This article by Ernest Lim was first published yesterday at www.ernestlim15.blogspot.com/

AMONG THE 800 plus stocks listed on the SGX, Eratat Lifestyle (“Eratat”) could be one of the stocks which provide the highest potential capital gain. Average consensus target price is around $0.44 which represents a whopping 120% upside from the closing price of $0.20 on 10 Dec 10.

Is the market missing out on Eratat or the market knows something that the analysts are unaware of? This piqued my interest and spurred me to take a deeper look into this counter. 

Eratat has completed its switchover from focusing on sportswear to casualwear, which can be priced higher and which is less vulnerable to competition. Photo by Leong Chan Teik

Focus on brand equity

Eratat focuses on brand building and this is evident in its management of distributors. Firstly, distributors are allowed to open specialty stores at new locations subject to Eratat’s approval. Eratat’s belief is that to have a strong and positive brand impression, the stores have to be opened and sustained for a number of years.

Secondly, Eratat has a model specialty store at its sales office. Here, it would impart distributors on the “standard look and format” of Eratat store layout so that every Eratat specialty store would provide a similar shopping experience to consumers.

Thirdly, Eratat requires its key distributors to directly own the specialty shops progressively so they develop ownership and loyalty to the brand.

Fourthly, Eratat also pays attention to advertising and promotion in order to create brand awareness. It has appointed celebrity Wang Lee Hom as its brand spokesman. Eratat also collaborates with CCTV5, Anhui TV etc to promote its brand.

Order book visibility

Eratat chairman Lin Jiancheng, sporting Eratat casualwear in his office in Jinjiang in Fujian province. Photo by Leong Chan Teik

According to SIAS Research, Eratat has recognised about 53% of its Autumn / Winter Season as sales in the quarter ended Sep. The balance of RMB236m, together with any additional restocking by distributors and contribution from third party footwear would be recognized in the coming quarter.

Coupled with the RMB477m orders won (to be delivered from January to June), this lends earnings visibility up to 1HCY2011.

Successful repositioning as a casual lifestyle wear manufacturer

Since 2008, Eratat has started to steer its growth path from being a sports shoe maker to a casual lifestyle wear manufacturer. In the midst of this changeover, its gross margins dipped from 30.1% in FY09 to 28.8% in FY10. (Company’s yearend was previously in March but management will be changing it to Dec from end 2010 onwards).

However, there are signs that the company’s repositioning is bearing fruits. Firstly, gross margins have rebounded to a record 32.2% in the latest quarter. Secondly, Eratat announced that its 2011 Spring / Summer season raked in an order book of RMB477m with 51% contribution from apparel and the rest from footwear (2010 Spring / Summer: 43% and 57% respectively). It is noteworthy that apparel carries higher margins than footwear.

Proactive in creating investor awareness

Eratat CFO Ken Ho and VP for investor relations Kellyn Tan have actively engaged the investment community. Photo: Leong Chan Teik

Conservatively managed

Since its listing, Eratat has not done any rights issue or shares placement via issuance of new shares since its IPO in April 2008. Furthermore, according to the latest available financials, it is debt free. It has been utilizing its internal resources for expansion and working capital.

Valuations – cheap vs. peers

With reference to the table at the top of the page, Eratat’s valuations are cheaper than China Hongxing but seem to be in line with China Sports. However, China Sports does not have much growth in the near term due in part to the continual competitive landscape of the sports shoes industry, whereas Eratat enjoys healthy growth rates underpinned by its strong growing orderbook.

Investment risks

Long cash conversion cycle

Eratat’s cash conversion cycle increased from 104 days as at 31 Mar 10 to 126 days as at 30 Sep 10. This trend is likely to persist as Eratat strives to motivate their distributors by owning the specialty shops through extending longer credit terms to them. Eratat prefers to extend credit terms, instead of providing sales discounts or rebates or renovation subsidies (unlike its peers) as this would affect Eratat’s margins.

Still in a competitive landscape

Although Eratat has repositioned itself as casual lifestyle wear manufacturer, clients have to be aware that this industry is also very competitive and there is also a limit to how much Eratat can raise its average selling prices to improve its gross margins. Furthermore, a casual lifestyle wear manufacturer also has to constantly keep abreast of fashions (as fashion comes and goes), in order to make apparels attractive to the consumers.

Conclusion – Company may see re-rating if it continues to deliver

Against average analysts’ target price of $0.44, Eratat offers a potential capital return of 120% and a potential dividend yield of 6% for a one year horizon period. Company is likely to see re-rating if it continues to deliver on its results.

This is an amended version of the write-up which I sent to my clients recently.

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