Summary: Fuqi International (Fuqi) is a Chinese
jewelry company and a recently busted IPO with its EV/EBITDA at 7.5x and 3.6x
for 2007 and estimated 2008 respectively with working capital of $96 MM and no
long-term liabilities. Also, the
company is carefully expanding from 7-8 % net-margin business selling to
wholesale channels to additional 12-14% net-margin retail business without
jeopardizing its existing client base.
With a successful implementation of such plan, it is likely the stock
could double from current price per share in next 12 to 24 months. The business is highly predictable
considering China’s vast population, its current hyper growth economic
situation, and its significance of jewelry as an asset class.
Business: Fuqi is a leading designer of jewelry in
China in an extremely fragmented industry with a focus on middle-income young
women in China. To promote its
brand-awareness and mind share of its target audience, they sponsor a variety
of beauty contests like China’s Miss World, World Miss University Contest, and
Miss Global of WTO etc. The company
specializes in the design and processing of base metal and selling it mostly to
wholesalers, retailer, and distributors at a nominal markup of 8%-14%. At present, the company’s businesses are in
these three categories.
- Department stores with counters selling
gold and platinum jewelry
- Regional Distributors selling to small
mom-and-pop jewelry stores
- Retailers with 5 to 20 counters: Greater than half of total sales accounted
in this category
In the wholesale
market, the company has targeted $ 300 MM in sales this year in a $ 20 BB
market, making them the leader with greater than 30,000 participants in
China. Furthermore, the recent
opportunistic IPO has left Fuqi flush with of cash and now it is the
best-capitalized jewelry company in China.
For the competition to catch up with the company and raise cash,
preparatory work of about two years may be required. For 2008 and beyond, the company plans to expand its retail
operations by selling directly to the end-consumer, which has a fatter margin
of 30%. Fuqi’s wholesale business is
predominantly in gold, platinum, and K-gold.
In order to diversify and avoid any backlash from its concerned
customers at the same time, Fuqi has decided to pursue diamond and other
precious stones in the retail front.
This is a win-win situation for the company and its current customers
because the branding of Fuqi benefits them both. The company’s advertisement plans promoting the Fuqi brand will
assist their wholesale partners in selling a more recognizable name brand in
gold and platinum jewelry. The
company’s 10K outlines two strategies in pursuit of expanding the company’s
business:
- Acquire leases and open new stores in
markets with sufficient concentration of target customers.
- Acquire existing jewelry stores and
counters.
Fuqi stated its
acquisition targets for 2008 to be 60 to 80 retail counters and 8 to 10 retail
stores. Retail counters are small
outlets housed within other businesses (like jewelry counter in JCPenny stores)
with average annual sales of $50K and retail stores are larger and independent
stores have sales of $ 2 MM.
Temix Acquisition
The company has
recently signed a MOU to purchase a retail jewelry chain, Temix, with 50 retail
locations (45 counters and 5 retail stores) in Beijing, Shanghai and
Ningbo. This $19.3 M Temix transaction
is structured as follows: A lump-sum
payment of $ 11.4 M for 100% of inventory-on-hand, fixed assets, and POS
software. The remaining $ 7.9M will be
distributed in restricted stock based on performance targets current management
is set to achieve. The performance
targets include the following:
- Increase gross margin to 25% and net margin
from current 10% to 14%-16% in next two years
- Increase net revenue between $20M and $22M
- Additional 10 retail counters
Upon completion of this
acquisition, the company will achieve the following:
- Jump-start into retail side of jewelry
business, while augmenting its existing design and processing business.
This will help the company achieve it’s stated long-term goal of
increasing net-margin from current 6-8% to 12-14%, without going through
the estimated two-year ramp up period by doing it from scratch.
- Acquire a license to buy diamonds from Shanghai
Diamond Exchange. This savvy move
cuts license application process by one year. Also, with the acquired license, the Diamond purchase costs
will come down in the future.
- Direct access to customer feedback will
assist the company to design closer to customer needs.
- Increased market share in fragmented
jewelry market and building more recognizable brand.
Also, with this
acquisition, company has finished the majority of its planned retail store
acquisitions targeted for year 2008, and hence will be focused on its
execution. Below is a conservative
picture of how the company’s revenues may look may look for next four
years. A more realistic picture for
wholesale growth in 2009-2011 will be 40%, 35%, and 30%, respectively. Even the conservative estimates below
present a good case in valuation of company’s business.
