Sunday, May 04, 2008

Hongguo - Growth prospects

Growth prospects

In the annual report for FY2007, Hongguo mentioned that their future plans are:

1. To build a multi-brand portfolio in order to cater for diversifying market niches, by forming 6 to 8 brand package in next 2- 3 years OR through in-house brand development or collaborations with renowned foreign partners

2. Sales network will be enlarged to support 260 more stores, comprising 200 for in-house brands and 60 for cooperative brands with Brown shoe

3. Production capacity will be expanded to 12 production lines, of which 6 will be for the production of in –house brands and the remaining 6 for supporting contract manufacturing business.

Their plans are based on their core beliefs that China’s economy will continue to grow and they will be more affluent consumers waiting to get their products. As a result of these core beliefs, they are increasing their production lines to make more shoes in anticipation of this rising demands. At the same time, they are collaborating with international partners to build up their brand portfolio, presumably to increase their market share.

Are these core beliefs valid? If it is valid, is it possible to gauge how much the increased demand will be like? Let’s have a go.

China GDP grew at a CAGR of 11.9% per annum from 1995 to 2006, which can lead to an emergence of a middle class which is both quality conscious and have the purchasing power to drive PRC consumer market. China’s footwear sales volume reached 2.1 billion in 2006 and is forecasted to increase to 3.5 billion by 2009. The sales volume per capita for china is forecasted to increase from 1.6 pairs to 2.2 by end of 2009, while leather shoes sales are forecasted to grow at 15% per year from 2006 onwards (from annual report FY07).

The national bureau of statistics revealed that China’s middle-income group (with annual income between RMB 60k to 500k) is likely to increase from 65.5 million (5% of total population) to 45% in 2020, with annual incomes per household of RMB 60k to 500k. With average salaries of RMB 2100-2300 for employees in major cities, there is a high proportion of workers belonging to the middle income group and this figure is still increasing.

The following shows the shoes sold per capita in different countries (from China International Capital Corp):

China – 2.3 pairs per year
South Korea – 3.9 pairs per year
US – 7.3 pairs per year

As disposable income rises, it’s very likely that China will increase its shoes sold per capita. Perhaps not as much as U.S but at least it’s likely to see that approaching more mature markets like South Korea.

What’s more interesting is that China’s luxury market is predominantly male-driven. In fact, it is the only market in the world where men consume more luxury than women (Feb 2008, Issue 12, Industry Series). They are also much younger than their western counterparts, with males aged 25 to 40, compared to 40 to 70 in western markets. These are young professionals, entrepreneurs and businessmen. Female consumerism is set to rise and there’s plenty of scope for growth in the ladies shoes market. So confident that Belle’s CEO mentioned during their IPO that shoes are a necessity hence they are not subjected to the whims of macro-economic trends.

Let’s summarise the main findings

1. Female consumerism is set to rise. Current luxury goods consumers are males.

2. Emergence of a middle-income class – forecasted to reach 45% of total population in 2020. Population of China at 2020 is forecasted to be 1.4 billion (UN world population 2004 revision)

3. Rising disposable income, especially from urban households. From 1990 to 2006, disposable income of urban household increases at a CAGR of 11.8%. This is against a backdrop of strong GDP growth of China with CAGR of 11.9% per annum from 1995 to 2006. GDP of China in 2007 revised to 11.9% (Shanghai Daily, 11th April)

4. Per capita sales of shoes set to increase from current 2.2 pairs to reach closer to South Korea 3.9 or U.S 7.3 pair per annum

Let’s do some rough estimation:

Assumptions (conservative, I must add):

Estimated population size of China in 2020 = 1.4 billion
Middle class proportion in 2020 = 45%
Market share of Hongguo in 2020 = 5%
Shoe sales per capita = 2.3 pairs per year
Average Selling Price of shoes = 300 RMB

Estimated revenue for Hongguo in 2020 = 1.4 x .45 x .05 x 2.3 x 300 = RMB 22 billion
Given 2007 revenue for Hongguo is RMB 7.39 billion,
Forward CAGR of revenue from 2007 to 2020 = 29.8%

Historical CAGR of revenue from 2003 to 2007 = 35.3%
Estimated revenue in 2020 based on CAGR of 35.3% = RMB 32.9 billion

Belle’s and Daphne market share is around 7-8%, with the top 10 brands making up 50% of total market share. I assume Hongguo having a market share of 5% despite being the top 2nd or 3rd brand in China for so many years. I also assumed that the shoe sales per capita remained at 2007 level, possible though unlikely.

I think this estimate is helpful because we know that if assumptions are met, we can conservatively expect Hongguo to continue growing their revenue at around 30% from year to year until 2020. If assumptions are more than catered for, we can expect an even greater revenue growth for Hongguo (in fact for the whole industry as well), perhaps around its historical CAGR of 35%. Any more optimistic than that is just pure speculation.