Invest in Vietnam: Bullish Vietnam Textile Investment on Back of TPP

May 14, 2016

Disclaimer: The opinions expressed herein are that of  RongViet Securities and not of VietnamAdvisors. This is NOT a solicitation to buy or sell securities.

Core operation sees improvement

• 2015 earnings result was not as expectations
• Core businesses have seen optimistic outlook since 2016
• Positive earning forecasts for 2016
• Lifting the FOL is uncertained

Outlook and Valuation:
Difficulties in fiber segment, the instabiltity of Vinh Long operation and negative exchange rate movements are the main reasons that 2015’s earnings result of TCM could not meet expectations. Net revenue rose by 8.6% but NPAT lost 8.7%, achieved only 90.4% of 2015’s guidance. However, prospects for 2016 is relatively more positive when many businesses have found ways to improve operational efficiency.

In the fiber segment, TCM plans to narrow some inefficient fiber production while renovating, upgrading mechanical systems in order to produce fibers with higher quality and increase the rate of internal use. With garment segment, labor productivity issue has been partially solved. The orientation to specializing in high fabric products segment with attractive gross profit margin (23- 25%) is a bright spot of TCM in the coming years.

We estimated that revenue and net profit of TCM in 2016 could reach VND3,483 billion (+25%) and VND184 billion (+20%), equivalent to an EPS of 2,809 dong/share. In long term, the industry-leading position and available closed end production process could help TCM benefit most from TPP agreement. We believe that the reasonable price for TCM is VND30,500/share, 17% higher than the closing price on April 26, 2016. Therefore, we recommend investors to ACCUMULATE stocks in the LONG TERM.

2015 earnings result was not as expectations
Based on the 2015 consolidated financial statements, net revenues and net income of TCM were VND2,791.9 and VND153.7 billion respectively. Thus, the net sales figure constituted an increase of 8.6% while profit fell 8.7% compared to 2014. Net profit margin, as a result, only reached 5.5% compared to 6.5% of 2014.

Among operating segments, TCM is in difficulties with fiber segment, which is considered as TCM’s best advantages because of helping the firm to meet the rule of origin on TPP agreement. In 2015, the decline in the price of commodities such as cotton (-17% yoy), crude oil (-47.5% yoy) (inputs of polyester fiber used for synthetic and mixed fibers) led to the -14% plunge in yarn prices of TCM on average. Fierce competition, especially from China, in the fiber sector also diminished fiber volume by 20.3% yoy. Along with high inventory cost, net profit margin of TCM was about -6%, equivalent to ~VND50 billion. For cloth, woven fabric production fell by ~ 30% yoy due to TCM’s focuses on replacing old weaving machine of new generation air jet looms for export orders along with expanding investment and knitting department in order to improve yields and quality of raw fabric exports. This is a preparatory step towards the development of TCM to Japanese fabric market where requires high technical standards, but have high profit margins of around 23-25%.

For apparel segment, Phase 1 of the new garment factory in Vinh Long province started production in July, 2015. The capex for this plant in Phase 1 was about VND165.55 billion with the designed capacity of 9 million shirts/year. In early days, Vinh Long plant operations was not stable, therefore, revenue contribution was modest (about 5%). In contrast, the other garment factories in Ho Chi Minh city remained stable with an attractive profit margin of about 23%.

Besides difficulties in core businesses, the jump in financing costs was also a main cause of low 2015’s earning results. As an exporter, TCM employs a large proportion of debts in US dollars (~90% of total debts) to purchase raw materials and finance fixed asset investments. In 2015, the firm recorded a foreign exchange loss of VND59.9 billion, tripled FY2014’s figure; this was the reason the financial costs nearly doubled compared to 2014.

However, compared to its peers, the business efficiency of TCM has been relatively better than the other specialized apparel entities such as TNG and GIL, maily thanks to high profit margin. TCM is also the largest enterprise among listed textile firms in term of market capitalization and revenues.

