makalot industrial target (twd): 178.00 upside:...

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■ Investment case We initiate coverage of global apparel manufacturer Makalot Industrial (Makalot) with a Buy (1) rating. Over the next 2 years, we foresee considerable business expansion and believe the company is well positioned to benefit from the ongoing industry consolidation among apparel makers globally and increasing orders from the world’s leading fast-fashion brands. ■ Catalysts We expect sales- and net-earnings growth to accelerate for 2014, by 20% and 27%, respectively, on the back of strong orders from Fast Retailing, Inditex Group and H&M. Also, we think the sales growth that we are seeing for its US clients will be a positive for the company over the next year. According to Makalot, Japanese retailer Fast Retailing will become a major sales-growth driver,

and one of its top-3 clients, over the next three years (Makalot targets sales growth of about 300% from this customer for 2015 vs. 2013). As Makalot is moving towards a vertically integrated business model (it is now in upstream areas such as dyeing and finishing), we believe this will boost the company’s manufacturing flexibility, product quality control and economies of scale. This should result in gross-margin expansion (Makalot’s gross margin outperformed the average gross margin of the regional pure OEM apparel makers in 2012). With this in mind, we forecast a revenue CAGR of 20% and earnings CAGR of 24% for 2013-15. Also, we expect net cash of TWD2,345m at the end of 2014, and for the ROE to range from 28-35% over the 2013-15 period. The company is committed to paying out around 90% of its earnings, suggesting a dividend yield of 4.6-7.1% for 2013-15. ■ Valuation We initiate coverage with a 6-month target price of TWD178, based on a 2014E PER of 18x (25% premium to its regional peers), which translates into a 2013-15 PEG of 0.7x. Our target price is also supported by our DCF valuation.

■ Risks The main risks to our earnings forecasts would include: 1) a lower- than-expected ASP, 2) slower-or-lower-than-expected shipment growth, and 3) a lower-than-expected improvement in the gross margin.

Consumer Discretionary / Taiwan1477 TT

22 January 2014

Makalot Industrial

Initiation: fashion-forward

• Japanese/European clients are driving strong sales-growth momentum

• Makalot is likely to benefit from ongoing industry consolidation among apparel makers globally

• Initiate coverage with a Buy (1) rating and six-month target price of TWD178

Source: FactSet, Daiwa forecasts

Consumer Discretionary / Taiwan

Makalot Industrial1477 TT

Target (TWD): 178.00Upside: 16.3%22 Jan price (TWD): 153.00

Buy (initiation)

OutperformHoldUnderperformSell

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138

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Jan-13 Apr-13 Jul-13 Oct-13 Jan-14

Share price performance

Makalot In (LHS)Relative to TWSE Index (RHS)

(TWD) (% )

12-month range 95.00-185.00Market cap (USDbn) 0.843m avg daily turnover (USDm) 8.78Shares outstanding (m) 165Major shareholder Li-Pian Zhou (Chairman) (4.0%)

Financial summary (TWD)Year to 31 Dec 13E 14E 15ERevenue (m) 17,911 21,515 25,845Operating profit (m) 1,635 2,075 2,633Net profit (m) 1,338 1,693 2,061Core EPS (fully-diluted) 7.814 9.889 12.037EPS change (%) 13.3 26.5 21.7Daiwa vs Cons. EPS (%) (1.3) 3.0 0.2PER (x) 19.6 15.5 12.7Dividend yield (%) 4.6 5.8 7.1DPS 7.0 8.9 10.8PBR (x) 5.0 4.5 4.1EV/EBITDA (x) 12.5 9.9 7.7ROE (%) 27.5 31.7 34.9

Helen Chien(886) 2 8758 [email protected]

Mark Chang, CFA(886) 2 8758 [email protected]

How do we justify our view?How do we justify our view?

Consumer Discretionary / Taiwan 1477 TT

22 January 2014

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Growth outlook Makalot: earnings

As Makalot now has a more diversified client base than previously, we are positive on its earnings outlook for 2013-15. We forecast revenue and earnings CAGRs of 20% and 24%, respectively, for the 2013-15 period, as we expect to see both shipment and ASP growth, as well as an improvement in the gross margin of 0.7pp over the same period.

Source: Company, Daiwa forecasts

Valuation Makalot: PER bands

Our target price of TWD178 is based on a fully diluted 2014E PER of 18x (a 25% premium to the average of its regional peers, at 14x for 2014, based on our and the Bloomberg-consensus forecasts; Makalot’s PER traded in the range of 11-26x over the past year), which translates into a 2013-15E PEG of 0.7x. As we now see a better earnings outlook for the company, given the more diversified client base beyond the US, we assign a higher PER to it than the current PERs of its regional peers (averaging at 14x 2014E PER, based on our and the Bloomberg-consensus forecasts). Our target price is supported by our DCF analysis, in which we assume a WACC of 7% and terminal growth rate of 2%. Source: Bloomberg, Daiwa forecasts

Earnings revisions Makalot: Bloomberg-consensus earnings revisions

The Bloomberg consensus has been raising its 2014 EPSforecast for Makalot since early 2Q13, driven by the better-than-expected 1Q13 results, although it was cut slightly in late 4Q13 given concerns in the market about margin compression and rising inventory levels at its main clients in 4Q13.

