Monday, May 12, 2008

Hongguo - Management


Three of the founders of Hongguo, Chen Yixi, Li Wei and Miao Bingwen are serving in the board as directors. Chen Yixi is the executive chairman, Li Wei is the Managing director and Miao Bingwen served as the executive director until 1st March 2007, where he became a non-executive director.

There is no employee stock options plan, hence no issues of the shareholder’s stake in Hongguo diluted. Furthermore, there is no stock buyback by Hongguo. There are no employees who are immediate family members of a director and whose renumeration exceeded S$150,000 since FY03.

Here is the breakdown of the founder’s salary indirect plus direct interest held:

We can see that the founders hold a substantial stake of their personal wealth being a stakeholder of the very own company which that set up. The executive chairman, Chen Yixi, alone holds 25.8% (direct and deemed interest combined) of the shares outstanding of Hongguo. Based on a market capitalization of SGD 204 million, that’s a cool SGD 53 million just by Chen Yixi alone. As a whole, the founders hold a 46% stake in their own company – a sure sign of confidence in their own baby.

There is ample planning and disclosure of the management’s plan for Hongguo, all stated clearly in their annual reports. It’s important to check this against what had been done over the years. Below shows the plans laid out and the check if the plans are carried out in the future:

I think the management did a very good job informing shareholders what they intend to do, so that they are no surprises. Their plans for expansion of their POS are very close to the actual POS set up in the future. Furthermore, all their design output targets and annual production targets that are set way in advance had been met uncannily.

A final look at the ROE and ROA will wrap up my analysis of the management of Hongguo. ROE is consistenly around 21-22% range, averaging 22.2% over 5 years since listing in 2003. ROA is improving from 13.66% in FY03 to 16.26% in FY07. Both of these figures show a certain level of competence in their business and management skills.

I find it very interesting that Prime Success and Belle are eagerly pursuing the sportswear segment and cited that the coming Olympics are going to ignite this sports fever in China. However, Hongguo did not once mention about going into the sportswear segment despite the show of confidence by their competitors. Doing business within their own circle of competence or too slow to respond to changing competitive landscape? Time shall tell.

What needs to be done is to attend their AGM.


It took me some effort to get the IPO prospectus of Hongguo, since the prospectus was dated 23 May 2003. I like to look at the IPO prospectus because with the benefit of hindsight, we can see if the ‘future plans’ listed by the management in the prospectus are fulfilled. Tracking management’s plan is one thing, checking to see if there is a major shift in their plans is another, so these are the 2 areas in which I’ll be looking for.

This is their plans stated in the prospectus:

1. Expansion of retail network and consumer base
a. Expand distribution network of department store outlets in major PRC cities to capture consumers with higher purchasing power

b. Launch customer loyalty privilege card program to develop customer database and to inform customers of new designs and promotions

2. Introduction of new brands and product lines
a. Expand stable of brands

b. Acquire established brands, and possibly production facilities and distribution network that come with acquired brands

c. Develop other brands

d. Introduce new product lines such as men’s fashion shoes to target different market segments

3. Expansion of manufacturing facilities
a. Acquire new equipment to increase production capacity

b. Carry out planned expansion where there is sufficient market demand

4. Contract manufacturing
a. Increase contract manufacturing operations

5. Trading and manufacturing operations in Jordan
a. Set up production facilities in Jordan to manufacture shoes for customers in USA when conditions are favourable

Comments on:

1. Basically their game plan for growth is still the same. They did expand their retail network from 280 POS in 2002 to 840 in 2007 and they also acquired Jiangsu Unity corporation (JUC), a chain of 63 boutiques carrying mainly foreign brands. As for launching of customer loyalty privilege card, it was not mentioned in previous annual reports. However, it was stated here that repeat customers are rewarded with gold and silver privilege cards to receive a 10-20% discounts on future purchases. Not sure if it’s still valid though, as it’s dated back in July 2003.

2. They did expand their holdings of brand, especially after acquiring JUC. The brand holdings under JUC include Byford, Hugo Boss, MaxMara, Bodyline, Ermenegildo Zegna and Tommy Hilfeger. The more recent brand in which Hongguo hold exclusive distribution rights include Naughty Monkey. Naturalizer and Via Spiga rights are accorded to them via a joint venture with US-based Brown Shoe Company in 2nd half of 2007. Besides acquiring established brands under JUC, they developed another house brand called E.Blan. As for men’s shoes, Hongguo distributes Lumberjack brand of casual shoes for men and women which Hongguo had an exclusive distribution rights in China. Besides that, they plan to have urban business/casual men’s shoes brand, as stated in their FY06 slides.

3. Manufacturing facilities expanded to 4.1 million shoes per annum. Expansion of design facilities in Guangzhou enabled them to design 6000 shoes per season in 2007, compared to only 600 designs per season back in 2003.

4. Revenue coming from contract manufacturing segment increases from 10% in 2003 to around 20% in 2007, representing an increasing proportion of Hongguo’s business. Management wanted a retail to OEM ratio of 80:20 mix, which is what we see in 2007. Besides Nine west, their contract manufacturing business include other notable brands like Kenneth Cole, Guess and Colorado.

5. I do not know much about their Jordan business as not much is mentioned.

I think the management did a fine job stating in advance what they had in store of Hongguo and they had the track record to prove it. Moving forward, the managements stated in FY06 slides that their plans forward is as follows:

1. Going to propel Hongguo as a fashion goods and branding company driven mainly by footwear distribution

2. Retail vs OEM maintained at 80% : 20% mix

3. Develop a comprehensive industrial chain to build up a leading status in the market to enjoy long term competitive advantage against other players

4. Construct a brand portfolio and product portfolio
a. E.Blan – transformation from a shoes brand to a multi-brand footwear store chain brand

b. To include a series of ladies’ fashion brands covering medium to high end market, including shoes, handbags and accessories

c. Urban business/casual men’s shoes brand

5. Maintain 8% to 10% annual same store sales growth
a. Open 100-150 new stores annually from 2008 to 2010

6. Enhance logistics and information system
a. Enhance sales system and update POS system

b. Streamline logistic process

7. Form alliance with outstanding companies internationally

If all goes according to plan, we can see a greater net margins and slightly slower POS increment in the years to come. I see that the management has no plans to venture into the sportswear segment and is cutting their niche into exclusively ladies fashion wear. No institutional imperative, it seems.