Stella International Holdings Limited (1836.HK) Earnings Call Transcript & Summary

Good morning, and good afternoon. Welcome to the conference call for Stella International Holdings Limited 2023 Interim Results Conference Call. And I'll now pass the call to our emcee today, Mr. Matthew Schultz. Please go ahead.

Thank you. Good evening, everyone. Thank you for joining us for the presentation of Stella International Holdings Limited's 2023 Interim Results. On the call with us today is Mr. Stephen Chi, CEO and Executive Director; Mr. Andy Tam, Group Chief Financial Officer; and Ms. Macy Leung, Head of Investor Relations. Andy will first present a summary of the group's financial performance for the 6 months ended 30th of June 2023, after which Stephen will present a business review of the group's manufacturing business as well as the outlook. [Operator Instructions] I will now hand it over to Andy to discuss the group's financial performance. Thank you.

Thank you, Matt, and good evening, everyone, and thank you for joining our interim results presentation today. Let's start with the group overview, the highlights. Now this is -- 2023 is the first year of our 3-year plan ending 2025. And we talked a lot about the 3-year plan in the last annual results. So for anyone who is not as familiar, please refer to that presentation as well. For first half 2023, we -- our revenue and shipment volumes declined year-on-year, pretty much in line with our expectation as some of the volume is back-end loaded in the second half. Our ASP is up 6.5%. Volume is down 18.6%, leading to our group revenue is down 13.4%. But we have an improvement in our operating margin and also gross margin perspective. Operating profit is $65 million, down 5.5% Operating margin percentage is down 9%, up 70 basis points. Our adjusted net profit is $60 million. It's flat year-on-year compared to first half last year, which is a very strong first half for us in 2022. The adjusted net profit margin of 8.4% was up 110 basis points. We have net cash of about $163 million on the balance sheet. A lot of the cash is reserved for our expansion project and part of our diversification initiative. And all of this remain on track despite we have some delay in Indonesia. We're also happy to -- delighted to share that the Board has declared an interim dividend of $0.42. That maintains our nominal payout ratio of 70% of our adjusted net profit of $60.3 million, which excludes a $5.1 million fair value loss related to our investment in Lanvin Group. If we turn to the next page to the income statement. The ASP [indiscernible] increased 6.5% to $29.60. That really partially offset by offsetting the 18.6% decrease in shipment volumes to 23.6 million pairs. Now the decline in volume due to a lot of things, but obviously, it's part due to the lower utilization in our sports factory, but also we talked many times before that as we move our customer mix to more complicated products, more premium style product, it takes a lot more cycle time. So we no longer compare historical pairs on an apple-to-apple basis. So volume going forward might not be as a good indicator when we discuss the results. Now the increase in ASPs was mostly driven by the declining share of lower ASP styles in the casual category. And of course, a more pronounced contribution from our sports, luxury and high-end fashion categories, which we're introducing actually new athleisure line and more often the product is actually much more premium than before. Our consolidated revenue for 6 months decreased by 13% to $716 million and is in line with our expectation. Our gross profit increased by 1.2% to $166 million. The gross margin increased by 340 basis points to 23%, really due to a very good production efficiency that we had in the first half and also, again, the more premium product styles that our customers are ordering. Our product -- operating profit declined by 5.5% to $65 million with a positive impact for our customer mix, kind of enhanced production efficiency and cost control. And this was offset by $16 million net provision related to Rockport Chapter 11 that we announced earlier. Our reported operating margin is 9%, which is 70 basis points better. We talked about earlier about there's a $5.1 million of fair value loss with the Lanvin investment, which is a mark-to-market equity instrument. So that instrument goes up and down. It's not related to the underlying operating performance. So if we adjust for that, the adjusted net profit is $60 million as opposed to $55 million. So on an adjusted basis, our net profit is basically flat on a year-on-year basis, but the net margin actually improved to 8.4%, which is about 110 basis points improvement. Going to CapEx and cash flow. Our net cash flow from operations was $28 million with a pretty better working capital management. Our CapEx was $23 million, lower than our initial planning as we delayed some planned expansion project to better match the timing with future demand. And in the beginning of the year, we guided to be about $110 million CapEx. It's going to look like we're going to be more close to $60 million to $65 million CapEx for the entire year. Going to next page on the balance sheet. As you see, we have $163 million net cash on the balance sheet. So our net gearing ratio is very healthy. But of course, a lot of cash is maintained for the Indonesian expansion project and some of the CapEx that were earmarked for, but it's just been delayed in terms of timing. Going to the next page on the valuation and dividend yield. We've historically paid, as a payout policy, 70% payout ratio. And there are years that we pay more and some years, we pay less in 2020 where we didn't make a profit. But in the first half, we want to stay consistent, $0.42 is 70% payout ratio. Looking at -- if we look at basically the last 12 months of dividend we paid, including interim of $0.42 and the final dividend from last results, we're basically about 11% dividend yield on a last 12 months basis. On the cost structure slide, the purple part is the gross margin. And you can see the expansion about 300 basis points from 19.8% to 23%. Material costs, which still make up the bulk of the cost of goods sold, is 56.7% for the first half of this year. And overall, because of a better efficiency management, you see some of the subcontracting costs, which is 11.6% last year, now is 10.2% in the first half this year as we better manage our people and kind of capacity and also timing of working hours. Next is the long-term trend that we show for our volume and ASP is a long-dated history. But on the volume, of course, like I was saying, as we do this mix shift to more luxury and fashion, more complicated products in general across category, the pairage is a little bit more difficult to compare on a like-for-like basis. So our first half volume seems to be down from 29 million to 23.6 million. And our ASP is trending up now from $27.8 million to $29.6 million. Going to the next page, this is a long-term chart on our operating profit and margin. We ended 2022 with 8% operating margin, and our 3-year plan target is to hit 10% operating margin. In the first half of this year, at 9%, we're pretty close to that target, and we'll continue to kind of march towards that in this 3-year plan. And a lot of that will be really part from our 3-year plan strategy that we're executing right now, which is more about enhancing our category mix to better align with our unique design, product development kind of capability and really expanding and diversifying our manufacturing capacity. We talked about Indonesia. We talked about Bangladesh. We are making more progress in Bangladesh now. We also have been really optimizing our management effectiveness and kind of efficiency, really changed our internal organization and how our team is structured in an industrial organization perspective. Lastly, we focused on strengthening our cost efficiency and really focused on our working capital basically to free up cash so we can reinvest in parts of the business. So on this plan by the end of 2025, we're still targeting a 10% operating margin, and we're targeting low teens annualized growth on our profit after tax. Now during these 3 years, nothing is going to be exactly linear. This year, it is a good start for the 3-year plan, but it won't be exactly mid-teens every single year, but there will be some fluctuations to the 3-year period. Now I'm going to turn it to Stephen for our business review.