Source: Bloomberg forecasts

How do we justify our view?

Growth outlook

Valuation

Earnings revisions

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Key assumptions

Profit and loss (TWDm)

Cash flow (TWDm)


Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015EASP (TWD) (m dozen) 1,878.2 1,848.7 1,740.8 1,853.4 1,732.2 1,704.2 1,734.9 1,766.1Shipments (m dozen) 7.0 7.2 8.1 8.2 9.2 10.5 12.4 14.6Consolidated gross margin (%) 16.2 21.7 20.1 20.9 19.9 19.9 20.2 20.6

Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015EUS 13,185 13,224 13,979 13,870 14,168 15,785 18,073 20,418Japan 0 0 0 0 159 896 1,721 3,360Other Revenue 0 87 157 1,253 1,540 1,230 1,721 2,068Total Revenue 13,185 13,311 14,135 15,123 15,867 17,911 21,515 25,845Other income 0 0 0 0 0 0 0 0COGS (11,056) (10,428) (11,296) (11,966) (12,712) (14,349) (17,172) (20,525)SG&A (1,435) (1,534) (1,503) (1,709) (1,671) (1,927) (2,268) (2,688)Other op.expenses 0 0 0 0 0 0 0 0Operating profit 694 1,349 1,337 1,449 1,484 1,635 2,075 2,633Net-interest inc./(exp.) (55) (25) (24) (23) (8) (8) (6) (114)Assoc/forex/extraord./others (217) (109) (139) (20) (38) 11 0 0Pre-tax profit 422 1,215 1,174 1,406 1,438 1,637 2,069 2,518Tax (132) (335) (257) (293) (261) (298) (375) (456)Min. int./pref. div./others (1) 0 0 (2) (1) (1) (1) (1)Net profit (reported) 290 881 918 1,111 1,175 1,338 1,693 2,061Net profit (adjusted) 290 881 918 1,111 1,175 1,338 1,693 2,061EPS (reported)(TWD) 1.963 5.795 5.905 6.916 7.169 8.087 10.235 12.457EPS (adjusted)(TWD) 1.963 5.795 5.905 6.916 7.169 8.087 10.235 12.457EPS (adjusted fully-diluted)(TWD) 1.853 5.505 5.506 6.630 6.895 7.814 9.889 12.037DPS (TWD) 2.000 5.200 4.570 6.133 6.257 7.036 8.904 10.838EBIT 694 1,349 1,337 1,449 1,484 1,635 2,075 2,633EBITDA 941 1,577 1,549 1,632 1,677 1,879 2,328 2,902

Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015EProfit before tax 422 1,215 1,174 1,406 1,438 1,637 2,069 2,518Depreciation and amortisation 247 228 212 183 193 244 253 269Tax paid (132) (335) (257) (293) (261) (298) (375) (456)Change in working capital 307 (132) (82) (817) 878 1,081 89 39Other operational CF items 146 5 87 (2) 17 (4) 6 112Cash flow from operations 990 982 1,134 476 2,264 2,661 2,042 2,482Capex (513) (99) (127) (394) (252) (3,075) (285) (285)Net (acquisitions)/disposals 15 39 13 26 5 0 0 0Other investing CF items 16 (2) (1) (9) (2) (122) (47) (60)Cash flow from investing (481) (63) (116) (377) (249) (3,197) (332) (345)Change in debt (135) 647 178 139 353 1,300 0 0Net share issues/(repurchases) 0 0 0 0 0 0 0 0Dividends paid (876) (304) (802) (734) (994) (1,026) (1,164) (1,473)Other financing CF items (110) (115) 0 0 4 0 0 0Cash flow from financing (1,122) 228 (624) (595) (637) 274 (1,164) (1,473)Forex effect/others 62 (17) (99) 63 (43) 0 0 0Change in cash (551) 1,130 296 (433) 1,336 (262) 546 664Free cash flow 477 883 1,007 83 2,012 (414) 1,757 2,197

Financial summary


22 January 2014

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Balance sheet (TWDm)

Key ratios (%)


Company profile

Makalot Industrial (Makalot) is a diversified garment manufacturer for brands and retailers globally. It not only produces apparel as an original equipment manufacturer (OEM), but is also an original brand manufacturer (OBM) with the launch of its FISSO brand in Taiwan and Mainland China in 2013.