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Expansion Plans
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Retail
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Wholesale
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Counters
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Stores
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Sales
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Growth
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Sales
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Total
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Net
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Net
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EV/Net
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(M)
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(M)
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(M)
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Income %
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Income $M
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Income
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2008
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80
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12
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$28
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100%
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$305
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$333
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8%
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$26.0
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3.9
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2009
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150
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25
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$33
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20%
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$366
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$399
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9%
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$36.0
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2.8
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2010
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240
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40
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$38
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10%
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$403
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$441
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10%
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$44.1
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2.3
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2011
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350
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60
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$44
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10%
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$443
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$487
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11%
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$53.6
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1.9
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For the year 2007,
Temix was profitable and its sales were $ 12.3 M, with inventory turnover of
1.1. A typical retail jewelry store in
China turns over close to 1.5. Fuqi
seems to increase the inventory turns higher than the typical average by
introducing various new designs and products.
If successful, this retail strategy will make a significant contribution
to Fuqi’s bottom line.
Due to a volatile stock
market in China, speculative assets may return to stable assets like
jewelry. This may be one of the reasons
allows the company to increase sales in 2008Q1. On April 17, 2008, the company raised guidance for its wholesale
business above their previous guidance of just a few weeks ago.
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Sales (Millions)
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Net Income (Millions)
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Previous
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New
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Increase
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Previous
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New
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Increase
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2008Q1
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62
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76.5
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23%
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4.2
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5.75
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37%
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FY2008
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242.5
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295
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22%
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16.4
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19.2
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17%
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With an emphasis on
retail, company intends to promote its Fuqi Brand and plans to undertake a
strong marketing brand-promotion campaign in the second half of this year.
The reasons that make
Fuqi is a great investment are:
- Opportunistic IPO has propelled the company
into best-capitalized jewelry company in China.
- The company has exposure in only 10 of 16
provinces. Therefore, within China
there is substantial room for company to expand.
- Wise use of capital to move company into
high margin business and better utilize its current position as wholesale
distributor and promoting its brand
- Enterprise Value trades at 7.5 x 2007’s
EV/EBITDA. With increased
guidance, the EV/EBITDA multiple is less than 4 times company’s revised
estimates for year 2008.
- Historically, jewelry has special place in
Asian countries, specifically in China.
From the Chinese consumer’s perspective, this spending is less
discretionary then in western world.
Furthermore, a count of number of jewelry stores in neighborhood
China town attests to this fact as well.
These factors help one to estimate future cash flows with greater
degree of confidence.
- The company has been profitable since its
inception and has been growing its bottom line by greater than 40% each
year.
- The Chinese retail market has been growing
greater than 20%, unlike the United States where it is maturing. Furthermore, the vast majority of the
1.3 billion Chinese have yet to join this growth. People in China typically save cash,
and jewelry is considered an alternative asset.
With this backdrop,
below is the snapshot of the company, as we see it.
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F/Y 12/31
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2004
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2005
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2006
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2007
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2008 (E)
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Net Sales
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56.8
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72.6
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92.4
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145.6
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333
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Gross Margin
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5.9
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7.6
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8.8
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16.5
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36
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Gross Margin %
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10.4%
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10.5%
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9.5%
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11.3%
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11.6%
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Selling & Marketing
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0.5
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0.6
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0.5
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1.1
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5.0
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General & Admin
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1.0
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0.7
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0.8
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2.9
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5.0
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EBIT
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4.3
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6.3
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7.5
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12.5
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26.0
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DA
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0.19
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0.24
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0.33
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0.33
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0.50
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EBITDA
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4.5
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6.6
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7.8
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12.8
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26.5
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EV/EBITDA
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NA
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NA
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NA
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7.5
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3.6
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Based on current market
capitalization, the company trades at EV/EBITDA of 3.6 for 2008 estimates.
Also, the tax rate for
the company per new PRC tax rule will ramp up step-wise from current 15% to 25%
by 2012. However, newer competitor will
have the uniform 25% tax rate, which helps put a few extra pennies in Fuqi
shareholders pocket.
Fuqi could double from
current quote as its expansion plans mature and market gets a better handle on
its business.
Risks:
- High volatility in commodity prices like
gold, platinum, etc could put a damper on stock performance
- Company lacks experience in retail or
acquisition strategy, hence, may cause some business risk.
- Retail strategy may also upset their
distributors, who may seek competitors without any retail business.
- Some market participants consider China as
having country risk.
1. Couple of quarters of reporting for company to recognition.
2. Recent earnings announcement to be digested by potential investors.
3. On going retail expansion will increase net margin.