Thank you, Andy, and good evening, everyone. Slide 13 gives an overview of customer portfolio we're working with. As you know, we separate our portfolio into different categories. Sports. Sports footwear ranges develop a well-known sportswear brands. It includes limited editions, collectible products and [ custom ] and collab. Luxury, which are mostly athleisure footwear ranges that we develop specifically for luxury high-end fashion brands. As for fashion, it's the best-in-class footwear, including boots and heals and sandals provided to many of the world's leading fashion brands. And for casual, it's mostly casual style for many of our long-term customers. Going to next page. It contains a breakdown of our manufacturing revenue by product category. Going through each category, our sports category accounts for 42.9% of revenue. And some of the sports customers were destocking during this period under review and manage inventory, but the improvement in ASP partially offset the impact of volume drop. Revenue attributed to our luxury and fashion category accounted for 8.8% and 25.7% of our total manufacturing revenue, respectively. And in our fashion category, we saw a strong recovery among existing customers on a year-on-year basis, while adding and growing with new high-end fashion customer as well. With one customer actually rebalancing its portfolio of products and adjusting its product launch strategy. As for our casual category, it accounted for 22.6% of revenue as we reallocate capacity to grow our other category in line with our own strategy as well. We also suspended working with one of the customer following a Chapter 11 filing. Slide 15 contains a breakdown of revenue by region. North America and Europe remains our 2 largest markets, accounting for 43.9% and 27.4% of our total revenue. This was followed by PRC, which accounted for 16%. Rounding this out, rest of Asia accounts for 9.2% of total revenue, while other geographic regions accounted for 3.6%. Slide 16 shows where we are currently in terms of capacity expansion and diversification strategy. Our newest manufacturing facility in Solo, Indonesia is ramping up in line with demand. But in alignment with ongoing weak macroeconomic conditions, we have delayed some planned capacity expansion projects to better match with the timing and future demand. As of 30th of June this year, China accounted for only 25% of our manufacturing capacity, while Vietnam accounted for 51% of our capacity. Collectively, our factories in other parts of Asia, Indonesia, Bangladesh and Philippines, accounted for 24% of capacity. And going on to Slide 18, which is our outlook for the rest of 2023. We expect ASP for the full year to follow the same trend as the first half, mainly a modest increase as a result of stronger sell-through to sports, luxury and high-end fashion brands, which are reflecting more premium products with higher production complexity. We expect to maintain our strong gross profit margin and operating margin level as we continue to implement our 3-year plan. With orders from our newly added luxury high-end fashion customers continuing to grow from a small base and supporting the further enhancement of our product and customer mix, we will also continue to improve our production efficiency. We expect our non-sports manufacturing facility will continue to operate at close to full utilization in the second half as we pursue a greater operational efficiency and cost control. We're committed to moving forward on our long-term capacity expansion projects. The ramp of our new facility in Solo, Indonesia remains on track and is performing well operationally, while we continue to build additional facility capacity in Bangladesh. However, we're slowing down the progress of building a new manufacturing facility in Indonesia for our major sports customer, reducing our planned CapEx for the year. We will continue to develop our own new handbag and accessory manufacturing business into another pillar of growth by continuing to enhance its product quality and production efficiency while introducing it to more of our high-end customer base. And this is the end of our presentation. We look forward to answering any questions that you might have. Thank you all.

Thank you, Stephen. We are now ready to move on to the Q&A.

[Operator Instructions] Our first question comes from Carlton Lai with Daiwa.

Just a quick question. Regarding the Rockport bankruptcy, I think it was acquired by Authentic Brands a couple of weeks ago. What's the implication of that? Are we going to write back or are we going to be able to get back some of the receivables?

On Rockport Chapter 11, it's unclear. They just closed the transaction. But under the Chapter 11, the account receivable was stuck on the Chapter 11 bank. So based on the deal and the valuation did the deal, there wouldn't be any recovery of that AR from an unsecured claim perspective. So we have right now a $16 million net provision, which includes an $8 million insurance against it. So we look at Rockport, this transaction is -- well, it's good to give that brand a second life under a new ownership with more, I would say, capable balance sheet and financial health, larger platform. But at the same time for unsecured creditors, during that process as you go to Chapter 11, you do get stuck in that bankruptcy court. And unlikely that we'll recover that or write back the full $16 million at this point.

Okay. But -- so there's still a chance that we can get some of that $16 million back through the bankruptcy courts, right?

Not necessarily from a bankruptcy court, but more from other secured claims. There's other -- I would say, aside from the main Chapter 11 bankruptcy process, you can still process the claim through other avenues that was [indiscernible] with our bankruptcy [ lever ] as a part of the old unsecured creditor committee. So not just us, but a lot of other secured creditors as well. So there are potentially other avenues, but it's too early to speak about that because it's more of a lawsuit that you have to file that we're kind of processing.

Got it. Okay. And my second question is regarding your sports customer. In I think the announcement you guys said that there's some signs of improvement towards the end of this year. Their commentary during their results seems to be quite positive. And just overall, I think just some things, it seems like things are turning around and they're starting to restock. So what's the situation there? And how are we looking at 2024?

2024, okay. Better doesn't mean it's going to be, let's say, double-digit growth. We do see slow recovery, low single digits. And I would be basically looking at the same thing for next year. Business are stabilizing, and we do see a very small growth next year on the sports side. Carlton, does that answer your question?

Our next question come from Darren with Chartwell Capital.