As at 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015ECash & short-term investment 888 2,020 2,316 2,039 3,378 3,116 3,662 4,326Inventory 1,227 1,371 2,065 2,279 2,389 2,697 3,228 3,858Accounts receivable 429 186 106 191 339 382 459 552Other current assets 659 1,512 834 1,775 770 770 770 770Total current assets 3,204 5,089 5,321 6,283 6,877 6,966 8,120 9,507Fixed assets 1,210 1,026 723 964 1,014 3,921 3,907 3,875Goodwill & intangibles 0 0 0 0 0 0 0 0Other non-current assets 229 232 328 267 283 145 205 280Total assets 4,643 6,347 6,372 7,514 8,174 11,033 12,232 13,662Short-term debt 0 47 225 364 17 17 17 17Accounts payable 849 1,054 1,005 1,199 1,278 2,607 3,200 3,857Other current liabilities 812 1,130 1,294 1,436 1,416 1,874 1,949 2,133Total current liabilities 1,662 2,231 2,525 2,999 2,712 4,498 5,167 6,008Long-term debt 0 463 0 0 644 1,300 1,300 1,300Other non-current liabilities 30 42 53 98 141 141 141 141Total liabilities 1,692 2,736 2,578 3,097 3,497 5,939 6,607 7,449Share capital 1,513 1,534 1,587 1,627 1,655 1,655 1,655 1,655Reserves/R.E./others 1,429 2,072 2,202 2,783 3,010 3,426 3,955 4,543Shareholders' equity 2,942 3,606 3,789 4,410 4,665 5,080 5,609 6,197Minority interests 9 5 5 7 12 14 15 16Total equity & liabilities 4,643 6,347 6,372 7,514 8,174 11,033 12,232 13,662EV 24,436 23,809 23,228 23,646 22,610 23,529 22,984 22,321Net debt/(cash) (887) (1,510) (2,091) (1,674) (2,717) (1,798) (2,345) (3,009)BVPS (TWD) 19.440 23.512 23.873 27.101 28.193 30.704 33.902 37.455

Year to 31 Dec 2008 2009 2010 2011 2012 2013E 2014E 2015ESales (YoY) (11.2) 1.0 6.2 7.0 4.9 12.9 20.1 20.1EBITDA (YoY) (47.1) 67.5 (1.8) 5.4 2.7 12.1 23.9 24.6Operating profit (YoY) (56.8) 94.3 (0.9) 8.3 2.4 10.2 27.0 26.8Net profit (YoY) (73.7) 203.9 4.2 21.0 5.8 13.9 26.5 21.7Core EPS (fully-diluted) (YoY) (74.5) 197.1 0.0 20.4 4.0 13.3 26.5 21.7Gross-profit margin 16.2 21.7 20.1 20.9 19.9 19.9 20.2 20.6EBITDA margin 7.1 11.8 11.0 10.8 10.6 10.5 10.8 11.2Operating-profit margin 5.3 10.1 9.5 9.6 9.4 9.1 9.6 10.2Net profit margin 2.2 6.6 6.5 7.3 7.4 7.5 7.9 8.0ROAE 4.6 26.9 24.8 27.1 25.9 27.5 31.7 34.9ROAA 2.8 16.0 14.4 16.0 15.0 13.9 14.6 15.9ROCE 10.7 38.1 32.9 32.9 29.3 27.8 31.1 36.4ROIC 23.1 46.9 54.9 51.6 51.6 50.9 51.7 66.5Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cashEffective tax rate 31.2 27.5 21.9 20.9 18.2 18.2 18.1 18.1Accounts receivable (days) 19.8 8.4 3.8 3.6 6.1 7.3 7.1 7.1Current ratio (x) 1.9 2.3 2.1 2.1 2.5 1.5 1.6 1.6Net interest cover (x) 12.6 54.8 56.7 63.1 192.8 212.5 341.7 23.0Net dividend payout 101.9 89.7 77.4 88.7 87.3 87.0 87.0 87.0Free cash flow yield 1.9 3.5 4.0 0.3 7.9 n.a. 6.9 8.7

Financial summary continued …


22 January 2014

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Initiation: fashion-forward

We initiate coverage on Makalot with a Buy (1) rating, as we believe it will benefit from its flexible business model and the ongoing industry consolidation that we are seeing globally

A diversified apparel maker in Asia

Founded in 1990, Makalot is one of the world’s leading apparel manufacturers (men, women and children) based in Taiwan. Its main product lines are: trousers (32% as of 2013 sales, according to the company), knitted tops (21%), sleepwear (16%) and shirts for both men and women (14%). The company has production bases in Indonesia, Cambodia, Vietnam, China and the Philippines, and exports mostly to the US. Its customers include department stores (Kohl’s, Macy’s), mass-market retailers (Target, Walmart), and retailers such as Gap. Furthermore, in a bid to expand its product range and develop a second core product line, Makalot decided to enter the casual-sportswear segment in 2013. Makalot: 2013 revenue breakdown by market (unaudited company data)

Source: Company

Makalot: 2013 sales mix by clients (unaudited company data)

Source: Company

Ongoing industry diversification

No longer a pure US mass-market fashion exporter From the start of operations until 2008, Makalot was a mass-market fashion OEM maker that focused mainly on the US market. However, after the 2008 global financial crisis and the hit on the US economy, the company entered the fast-fashion segment and expanded into Japan and Europe, to reduce its reliance on the US market. As well as diversifying its client base, Makalot has been working on improving its manufacturing flexibility and building a more vertically integrated business model. Makalot: sales by market


USA88.1%

Asia8.5%

EU3.4%

Kohl's28.0%

Target22.8%Gap

14.6%

Walmart5.5%

Japan5.0%

Others24.1%

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2008 2009 2010 2011 2012 2013 2014E 2015E

