the Group s stock is cheaper than the 44x average PER of its peers. Peer comparison Share Issued Market GP NP Reuters Price Shares Cap Turnover Margin Margin EPS PE Code Company Name (Year ended) Curr. (3/23/01) (mn) (mn) (mn) (%) (%) ($) (x) 0104.HK Asia Commercial Holdg. Ltd (3-00) HKD % -4% n.a 0926.HK Egana Jewellery & Watche (12-99) HKD % 10% HK Medtech Group Co. Ltd (12-99) HKD % -17% n.a 6952.T Casio Computer Co Ltd (3-00) JPY , ,289 23% 1% T Citizen Watch Co Ltd (3-00) JPY , ,912 13% 1% T Orient Watch Co Ltd (3-00) JPY ,216 27,948 11% -5% n.a 7769.T Rhythm Watch Co Ltd (3-00) JPY ,793 31,497 23% -21% n.a UHRZ.S The Swatch Group (12-99) CHF ,054 3,518-3% 13% TIMX.BO Timex Watch Ltd (2-99) INR % -26% n.a 0304.HK Peace Mark Holdings Ltd (3-00) HKD % 2% Mean 20% -5% 44 Source: Reuters, GTJAS Research Recommendation We estimate the Group will experience an average annual growth rate of 18.6% in turnover from HK$904mn to HK$1130mn in FY2001 to FY2003, and of 55.5% in net profit from HK$34mn to HK$77mn due to the restructuring of its business. The Group s stock is trading at a reasonable PE multiple of 4.7x at 2001F earning, and 0.29x price to book value; thus, we rate the shares as a Long Term Buy. 8

9 Income Statement (Year ended March 31, HK$ 000) F 2002F 2003F Turnover 784, , ,293 1,082,739 1,129,506 Cost of sales (687,140) (708,204) (759,781) (873,549) (889,240) Gross profit 96, , , , ,266 Other revenue 22,586 25,935 27,220 23,014 21,352 Distribution costs (17,778) (14,662) (25,211) (82,502) (62,453) Administrative expenses (27,219) (18,293) (19,085) (20,323) (21,562) Other operating expenses (12,317) (4,121) (4,982) (5,019) (5,238) EBITDA 62, , , , ,365 Depreciation and amortization (17,952) (31,868) (45,528) (42,835) (55,962) Finance costs (11,589) (10,375) (29,623) (30,323) (26,329) Other expenses (7,575) (43,230) Share of loss of associate (3,496) Profit before taxation and minority interests 21,582 16,339 47,303 51,202 90,074 Taxation (1,327) (1,385) (15,851) (14,312) (15,762) Minority interests 3,817 2,271 2,271 2,271 2,271 Profit attributable to shareholders 24,073 17,224 33,723 39,161 76,583 Earning per share Basic(cent) Diluted(cents) Weighted avg. no. of shares( 000) 2,969,679 2,993,106 3,634,098 3,678,223 3,678,223 Diluted Weighted avg. no. of shares( 000) 2,969,679 2,993,106 3,648,407 3,678,223 3,678,223 Outstanding no. of shares( 000) 2,982,723 3,081,723 3,678,223 3,678,223 3,678,223 Source: Company data, GTJAS estimates 9

10 Balance Sheet (As at March 31, HK$ 000) F 2002F 2003F Fixed assets 111, , , , ,305 Intangible assets 16,622 31,437 55,014 51,305 80,328 Investment in securities 56,490 64,295 30,383 30,383 30,383 Interest in an associate 8,245 Investment in distributors 40,000 80,000 Club debentures 1,498 1,498 1,498 1,498 1, , , , , ,514 Current assets Inventories 139, , , , ,116 Debtors, deposits and prepayments 110, , , , ,436 Bank balance and cash 116, , , , ,742 Total current assets 366, , , , ,294 Total assets 560, , ,565 1,077,601 1,094,808 Current liabilities Creditors and accrued charges 37,592 41,332 64,378 92,059 96,647 Bank borrowings 91, , , , ,161 Obligations under finance leases and hire purchase contracts 1,715 3,339 3,807 3,302 3,735 Taxation 2,664 (5,643) 15,100 14,300 15,700 Total current liabilities 133, , , , ,243 Net current assets 233, , , , ,051 Total assets less current liabilities 427, , , , ,566 Capital and reserves Share capital 296, , , , ,822 Reserves 99, , , , ,703 Shareholders equity 396, , , , ,525 Minority interests 22,747 21,987 24,250 26,433 29,433 Bank borrowings due after one year 7,531 5,834 56,800 22,988 6,487 Obligations under finance leases 1, ,000 1,121 and hire purchase contracrs Deferred taxation , , , , ,566 Source: Company data, GTJAS estimates

11 Cash Flow (Year ended March 31, HK$ 000) F 2002F 2003F Operating profit before taxation 21,582 16,339 47,303 51,202 90,074 Net interest 7,858 7,284 26,408 32,363 25,908 Depreciation & amortiation 17,952 31,868 45,528 42,835 55,962 Loss/(gain) on disposal and write off of assets (10,618) (11,065) Adjustment for investments 12,060 Chang in working capital 52,955 (47,760) (138,274) (88,836) 33,650 Cash flow from operating 101,790 (3,335) 19,035 37, ,594 Returns on investments and servicing of finance (26,740) (6,685) (28,416) (32,686) (26,123) Taxation paid (225) (9,716) 5,713 (15,122) (14,325) Investment and capital expenditure (42,217) (48,446) (195,125) (39,691) (100,365) Share issue 11,200 59,650 Cash flow from financing 17,758 14, ,612 (27,129) (11,030) Cash flow for the year 50,365 (54,066) (85,181) (77,064) 53,751 Cash and cash equivalents at beginning of year (19,687) 30,678 (23,388) (108,569) (185,633) Cash and cash equivalents at end of year 30,678 (23,388) (108,569) (185,633) (131,882) Source: Company data, GTJAS estimates Ratio Analysis (Year to March 31) F 2002F 2003F Operating ratio EBITDA margin(%) 8% 12% 14% 11% 15% Net profit margin(%) 3% 2% 4% 4% 7% EPS growth(wtd avg.) (%) -29% 17% 15% 96% EV/EBITDA(x) Inventory days Receivable days Payable days Valuation ratio EV / share(hk$) PER(x) Price / book(x) ROE(%) 6% 4% 6% 7% 12% ROA(%) 4% 3% 3% 4% 7% Financial ratio Current ratio(x) Quick ratio(x) Debt ratio(x) Net debt/ equity(%) cash cash 14% 27% 15% LT debt/equity(%) 25% 32% 58% 62% 44% Interest cover(x) Source: Company data, GTJAS estimates

12 Guotai Junan Securities (Hong Kong) Ltd. 25/F, Asia Pacific Finance Tower, 3 Garden Rd., Central, Hong Kong. Tel: (852) Fax: (852) Guotai Junan Securities Company Ltd. No.135, YanPing Road, Shanghai(200042) P.R.China Tel: Fax: District Headquarters Shenzhen Headquarter No.2008, ChunFeng Road, Shenzhen (518002), GuangDong Province,P.R. China Tel: Fax: Shanghai Headquarter No.369, JiangSu Road, ShangHai (200050),P.R. China Tel: Fax: Beijing Headquarter No.3, DeWai Street, BeiJing (100088),P.R.China Tel: Fax: Chengdu Headquarter No.48, RenMing East Road, ChenDu, (610016), SiChuan Province,P.R.China Tel: Fax: Wuhan Headquarter No.77, ZiYang East Road, WuHan (430070), HuBei Province,P.R.China Tel: Fax: