US recovery to spark turnaround at Korean OEMs

2017. 5. 24 Apparel(OVERWEIGHT) US recovery to spark turnaround at Korean OEMs ● Expectations that the US apparel industry will soon turn around are building as sales rise and inventory falls. With interest in Korean OEMs growing as a result, we reinstate coverage of the apparel sector at OVERWEIGHT and of Hansae and Youngone at BUY, with respective target prices of KRW33,000 and KRW44,000. WHAT’S THE STORY? Apparel OEMs deserve attention: US consumption data is improving, with apparel indicators leading the way after a two-year downturn. Apparel retail sales is the US rose 0.5% y-y in April, growth in apparel retail inventory slowed visibly y-y in April, and wholesale inventory/sales ratios have been trending down since Mar 2016. With the worst likely over for the US industry, more and more investors are starting to eye global apparel original equipment manufacturers. Hansae and Youngone, Korea’s top-two apparel OEMs—having corrected precipitously in the past year and underperformed their foreign peers—are looking like good investments now. Hansae—lean years behind: Casualwear-focused Hansae’s OEM sales and operating profit dipped a respective 2.6% and 44.3% y-y in 2016 as orders from global apparel buyers dropped alongside sluggish US apparel consumption. In 2H, however, we believe the OEM operation will should turn around, backed by an upturn in the US apparel industry, increasing orders (as buyers restock inventory), and the addition of new clients. We view the Jul 2016 takeover of MK Trend as an investment in long-term growth rather than a candidate for near-term synergy. Nevertheless, we expect the firm’s sales and operating profit to rise a respective 20.9% and 23.1% this year to KRW1.87t and KRW100.5b, and believe Hansae’s enterprise value will rise on a downstream-industry rebound and its increasing capabilities in original design manufacturing. We reinstate coverage of the stock at BUY with a 12-month target price of KRW33,000. Youngone—bike subsidiary set for turnaround: Growth in the outdoor/ sportswear industry has slowed after two to three of robust gains, but we believe Youngone’s orders will increase on an upturn in the US apparel industry and restocking by buyers. Looking to add diversity to revenue sources that have almost exclusively been OEM-driven, the firm took over Swiss bicycle brand Scott in Jul 2013. We expect the subsidiary to deliver robust growth this year thanks to increasing demand and the base effect of one-off costs in 2016. We estimate that Youngone’s sales and operating profit will rise a respective 6.8% and 14.7% in 2017 to KRW2.1385t and KRW205.8b, and reinstate coverage of the stock at BUY with a 12-month target price of KRW44,000. Hansae’s earnings to grow faster than Youngone’s: We expect results at both Hansae and Youngone to pick up in 2H and advise buying into any weakness triggered by 1H sluggishness, as US apparel buyers are likely wrap up store closings and inventory adjustments by end-1H and rebuild inventories in 2H as sales rebound. We prefer Hansae to Youngone, as Hansae has greater exposure to the US market and thus should benefit more from an upturn there, and we expect lower-end and medium-range casualwear brands to turn around soon, while growth in the outdoor/sportswear market has slowed. Sanghoon Cho Analyst sanghoonpure.cho@samsung.com 822 2020 7644 Sector Update AT A GLANCE Hansae (105630 KS, KRW24,450) Target price: KRW33,000 (35%) Youngone Corporation (111770 KS, KRW34,050) Target price: KRW44,000 (29.2%) Apparel 2017. 5. 24 2 1. Apparel OEMs: Boom and bust What happened to apparel OEMs over past three years? Large Korean apparel original equipment manufacturers rallied between early 2014 and mid-2015, outperforming the wider apparel sector as orders surged on a boom in the global apparel industry, COGS-to-sales ratios and utilization rates rose after production moved to cheap labor markets, and buyers consolidated vendors. In 2H15, however, shares fell as the apparel industry turned down and orders dried up. OEMs depend highly on apparel buyers, which—with US consumption decreasing—suffered an erosion of brand equity, saw fewer visitors to offline channels, and had to contend with rising inventories. Net profits at Hansae and Youngone, Korea’s top-two OEMs, fell a respective 55.6% and 24.6% in 2016, and by end-2016 the stocks had retreated 60% and 56.6% from 2015 highs. Korean apparel OEMs: Sales and market cap* Note: * Index of Hansae, Youngone, Shinsung Tongsang, Shinwon, Pam-Pacific, weighted by market cap Source: Samsung Securities Korean apparel OEMs: Share performances Source: Samsung Securities Contents 1. Apparel OEMs: Boom and bust p2 2. Why apparel OEMs deserve attention now p3 2. Forecasting OEM earnings by examining buyers p13 3. Risk factors p23 4. Investment ideas p28 Company p29 01,0002,0003,0004,0005,00