USA Asia EU


22 January 2014

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Seasonal factors have limited impact and high outsourcing trend Over the past few years, Makalot has been working on improving its production efficiency by reducing the impact of seasonal factors and increasing its outsourcing ratio. The impact of seasonal factors has become less apparent over the past few years as third-quarter (usually the high season; the low season is during the second quarter) sales have fallen, from accounting for 31% of total sales in 2008 to 29% in 2013, based on the company’s data. In addition, the company expects to outsource elements of its production orders to external partners, and according to the company the outsourcing rate is likely to rise from 15% for 2013 to 18% for 2014, and to 20% in 2017. Outsourcing allows Makalot to more easily allocate capacity between its peak and off-peak seasons, and maintain the operating flexibility. Makalot: quarterly sales

Source: Company

US OEM/ODM market: cash cow

The US is the world’s largest importer of apparel, accounting for more than a 20% share of the market, representing an import CAGR of 7% over the 2009-12 period, according to data from International Trade Statistics (a WTO website). According to International Trade Statistics, Makalot’s existing share of total apparel imported into the US is about 0.5%.

Makalot: share of US imported apparel


Given its diversified product lines, sufficient production capacity, value-added service (eg, design and fabric development) and lower production costs (92% of capacity in Southeast Asia in 2013, in view of cheaper wage costs), Makalot believes it will benefit from the ongoing industry consolidation trend among apparel makers, and thinks its market share will grow as it captures market share from its competitors.

In the US market, Makalot’s major clients include Kohl’s (28% of 2013 sales), Target (23%), Gap (15%), and Walmart (6%). In 2013, it gained new clients, including VF Corporation and Ralph Lauren Corporation, both also in the US. Although the Bloomberg consensus expects Makalot’s major US clients to generate only moderate sales growth (about 5% in average) for 2014 (see the following chart), we believe Makalot stands to benefit, given the ongoing industry consolidation trend that we see, as it is a leading player in the apparel industry. Makalot: sales growth of its major/new US clients


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Kohl's Target GapWalmart Ralph Lauren VF Corporation


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Japan and Europe

Over the past 3 years, some of the major fashion retailers globally have started placing more orders with the Asia apparel makers, and Makalot has benefitted from this trend. Sales for Makalot from non-US clients increased from 1% for 2010 to 12% for 2013. Makalot has been expanding into non-US markets, such as Japan and Europe, since 2010. The company entered the Japan market that year and management expects the revenue contribution from there to rise to 8-9% for 2014, from 5% for 2013 on the back of increasing orders from Fast Retailing (9983 JP, JPY38,840, Hold [3]), the company’s 5th-largest client for 2013. Makalot has been making a Fast Retailing brand since 2010, and expects Fast Retailing to become one of its top-3 clients in terms of sales over the next 3 years. Meanwhile, the company is likely to gain orders from other Fast Retailing brands over the long term. We expect Makalot to benefit from strong sales growth at Fast Retailing this year, and forecast sales growth of 25% YoY for 2014 for the Fast Retailing brand that Makalot makes. In Europe in 2013, Makalot won orders from Inditex Group and H&M. Although sales from these 2 customers accounted for only 2% of 2013 sales, the company expects their contribution to more than double to TWD861m for 2014 from TWD358m for 2013. The Bloomberg consensus forecasts Fast Retailing, Inditex Group, and H&M to see 2014 sales growth of 16% YoY, 10% YoY, and 12% YoY, respectively. We expect Makalot to be one of the beneficiaries of these increases. Makalot: sales growth in its major/new clients in Japan and Europe


Moving to a vertically-integrated business model

Makalot is becoming vertically integrated as a result of joint ventures with or investments in upstream producers. This has started to ensure better product quality and production efficiency for the company, and should also mitigate the risks from raw-material price rises. In October 2013, Makalot took a 50% stake in Namtex, a Vietnam-based subsidiary of Tainan Spinning (Not rated), with a view to expanding into the dyeing and finishing process. This should also allow the company to capitalise on the favourable tariff treatment for companies in Vietnam under the planned Trans-Pacific Partnership (TPP), which would mean Makalot’s customers pay zero import tariffs. Over the next 5 years, Makalot intends to allocate more orders to the Vietnam factory given the favourable labour costs and potential TPP benefit. We believe a more vertically integrated business model will make the company’s manufacturing process more flexible, ensuring better product quality control, and greater economies of scale – and we expect these factors to boost Makalot’s gross margin. We forecast the margin to improve from 19.9% for 2013 to 20.6% for 2015. Makalot: gross profit and gross-profit margin


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Gross profit (LHS) Gross profit margin (RHS)


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Aiming to double shipments between 2013 and 2017

Although Makalot’s shipments rose consistently over 2003-13 (see the following chart), the company’s ASP trended down over the period. It aims to double its shipments from 11m dozens a year for 2013 to 23m dozens for 2017, equivalent to around a 20% YoY growth for each of the next 4 years. Makalot also aims to increase its ASP by 1-2pp this year on the back of better product and client mixes, which we expect to boost to its gross margin and earnings growth. We forecast revenue to increase by 20% YoY for both 2014 and 2015, to TWD22bn and TWD26bn respectively, and net earnings to rise by 27% YoY to TWD1.7bn for 2014 and by 22% YoY to TWD2bn for 2015. Makalot: ASP and shipments


Makalot: sensitivity of 2014E EPS to changes in shipments and an increase in the gross-profit margin

Change to 2014E EPS Shipment growth

(%) 12% 15% 18% 21% 24%

ASP growth

2.4% 20.8% 24.0% 27.3% 30.5% 33.8% 2.1% 20.4% 23.7% 26.9% 30.2% 33.4% 1.8% 20.1% 23.3% 26.5% 29.8% 33.0% 1.5% 19.7% 23.0% 26.2% 29.4% 32.6% 1.2% 19.4% 22.6% 25.8% 29.0% 32.2%

Source: Daiwa estimates

Note: Columns and rows in blue represent our base-case assumptions

Flexible in production

Makalot has five production bases in Indonesia, Cambodia, Vietnam, China and the Philippines, and we believe this has enabled it to reduce the impact of rising labour costs in China (see the following capacity distribution chart). Makalot is assigning more production orders to its Indonesia, Cambodia and Vietnam plants, as these countries have lower labour costs than China.

The company will raise its basic wage in Cambodia (to USD100/month in February this year from USD80/month currently) in the wake of a nationwide strike by workers at apparel companies in the country in December 2013. Even so, average labour costs at its factories there will still be the lowest among the company’s 5 production sites in Asia. According to the Garment Manufacturers Association in Cambodia, apparel workers mounted at least 131 strikes in 2013, up from 121 in 2012. Further strikes could take place in Cambodia to press for a rise in the minimum wage. If they did, we believe Makalot would be able to transfer production to its plants elsewhere. Makalot: monthly wages (2013)

Source: Company

Makalot: capacity distribution by country


Diversifying into new segments

In 2013, Makalot decided to enter the casual-sportswear segment in a bid to broaden its product range and develop a second core product line. According to our research in the market, the company is likely to add a well-known US sportswear/brand to its client list in 2014; any related orders would provide upside to our forecasts.

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In February 2013, Makalot launched its Original Brand Manufacturer (OBM) business under the FISSO brand in Taiwan and Mainland China. According to management, moving into the OBM business has enabled the company to get a better idea of fashion trends, thus enhancing the service it gives its OEM/ODM clients. The OBM business contributed only around TWD30m in revenue in 2013, on our estimates, and the company is targeting to break even in this segment within the next 2 years. Aside from its modest contribution to revenue, we see the OBM business as underlining Makalot’s efforts to offer more value-added services as a way of increasing client loyalty. Makalot: OBM business (www.fisso.com.tw/)

Source: Company

Company background

Makalot was set up by Mr. Li-Ping Chou in 1990. It started out as a small apparel producer, with the US as its main export market. After securing a large order from Walmart in 1996, the company went on to become a supplier to large retailers in the US such as GAP and Target. The global financial crisis of 2008 prompted the company to expand its footprint into Europe and Japan, and it has since won orders from global retailers such as Fast Retailing, Inditex, and H&M. Makalot was listed on the Taiwan Stock Exchange in January 2003. Its management team has an average of 20 years’ experience in the apparel industry.

Makalot: management team (January 2014) Management Position Background and experience Mr. Li-Ping Chou Chairman Founder of Makalot. Mr. Chou has more than

25 years’ experience in the apparel industry Mr. Hung-Jen Huang General manager in China Co-founder of Makalot. Mr. Huang is

responsible for the management of the manufacturing operations in China.

Miss Chiu -Ling Chou CFO Co-founder of Makalot. Miss Chou is in charge of general administration and financial management.

Mr. Kuo-Lung Chen Vice-president Mr. Chen is responsible for the management of the manufacturing operations in Cambodia, Vietnam and the Philippines.

Mr. Kuang-Han Sung Senior consultant Mr. Sung is responsible for the management of the manufacturing operations in Indonesia

Mr. Wei Lieu CMO/spokesman Mr. Lieu joined Makalot in 1999. He is responsible for the company’s marketing

Source: Company

Makalot: major shareholders (as at 11 January 2014) Holder Share (%)Li-Ping Chou 4Nan Shan Life Insurance 3.15Hung-Jen Huang 2.77Shuang-Chuan Liu 1.86Chunghwa Post Co LTD 1.72Deutsche BANK 1.64Robeco Investment Mgmt Inc 1.57Chien Wang 1.52NTUC Income Co-op Ltd 1.22

Source: Bloomberg

Financial analysis

3Q13 results In 3Q13, Makalot’s revenue was TWD5.2bn (+25% QoQ, +12% YoY) and its net profit was TWD368m (+25% QoQ, +10% YoY). According to the company’s unaudited figures, its sales in full-year 2013 totaled TWD18bn (+13% YoY), in line with the company’s guidance. Makalot: monthly sales

Source: Company

Note: 2013 figures unaudited

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2014 outlook For 1Q14, the company expects its shipments to grow by 20% YoY to a record-high level. On our forecasts, Makalot will see a net earnings CAGR of 24% for 2013-15, on the back of a 20% sales CAGR and an expanding gross-profit margin. For full-year 2014, we forecast its revenue to increase by 20% YoY to TWD22bn and its net earnings to rise by 27% YoY to TWD1.7bn. Makalot: revenue