So excited to see kind of a first glimpse of how our 3-year plan is coming together. Obviously, this year, the contribution from our fashion category is up year-on-year. I think in the past, we've touched on the difference in cycle times for casual versus luxury. But what about against the fashion category? Like how much longer does it actually take to produce fashion shoes for us compared to like a casual shoe?

Let me answer that. I think that's actually a very difficult question to answer. Depending on the style and depending on -- let's say, boots, it seems probably easier in certain regards, but then there's a lot of process that's involved, whether you say it's crimping, it's leather, it's the treatment. So fashion customer in general are a bit more complicated because it tends to follow the trends and different type of leather or mixing of leather and fabric. So that is a really hard question to answer in regards to actual time cycle. But in -- generally speaking, with fashion brands and luxury brands, what they're asking is a lot more complicated. So the cycle time is definitely much longer.

You mentioned -- sorry, go ahead.

As a result of that, it's probably one of the reasons why we have higher ASP.

Okay. And then yes, I meant to touch on ASP. So we mentioned that on the sports side, we did see some ASP increase within the category. And then I wanted to just follow up and ask because our ASP is up year-on-year on a blended basis. I was wondering for some of the other categories, for example, for the fashion category or for the luxury category, which we're trying to get more exposure to, did we see pronounced ASP growth in other categories as well?

Yes. So in general, across all the categories, ASP is actually up, okay? And this across -- even within the casual category is up, okay? And -- every single category is different. Sports is up because we have some new customers coming in with more premium products that we're making for them. On the casual side, even casual is up because as we, I would say, decrease the production of, I would say, the low ASP products, it kind of lifts the ASP of that category by itself, okay? So the mix shift with -- a customer mix shift within that category has contributed to that. In fashion and luxury, of course, they're asking for more premium products. And that's what we've noticed. There's a trend almost across category, every single branded customer is looking for, I'd say, a premiumization of their product line, the product set. Now you can try to charge higher ASP to the consumer, but the consumer basically are not stupid in a way. So they demand a higher quality, much more complicated product that differentiates even more in the marketplace. Especially now a lot more brands trying to launch a product in this category and the kind of action sneaker category is, to make it more standout and differentiated, we do have to incur more cost and production capacity for that. So we've seen that kind of premiumization across every single category in terms of product set. So that's why at the beginning of the year, we're looking at ASP to be flat year-on-year, but it seems to be -- actually, it really is going to be up for the entire year around 6%, 6.5% ASP increase.

Okay. And then as far as the contribution goes for revenue for fashion luxury, I'm sure a lot of people have asked, is there like a target contribution that we're looking to get to maybe by the end of the 3-year plan or maybe even on a longer time horizon?

I can answer that a little bit. As you know, works with so many different brands. And one of the reasons why we broke this down into 4 different categories because the business is changing almost daily. For example, the Rockport filing on Chapter 11, that's not unexpected. But the brand comes in and now changing CEO all the time, different strategy, different, let's say, direction, moving up to premium or moving down to more mass. So we don't really have a target, to be honest with you, in terms of each category, but each category has its own strategy and its own growth plan.

And to build on Stephen's comment, I think we talked a lot about when we look at our customer, we rank them from -- on a kind of scorecard perspective on kind of return basis, risk reward margin versus how much working capital use and what's also, qualitatively long term, can we do a larger, bigger business with them? And does this strategy match with kind of our design product development driven capability. So a lot of come into play even when we evaluate even a casual category customer and how much we can work with them on an ongoing basis. So as we look forward in this kind of 3-year plan, right now, Sports is about 43%. By the end of this 3-year plan, it is probably similar to that range. Category or just casual category is the one that has been declining since 2022. So now it's 22.6% in the first half of this year, and we might be closer to the 20% range by the end of our 3-year plan in 2025. But even when we look at beyond that, we might see even casual customers, even looking at them, they are looking at premiumization of their product line as well. So a lot of things can change in the dynamics in terms of each of this category and might be a good customer in the casual side that we might look forward to dealing with in the future actually.

All right. And then on cost of sales, you mentioned that you realized better efficiency basically from -- just better management overall, whether it's with the labor force or with the working hours. Could you maybe give some examples of what kind of measures you implemented that led to us realizing this better efficiency, just so we can get a better sense of what's actually going on at the plant?

One major thing is when we talk about capacity, there is the physical real estate capacity of the plant built. But the other capacity -- that first capacity is hard to manage because once you build a plant, the plant is there. The second capacity and we look at is people capacity. And that changes all the time. So we want to make sure our workers are utilized at 95% utilization, we can, okay? We don't go beyond that. We want to make sure that people are -- have opportunity to rest and things like that, but make sure that we have high utilization of the labor capacity. Now with the labor force, you know that naturally in manufacturing, there's a high attrition rate, okay? So there's not a lot of natural attrition that goes on during the year. And to maintain it at 95% utilization, we always have to keep hiring, okay? And that's a normal process. In a time where one of our large customers told us and also a lot of the vendors that we're not looking at as high utilization from a labor capacity perspective, we really took a part and like really try to preempt that and really try to manage our labor force in a more accurate way. And this is a day-to-day planning. So during the time, we never had really any big layoffs or severance that you've heard the news in Southern Vietnam, other manufacturers of large layoffs during that first half of the year. And we never had any of that during this time period. So we were at very high people utilization across the board. And also, we were able to reduce overtime because we're able to manage our people to kind of demand and production cycle a little better. And that's really just kind of going into the weeds in detail on how we manage people and what kind of demand and we need for the production cycle.

Okay. Great. And then my last question is when it comes to Solo, you mentioned that the ramp-up is on track. Just wondering where we're at now in terms of the [indiscernible]?

It is only in the first half. So on a full year basis, we will see a slight increase on a year-on-year. But that's probably what we will say for now. And on a full year basis, when we have the full year, we can talk more about the utilization of the Solo factory. But it is one of the place where we are -- actually, the quality is getting better faster than we expected. Originally, it was more for casual, but now we're introducing sports. So it's a little bit ahead of our expectations. So that's progressing well actually.

And our next questions come from Alison with DBS.

Can we also comment on the other categories? You just commented on sports in terms of the order book? That's the first question. And the second question is, has there been any new customers in discussion? I remember -- I think a couple of quarters ago, there was mention of newer customers such as KOL, for example. These are...

Let me talk about maybe just order growth and visibility for the full year. Right now, we're in mid-August. So we're shipment production volume is pretty clear for the entire year. We talked about it is similar to our guidance at the beginning of the year. We're going to be down probably 13% to 14% in terms of volume, okay? So -- and our ASP is going to be up similar to first half, so which means revenue is probably going to be down around 10% on a full year basis. We're going to maintain pretty much our gross margin. And typically, second half is actually a higher gross margin period than the first half. And as we do more luxury and fashion, which is more second half loaded, okay, more of that shipment comes in the second half. So there's a little bit of seasonality within our mix as well. So looking at our operating profit margin target of 10%, we think that we will actually get there on a full year basis this year. And looking at first half, second half, we probably have more of a 40-60 split in terms of profitability, a lot for the full year basis. Stephen, do you want to talk about some new customers or anything like that?

I think for new customers that I probably can't disclose the name, some is actually on the luxury side, some on the high fashion side. So maybe during the end of the year call, I'm sure I can disclose that. We're currently making samples and prototypes for that.

Got it. Last question is, does renminbi depreciation have any impact on the P&L?

The RMB depreciation on the labor side. So a lot of the costing that we do in general, exchange rate cost, okay, across the customer, we've gone to a point where we try and narrow the duration of our FX fluctuation with our customer, okay? So obviously, the best you can do is like you fix the spot rate, you take the spot rate every year, so there's no fluctuation risk for a supplier, but that's too much. So for most of the customers, we do like a 90-day period where we price kind of the purchase order of that season or that 90-day cycle equivalent to a season for a lot of customers, what the FX rate will be. And if there's major fluctuation, more than 5%, then we have a discussion after that. But if it is within that range during the time period and then during the entire duration, okay, not just like 1 day or 2 days, but during the entire duration, just drastic movement that we talk and we negotiate. But otherwise, we -- sometimes you win, sometimes you lose. So there hasn't been really -- unless we implement, there hasn't been really major like fluctuation impact in terms of FX to our P&L. And granted, some year, we do gain, some year we do lose. In general, this year, U.S. dollar is a little bit stronger. So it might be gained a little bit, but it's not really that much because the duration of FX exposure we have to the customer is very short.