Core businesses have seen optimistic outlook since 2016

Tightening the fiber segment could reduce its own losses
In 2016, TCM plans to narrow the production of several ineffective fiber products like polyester. In the meantime, the firm is replacing some spare parts and equipment’s in order to produce higher quality fibers and attain better margins. The upgrade, on the other hand, could help increase the percentage of internal fiber used; the goal is to raise to 20-30% from the current level of about 10%. This could not only lower the risk of fiber segment but also contribute to value chain of the closed-end production cycle.

Relating to commodity prices affecting TCM cost of good sold, we belive that the oil price would be stable at about 40 USD/barrel on average in 2016 and might increase by 50% next year (Vietnam Equity Strategy 2016). However, world cotton prices are under immense pressure from China, the country accounts for ~ 60% of cotton inventories and ~1/3 cotton consumption in the world and is expected to hold an auction to sell 2 out of 11 million tons of cotton inventories at sometime between May to August. However, negative movements in cotton price could not last long because (1) the whole consumption was 23.9 million tons in 2015; which means above volume only made up 8.4% of the global demand; (2) the area and production volume of global cotton have been in a downward trend since 2011 (Exhibit 8); according to ICAC, cotton area is forecasted to decline by 8% in 2016 and production output could reach only 23.9 million tonnes, a decrease of 9% but sales volume should go up 2% to 24.5 million tons; this could cause cotton prices to rebound at $1.54/kg; (3) the current cotton prices are at their lowest level in 7 years.

Moreover, the decline in long cotton forward contracts from 80% to nearly zero and only accumulating one-month cotton inventory help lower significantly the risks in cotton segment. In addition, a proportion of TCM’s fiber products are synthetic and mixed fibers, therefore, the Company only bears partial effects of cotton price movements. We expect TCM’s fiber price to rise slightly or at least stabilize at current levels of $2.6/kg. 2016’s revenue is forecasted to decline by 8% (~U$2-3 million) compared to 2015. The gross margin of fiber could increase from 4% to 7% and the firm might reduce losses this year.

The improvement in labour productivity of Vinh Long factory could support garment revenue growth

Although human resources in Vinh Long province are relatively abundant and cheap, at ~ 50% of existing plants in Saigon, the workmanship is relatively low. In 2015, the utilization rate in Vinh Long plant only achieved 30% of design capacity. However, with the promotion on training, labor productivity of Vinh Long is doubled compared to 2015, and closer to the average of the existing plants in Ho Chi Minh. We estimated that the utilization rate could increase to 55% in 2016 and revenue might reach VND110 billion. This plant is expected to just loss slightly in 2016 and could start making profit from 2017.

In term of garment segment, TCM has received enough shirt orders for 2016. Positive order outlook thanks to shifting Chinese garment trends and TPP will continue to support the growth momentum of the TCM. We estimated revenue of garment segment to achieve USD104 million (~ VND2,391billion), an increase of 67% compared to 2015.

Prominent fabric market could improve gross profit margin for TCM
The reasonable market orientation has provided positive effects on the development of fabric segment. Specifically, from 2014, the company has boosted production of high quality textile fabrics for exports to Japanese market. Although this is a challenging market with strict quality requirements, profit margin of the fabrics exported to Japan has been quite attractive, about 23-25%. Moreover, Japan is also one of the 12 members of the TPP agreement, therefore, expected revenue from this market segment will significantly grow in the coming period, especially when official TPP takes effect.

Reportedly, in the first two months of 2016, the volume of orders reached 5 million meters of fabric cloth, corresponding to 77% of TCM’s current production capacity. The company has invested US $ 1-2 million in increasing production capacity by 1.2 million meters/year. Besides, the increasing proportion of finished fabric (completely dyed) from 80% in 2015 to ~ 90% in 2016 is expected to help TCM achieve better profit margins. Actively boosting exports to Japanese market, we expect revenue of fabric will increase by 22% compared to 2015.

Positive earning forecasts for 2016
As mentioned above, TCM’s business segments are expected to experience positive improvements this year. Of which, garment segment was estimated to achieve highest growth, ~48% due to high volume of new orders and much more stable Vinh Long plant operation. We estimated sales of TCM to reach 3,483 billion, up 25% compared to 2015. The 2016 revenue structure of TCM could shifted towards increasing the proportions of apparel and fabric industry, reducing fiber segment. This is also the orientation of the Company during the period 2015-2020.