Makalot: earnings


Sustainable gross-profit margin With the exception of 2008, when its gross-profit margin was 16%, Makalot had a stable gross margin of 20-21% over the course of 2007-12. We attribute this stability to the company’s flexible business model and diversified product range, client base, and manufacturing sites, which allow it to select relatively high-margin orders and offset rising labour/raw material costs. Makalot: gross and operating profit margin trends


In 2012, Makalot recorded higher gross-profit and operating-profit margins than the other pure OEM garment manufacturers. Makalot: gross / operating profit margin comparison

Ticker Company 2012

Gross margin (%) 2012

Operating margin (%)1477 TT Makalot 19.9 9.4311 HK Luen Thai 17.2 4105630 KS Hansae 19.8 5.6

Source: Company

Solid balance sheet Makalot has a strong balance sheet, with a net cash position of TWD1.3bn (16% of total assets) as of end-3Q13. We expect its net-cash position to expand over the next three years, given our expectations for its core business. In our view, Makalot’s strong balance sheet will allow the company to maintain a dividend payout ratio of around 90%, for a dividend yield of 4.6-7.1% over 2013-15. Makalot: breakdown of working-capital days

2011 2012 2013E 2014E 2015EInventory days 66 67 65 63 64Accounts-receivable days 4 6 7 7 7Accounts-payable days 34 36 35 34 34Cash-conversion cycle 36 37 37 36 37


0

5

10

15

20

25

30

2007 2008 2009 2010 2011 2012 2013E 2014E 2015E

(TWDbn)

0.0

0.5

1.0

1.5

2.0

2.5

2007 2008 2009 2010 2011 2012 2013E 2014E 2015E

(TWDbn)

0%

5%

10%

15%

20%

25%

2007 2008 2009 2010 2011 2012 2013E 2014E 2015E

Gross profit margin Operating profit margin


22 January 2014

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Limited forex impact Makalot’s trading currency is the US dollar. According to the company, 80% of its currency risk is naturally hedged and the remainder is hedged using USD/TWD forwards. Over the 2002-9M13 period, Makalot kept its forex gains/losses under control, at only -0.8% to 0.4% of annual sales. We believe Makalot has limited currency risk. Makalot: forex gain/loss as percentage of sales

Source: Company

Valuation

Our 6-month target price of TWD178 is based on a fully diluted 2014E target PER of 18x, which is a 25% premium to the average multiple of regional peers. We apply a 25% premium as investors in Taiwan typically ascribe higher multiples to textile- and apparel-related companies than do investors in other markets. The stock’s one-year forward PER multiple over the past 12 months ranged from 11-26x. Our target PER translates to a 2013-15 PEG of 0.7x, which we believe is fair given the company’s earnings-growth outlook. Our TWD178 target price is supported by our DCF-derived fair value estimate of TWD180/share. Makalot: DCF assumptions Cost of equity (%) Risk-free rate (%) 1.7Beta 0.62Equity risk premium (%) 9.9CAPM unleveraged discount rate 7.8 Cost of debt (%) Average spread over risk-free rate (%) 3.0 Pre-tax cost of debt (%) 4.7Average corporate tax rate for company (%) 25.0 Post-tax cost of debt (%) 3.5 Estimated target gearing (net debt/EV) (%) 20.0 WACC (%) 7.0


Makalot: DCF assumptions (cont’d) Middle period assumptions Growth rate (%) +8.5Operating-profit margin (%) 7.0 Capex/depreciation ratio (x) 1.1Working capital/ turnover ratio (%) 15.0 Tax rate (%) 25.0 Terminal period assumptions Growth rate (%) +2.0 Operating margin (%) 5.0 Capex/depreciation ratio (x) 1.0 Working capital/ turnover ratio (%) 10.0 Tax rate (%) 25.0


Compared with the other pure OEM names, such as Eclot (Not rated), Hansae (Not rated) and St. Shine (1565 TT, TWD809, Hold [3]), we believe our target 2014E PER multiple of 18x for Makalot is conservative, given our view of the company’s earnings-growth prospects. Since listing, Eclot, Hansae and St. Shine have traded in a one-year forward PER range of 5-35x, based on Bloomberg consensus and Daiwa forecasts. Makalot: one-year forward PER bands

Source: Daiwa; Data as at 20 January 2014

Eclot: one-year forward PER bands

Source: Bloomberg; Data as at 20 January 2014

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 9M13

% of total sales

0

50

100

150

200

250

May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13

(TWD)

19x

16x

13x

10x

22x

0

50

100

150

200

250

300

350

400

450

May-11 Nov-11 May-12 Nov-12 May-13 Nov-13

(TWD)

28x

23x

13x

8x

18x


22 January 2014

- 12 -

Hansae: one-year forward PER bands

Source: Bloomberg; Data as at 20 January 2014

St. Shine: one-year forward PER bands

Source: Daiwa; Data as at 20 January 2014

Risks

We highlight the following factors as risks to our rating, target price and forecasts for Makalot:

1) The company’s ASP and gross margin for 2014 hold steady or decline YoY. This is the major risk to our view.