And our next question is come from Terence with Morgan Stanley.

I have 2 questions. The first one is about the -- I think the follow-up on the labor cost. If we do the calculation in the first half this year versus the first half of last year, the labor cost per pair actually down about 6%. So just wondering if there's any more specific example on how you managed to do that because I believe most of your peers, not only their first half GP margin was down year-on-year basis, but also I think the labor costs are more like fixed cost and they are seeing pair labor cost is rising up. So just wanted to ask if any specific example that given the longer lead time that you place in the more fashion or luxury category, how you managed to sort of reduce labor cost of pair. So that's the number one question. Number 2 question is regarding the -- I think on the sports category, if you can -- I may miss some of the comment, but maybe you can share with me about the overall sort of outlook and the current discussion with your key customers regarding how they see 2024 regarding especially the first half. Is there any recovery from the customer perspective or they still think that in 2024, the first half, they are building in the overall order momentum and also the consumption momentum will still be weak for them? Yes, that's 2 questions from me.

Thank you. Let me address the first one. On the labor cost, it is really about detailed people day-to-day management. It is really important to -- you want efficient utilization, you got to manage your people right. And that's why I go back to where first half this year, we didn't lay off anyone, okay? I think some other manufacturers you hear, they have major massive layoff in Southern Vietnam, pay big severance costs. That basically means they have way too many people, okay? And that's just not as efficient as people management. And we didn't have to do any of that because we're very focused and very lean even from last year. We need to -- we have to get in front of this. There will be low utilization by our large customers because that's what they told us and to all the vendors as well. So we need to make sure that we manage our operational efficiency, people management capacity utilization very well. And also within that, how do we minimize overtime and kind of other subcontracting costs, which is high. So we manage just the people power and planning. That's what actually allows to lower labor cost per pair, okay? And that's the efficiency measure, even our customer measure as well. Maybe Stephen, you can talk about the sports category outlook.

Okay. In terms of the sports category outlook, other than our major customers, we do have other sports brands as well. In general, the sports category, I would say they're basically normalizing their inventory issue. I believe it's still there. So it will still take them some time to really clean everything out. So from our perspective, we do not expect the sports brand in general to have a tremendous growth. Low to mid-single digits will be a good year, '25, and that's basically what we're preparing. That's basically what we did in terms of preparation and planning for this year. And that's what -- like Andy said earlier, that's how we manage the labor force and labor utilization.

Got it. So I can more so conclude that for the sports category, the major customers, no matter who is still pretty cautious, everyone, every sports brand is still a little bit cautious on the outlook even up to now, right?

Correct.

[Operator Instructions] Matt, we don't have questions at this point of time.

Stephen, Andy, did you have any final comments to make?

Yes. So I think this is the first half of our 3-year plan. Looking at first half performance so far and also looking at the rest of the year, we feel like we're in a very good track to achieve our 3-year plan. In fact, we're probably looking at a little bit ahead than what we originally expected. So we're kind of almost midway in terms of -- if I look at the goal line, we kind of outperformed better than we expected from the original plan from our strategy. So everything is great. I think nothing is going to be entire linear though for the entire 3-year plan I mentioned earlier. So you might see that we do so well this year that maybe next year, 2024, the growth, which will grow, but then it might not be as aggressive as say, we have this year on a full year basis. But either way, we are still on track to get to that mid-teens net profit growth for all 3 years, and we'll probably hit the 10% operating margin target pretty soon. Stephen, anything you want to add?

No. That's perfect.

Okay. Well, thank you very much. I look forward to speaking to you guys and seeing you guys in person. So give us a shot if you guys have any other questions. Thank you, everyone.

Thank you all.

Thank you, everyone, for joining the presentation today. This concludes today's call. Have a great evening. Thank you.