However, being the textile enterprises with labor accounting for ~20% of production cost with increasing trend, social insurance policies and the increases in minimum wages will have major impacts on TCM’s manufacturing costs. We estimated that labor costs could increase by 18%, equivalent to about VND97 billion. In our model, we expect gross margin of TCM in 2016 could still increase ~73 percentage points compared with 2015, equivalent to VND558 billion (+31% yoy) thanks to the enhance of remaining segments. Profit after tax is estimated to reach VND184 billion, an increase of ~20% compared to 2015. Notably, ratio of bonus and welfare funds are often quite high, about 30% of annual profit after tax. However, in 2016’s guidance, TCM has reduced the ratio to 25%. Accordingly, we estimate that 2016’s EPS of TCM could reach 2,809 VND/share.

Lifting the FOL is uncertained
According to Decree No. 60/2015/ND-CP providing details and guidance for implementing the Securities Law and the Law Amending and Supplementing to a Number of Articles of the Securities Law, garment sector does not belong to conditional businesses. Therefore, TCM’s foreign ownership will not be limited. Most recently, a textile enterprise, Everpia Vietnam JSC (HSX-EVE), was approved to increase the room for foreign ownership to the maximum of 100% on February 03, 2016. Currently, the proportion of foreign investors is around 60%. With TCM, the ownership of foreign investors has hit its ceiling rate of 49%, including strategic shareholder E-land holding of 43.32%. The majority of investors interested in this stock expected the FOL lifting plan be submitted at the 2016’s AGM.

Although TCM had several actions preparing for FOL increase such as asking for guidance from the Ministry of Planning and Investment and doing paper works to separate real estate segment from its businesses, the Company asserted that the FOL increase should be consider further. Reportedly, TCM and its major shareholder, Korea Eland, plan to develop a retail network in Vietnam. With abundant experience of Eland in retail sector (Eland is the leading retailer in Korea with over 60 branches and 10,000 retail stores worldwide), we are optimistic about the plan. However, retail is on the list of conditional businesses for foreign investors, so this could be the reason TCM temporarily postpones its intension to increase the FOL.

However, should the increase FOL be approved, the major shareholder Eland could continue to raise its ownership to more than 51% to maintain its controlling interest. Vietnam’s garment sector is considered as one of the most beneficiary from the TPP agreement thanks to high level of exports to the members of the TPP, i.e. US and Japan (total of ~60%) (Exhibit 10). Shifting order is expected to continue to grow stronger in the coming years, providing many opportunities to enhance the leading position from textile enterprises like TCM. In addition, the participation of its strategic partner Eland might orient TCM’s expansion and development in other sectors such as real estate, retail, etc. as the model of parent company in Korea.

Outlook

Difficulties in fiber segment, the instabiltity of Vinh Long operation and negative exchange rate movements are the main reasons that 2015’s earnings result of TCM could not meet expectations. Net revenue rose by 8.6% but NPAT lost 8.7%, achieved only 90.4% of 2015’s guidance. However, prospects for 2016 is relatively more positive when many businesses have found ways to improve operational efficiency.

In the fiber segment, TCM plans to narrow some inefficient fiber production while renovating, upgrading mechanical systems in order to produce fibers with higher quality and increase the rate of internal use. With garment segment, labor productivity issue has been partially solved. We expect Vinh Long plant could reach break even point this year and start contributing to income in 2017. The orientation to specializing in high fabric products segment with attractive gross profit margin (23- 25%) is a bright spot of TCM in the coming years.

We estimated that revenue and net profit of TCM in 2016 could reach VND3,483 billion (+25%) and VND184 billion (+20%), equivalent to an EPS of 2,809 dong/share. In long term, the industry-leading position and available closed end production process could help TCM benefit most from TPP agreement.

Combining discounted cash flow and relative valuation methods (FCFF, P/E and P/B), we believe that the reasonable price for TCM is VND30,500/share, 17% higher than the closing price on April 26, 2016. Therefore, we recommend investors to ACCUMULATE stocks in the LONG TERM.

Disclaimers