2) The company expands its shipments by less than we expect.

3) Competition from international and local peers increases by more than we expect.

4) Basic labour costs at production sites increase by more than we expect.

5) There are labour disputes at production sites.

Valuation: Makalot and its peers

Companies Bloomberg code Rating

Market cap (USDm)

Share price (local curr.)

PER (x) PBR (x) ROE (%) Dividend yield (%) 2014E 2015E 2014E 2015E 2014E 2015E 2014E 2015E

MAKALOT INDUSTRIAL 1477 TT Buy 853 153 15.5 12.7 4.5 4.1 31.7 34.9 5.8 7.1 NIEN HSING TEXT 1451 TT Not rated 413 31.15 NA NA NA NA NA NA NA NATAINAN ENTERPRIS 1473 TT Not rated 151 31 NA NA NA NA NA NA NA NA ECLAT TEXTILE CO 1476 TT Not rated 2,678 322 22.0 16.5 7.8 6.3 41.1 42.5 2.8 3.6 LUEN THAI 311 HK Not rated 315 2.36 5.1 4.8 0.7 0.7 15.0 14.8 5.9 6.6 SHENZHOU INTL GP * 2313 HK Buy 4,951 27.45 13.8 11.4 2.6 2.3 19.5 21.4 4.4 5.3 WIN HANVERKY 3322 HK Not rated 211 1.29 NA NA NA NA NA NA NA NA CHINA TING GROUP 3398 HK Not rated 149 0.55 NA NA NA NA NA NA NA NA YOUNGONE CORP 111770 KS Not rated 1,596 38,450 12.9 11.0 1.9 1.6 15.6 15.8 0.5 0.5 HANSAE CO LTD 105630 KS Not rated 729 19,450 13.7 11.1 2.4 2.0 19.0 19.5 NA NAAverage 13.8 11.3 3.3 2.8 23.7 24.8 3.9 4.6

Source: Bloomberg;*Daiwa forecasts

Note: data is based on share prices as at 22 January 2014; NA denotes no Bloomberg-consensus forecasts

0

5,000

10,000

15,000

20,000

25,000

30,000


(TWD)

17x

14x

8x

5x

11x

0

200

400

600

800

1,000

1,200


(TWD)

35x

30x

20x

15x

25x


22 January 2014

- 13 -

Appendix

Makalot: major clients

Source: Company

Makalot: major products

Source: Company

Makalot: regional garment OEM companies

Ticker Company name Business model Product type Customers Production sites 2012

Gross margin (%) 2012

Operating margin (%)1477 TT Makalot Garment maker Mass-market/fast

fashion Kohl’s, Target, Gap, Walmart, JC penny, etc

Indonesia, Cambodia, Vietnam, China, and the Philippines

19.9 9.4

1451 TT Nien Hsing Fabric and garment maker Denim Gap, Kohl's Levi's, Target, etc Taiwan, Vietnam, Cambodia, Lesotho, Mexico, Nicaragua

6.3 1.1

1473 TT Tainan Enterprise Garment maker; owns Tony Wear brand

Mid to high-end casual wear

Gap, Mast, Ann Taylor, Macy’s, Talbots, etc

Indonesia, Cambodia, China, Taiwan

6.6 0.4

1476 TT Eclot Fabric and garment maker

Functional sportswear Lululemon, JC Penney, Gap, Champion. Kohl's, etc

Taiwan, China, Vietnam

25.4 15.9

311 HK Luen Thai Garment maker Casual, fashion apparel and lifestyle apparel

Adidas, Coach, Polo Ralph Lauren, Fast Retailing,

China, Cambodia, Vietnam, China, and Philippines

17.2 4

2313 HK Shenzhou Fabric and garment maker Sportswear, casual wear, lingerie, other knitted products

Uniqlo, Nike, adidas, Puma, FILA, etc

China, Cambodia 28.5 22.3

3322 HK Win Hanverky Garment maker; owns D-mop, Blues Heroes, Loveis, Queen 11 brands

Sportswear Adidas, Reebok, Umbro, Diadora, Puma, and Jako

Cambodia, Vietnam, China

22.1 3.3

3398 HK China Ting Group Garment maker; owns FINITY, ÉLANIE, Dbni, RIVERSTONE brands

Silk or silk-blended women's clothing

Calvin Klein, A&F, Gap, Macy's, Ralph Lauren, etc

China 29.9 7.8

105630 KS Hansae Garment maker shirts, knits, ladies wear, casual clothes

A&F, Gap, American Eagle, JC Penney, Walmart, Kohl's, Target, Fast Retailing, etc

Vietnam, Indonesia, Nicaragua, and Guatemala.

