Friday, May 09, 2008

Hongguo - Profitability part 1


Let’s take a closer look on the profitability of Hongguo. To really see how good/bad Hongguo is, it’s inevitably that I’ll have to look through its main competitors – Belle and Prime Success again. Below is my calculated data, after spending days poring hunting down annual reports and compiling them.

Prime Success is the longest listed company out of the trio, while Belle is the youngest, having been listed only in May 2007 (though it had been in business for a far longer time). As such, do take Belle’s data with more skepticism than your normal dosage.

Here, I’ll just focus on ROE, ROA and the margins.


We can see that for the trio, all ROE is relatively high as it should be, given their market position in PRC. Hongguo has a more consistent and steadily increasing ROE, while Prime success’s ROE peaks at 2004 and is steadily declining ever since. In ascending average ROE, Belle is ranked first, followed by Hongguo then Prime. Since Prime success is touted as Hongguo’s main competitor (see previous posting), we ought to do a closer comparison between the two.

As mentioned earlier, Prime has a spottier ROE compared to Hongguo. On average over the same period of time, Prime has a lower ROE of 24.50% compared to Hongguo’s 25.77%. It seems like Hongguo is better at investing retained earnings than Prime does. It’s not surprising given that Hongguo has the smallest market share among the trio, and the bigger competitors will always find it harder to invest in themselves than when they are much smaller.

I am quite pleased with the stability of Hongguo’s ROE though, it definitely makes valuation much more predictable.


Actually, whatever had been mentioned for ROE can be copied directly to this part. In ascending average ROA, again we have Belle ranked as the top, followed by Hongguo and finally Prime.

Hongguo showed steadily improving ROA, while Prime shows a spottier ROA record, like what we’ve seen earlier on its ROE. Again, I’ll attribute this partly to the smaller size of Hongguo. The management must also play a certain part in creating these figures, since not all can be explained by just the size of the company. In this aspect, Hongguo is once again ranked highly by being consistent.

Gross and net margins

Net margin for Hongguo is showing a decline, though its gross margins increases. Since gross margins didn’t decline along with net margins, I believe that it is the increasing expenses of maintaining a greater sales force and expansion plans that causes the decline in net margins. I would start to worry if after the expansion plans slows down, the net margins still didn’t improve, or if the gross margins start to drop. If this scenario actually plays out, I’ll have reasons to believe that somehow, the brand of Hongguo is no longer as attractive as it is now, so they can’t pass the rising costs down to consumers. As it is now, it’s more reasonable to adopt a wait-and-see attitude to see if the net margins can improve in the future.

Prime is also expanding rapidly, yet their net margins didn’t drop. In fact, for Prime, gross margins increases while net margins remain more or less constant. Strange isn’t it? I’ll keep a lookout on this point for Hongguo.


Earnings come from two parts – volume of sales and price of sales. A company with low net margins, selling huge volume can rival that of another company with high margins but with lesser volume.

Prime seems to be the low net margins, high turnover kind, judging from its asset turnover of 1.69 (highest among the three) and net margins of 8.06% (lowest among the three). Prime gives me a mental image of them selling lower priced items to mass consumer. The higher volume because of the lower price compensates for the lower net margins, giving Prime their earnings.

Hongguo, on the other hand, has a higher net margins but with lower asset turnover. Is is interesting to take note that while net margins drop over the years, the asset turnover increases more. This gives me a mental image of Hongguo selling higher priced items but with lower volume. The Average selling price of Hongguo shoes compared to Prime seems more or less to confirm this observation. If that indeed is the case, then Hongguo’s management is right; they do not have to worry much about Prime’s Daphne brand as it caters to a different crowd and have lower selling price.

Belle’s net margin is the highest, based on 2007, yet their asset turnover is also the lowest in the same year. It is stated that Hongguo will follow this model of going for the higher end consumer where there is more emphasis on brands than the more cutthroat mass market. If that is the case, we only have to see the margins of Belle to have a rough guide on where the net margins of Hongguo will go in the near future – around 16% and above. Since Belle and Prime (except Hongguo) indicated interest in growing their sportswear brands, it will be crucial to see what the margins for sportswear and the ladies fashion shoes are. That should shed more light on what the margins for Hongguo will be like.

Points of sales (POS) analysis

I thought this could be a good way to analyse retail business – by analyzing the revenue, expense and earnings stream of each company with reference to their POS. I came out with this table.

A few trends I noticed:

1. Belle is getting the most bang for its buck. Revenue per POS of 1.90 RMB million beats Prime and Hongguo hands down. Revenue per POS for Prime is coming down steadily while Hongguo is climbing up. It’s important that revenue per POS is at least constant or improving because it shows us how each dollar of revenue is generated from each point of sales being set up, even as the company expands. We certainly do not want to see more stores but less revenue generated – could be a sign of expanding too fast or too aggressively into regions outside their target market.

2. Belle again wins hands down for the net profit generated per POS. Here, we see an increasing trend of net profit per POS for Hongguo and a decreasing trend for Prime. Can you imagine it – in 2007, an average POS for Hongguo earns the same net profit as an average POS for Prime?

3. Selling & Distribution (S&D) expense per POS for Belle is the highest, so here we see that the higher net margins comes at a higher cost. The high selling and distribution cost per POS for Belle seems to confirm the earlier image of Belle as the high end seller. To create a perceived difference in their shoes, Belle must necessary spend more on advertising, which chalks up their S&D expenses. Surprisingly, Hongguo has the lowest cost per POS. Why surprising? Because given their decreasing net margins, I would expect the cost to run up faster than the earnings they get from opening new POS. Hmm, this is indeed an interesting point to investigate further – why did net margins of Hongguo drop over the years?

I do hope that Hongguo can increase their advertising further, yet this will cause the S&D to increase higher too. The only way around this is that the advertising will eventually generate enough consumer goodwill which will make the consumers pay more for the branding, thus improving margins in the long run.


I think Prime Success is in some sort of a trouble. Something isn’t just quite right when we look at its numbers – the story seems a bit bleak for Prime. As for Hongguo, I think they do have the potential to maintain or even improve its market position. It’s good that while Hongguo seeks to expand over as many POS as possible, they did it from their own cash flows and didn’t borrow excessively to achieve this. When times are bad, this kind of cautionary and prudent expansion plans will bode well for the company’s long term future.