19.8 5.6

111770 KS Youngone Fabric and garment maker Outdoor and sportswear

The North Face, Nike, etc Bangladesh, Vietnam, China, Thailand

27.8 17.5

Source: Company, Bloomberg


22 January 2014

- 14 -

Daiwa’s Asia Pacific Research Directory

Daiwa’s Asia Pacific Research Directory

HONG KONG

Hiroaki KATO (852) 2532 4121 [email protected] Regional Research Head

John HETHERINGTON (852) 2773 8787 [email protected] Regional Deputy Head of Asia Pacific Research

Rohan DALZIELL (852) 2848 4938 [email protected] Regional Head of Product Management

Kevin LAI (852) 2848 4926 [email protected] Deputy Head of Regional Economics; Macro Economics (Regional)

Christie CHIEN (852) 2848 4482 [email protected] Macro Economics (Taiwan)

Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong Research; Head of Hong Kong and China Property

Jeff CHUNG (852) 2773 8783 [email protected] Automobiles and Components (China)

Grace WU (852) 2532 4383 [email protected] Head of Greater China FIG; Banking (Hong Kong, China)

Jerry YANG (852) 2773 8842 [email protected] Banking (Taiwan); Insurance (Taiwan and China)

Leon QI (852) 2532 4381 [email protected] Banking (Hong Kong, China); Broker (China)

Winston CAO (852) 2848 4469 [email protected] Capital Goods – Machinery (China)

Alison LAW (852) 2532 4308 [email protected] Head of Regional Consumer; Consumer (Hong Kong/China)

Jamie SOO (852) 2773 8529 [email protected]

Consumer (Hong Kong/China)

Anson CHAN (852) 2532 4350 [email protected]

Consumer (Hong Kong/China)

Eric CHEN (852) 2773 8702 [email protected] Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional)

Felix LAM (852) 2532 4341 [email protected] Head of Materials (Hong Kong, China); Cement and Building Materials (China, Taiwan); Property (China)

Dennis IP (852) 2848 4068 [email protected] Power; Utilities; Renewables and Environment (Hong Kong/China)

John CHOI (852) 2773 8730 [email protected] Regional Head of Small/Mid Cap; Small/Mid Cap (Regional); Internet (China)

Jackson YU (852) 2848 4976 [email protected]

Small/Mid Cap (Regional)

Joey CHEN (852) 2848 4483 [email protected] Steel (China)

Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong, China); Transportation (Regional)

Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group; Custom Products Group

Thomas HO (852) 2773 8716 [email protected] Custom Products Group

PHILIPPINES

Norman H PENA (63) 2 813 7344 ext 301

[email protected]

Banking/Property

Michael David MONTEMAYOR

(63) 2 813 7344 ext 293

[email protected]

Consumer/Retail

Patricia PALANCA (63) 2 813 7344 ext 408

[email protected]

Utilities/Mining

SOUTH KOREA

Chang H LEE (82) 2 787 9177 [email protected] Head of Korea Research; Strategy; Banking

Sung Yop CHUNG (82) 2 787 9157 [email protected] Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel

Jun Yong BANG (82) 2 787 9168 [email protected] Tyres; Chemicals

Mike OH (82) 2 787 9179 [email protected] Capital Goods (Construction and Machinery)

Sang Hee PARK (82) 2 787 9165 [email protected] Consumer/Retail

Jae H LEE (82) 2 787 9173 [email protected] IT/Electronics (Tech Hardware and Memory Chips)

Joshua OH (82) 2 787 9176 [email protected] IT/Electronics (Handset Components)

Thomas Y KWON (82) 2 787 9181 [email protected] Pan-Asia Head of Internet & Telecommunications; Software (Korea) – Internet/On-line Game

TAIWAN

Mark CHANG (886) 2 8758 6245 [email protected] Head of Taiwan Research

Steven TSENG (886) 2 8758 6252 [email protected]

IT/Technology Hardware (PC Hardware)

Christine WANG (886) 2 8758 6249 [email protected] IT/Technology Hardware (Automation); Cement; Consumer

Kylie HUANG (886) 2 8758 6248 [email protected] IT/Technology Hardware (Handsets and Components)

Lynn CHENG (886) 2 8758 6253 [email protected] IT/Electronics (Semiconductor)

INDIA

Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Head of India Research; Strategy; Banking/Finance

Navin MATTA (91) 22 6622 8411 [email protected] Automobiles and Components

Saurabh MEHTA (91) 22 6622 1009 [email protected] Capital Goods; Utilities

Mihir SHAH (91) 22 6622 1020 [email protected] FMCG/Consumer

Deepak PODDAR (91) 22 6622 1016 [email protected]

Materials

Nirmal RAGHAVAN (91) 22 6622 1018 [email protected] Oil and Gas; Utilities

SINGAPORE

Adrian LOH (65) 6499 6548 [email protected] Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore)

Angeline LOH (65) 6499 6570 [email protected] Banking/Finance, Consumer/Retail

David LUM (65) 6329 2102 [email protected] Property and REITs

Ramakrishna MARUVADA (65) 6499 6543 [email protected] Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India)


22 January 2014

- 15 -

Daiwa’s Offices

Office / Branch / Affiliate Address Tel Fax

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Room 301/302，Kerry Center， 1 Guanghua Road，Chaoyang District， Beijing 100020, People’s Republic of China

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London Research Centre 3/F, 5 King William Street, London, EC4N 7AX, United Kingdom (44) 207 597 8000 (44) 207 597 8550


22 January 2014

- 16 -

Disclaimer

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Daiwa Capital Markets Europe Limited and/or its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and/or its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.


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When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

makalot industrial target (twd): 178.00 upside:...

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