Despite the lower-than-expected results, Zaino is preparing for its next leg of growth, to be driven by its enhanced market leadership and healthy financials. Maintain BUY.

Update from distributors: better sales since July. We called the respective distributors after China Zaino International’s (Zaino) 2Q09 results announcement to obtain an update on the recent sales performance. Some new findings are summarised in the table below. Generally, distributors are feeling more confident in sales in the coming months and they also commented that sales from July onwards are getting better. They have expressed concern about future sales as there is a change in consumers’ preference towards cheaper products, where competition is more intense in this segment.

Expansion of distribution network and renovation of existing POS. Zaino intends to expand its distribution network to over 4,000 point of sales (POS) by 2011 and renovate existing POS outlets to provide a larger shop area to increase product penetration. Currently, 1,000 shops have to be revamped from metal fit outs to new wood fit outs. We believe such strategy is likely to enhance the market leadership of Zaino. Its luggage segment will continue to ride on its vast distribution network with further volume growth expected.

M&A opportunities. Zaino’s management has reiterated that they are actively looking for merger and acquisition (M&A) opportunities to further expand the group’s business structure. Possible M&A targets include backpack and luggage manufacturers that have already established a brand and existing network, similar to the group’s current competitors but with a smaller business scale and good track record.
Restart TV advertisement from June to strengthen brand image. After seeing the positive feedback from the TV advertisement shown from Jul 08 to Jan 09, the group restarted TV advertisement from Jun 09, expecting to continue throughout the rest of the year. We believe such a move will help to strengthen Zaino’s Daipai brand further and pave the way for its long-term growth.

Dividend payout is a sure thing for 2009. Despite a possible drop in earnings this year, the management has promised to pay dividends for 2009. The payout ratio is at least 20%, same as 2008.

Healthy financial position. Amid improving fundamentals in the overall economic environment, the group has been keeping its financial position healthy, paving the way for growth. As at end-2Q09, it had net cash of Rmb854m, or S$0.19/share. Trade receivables continued to fall from Rmb318.6m at end-08 to Rmb237.9m at end-Jun 09, suggesting that the group is enhancing its credit control ability.

Zaino is trading at 2.7x 2009 PE, a 40% discount to its Singapore-listed peers’ average, not to mention the huge discount compared to Hong Konglisted sportswear retailers’ average of 14.8x. We value the stock at a 10% discount to S-shares’ average and arrived at our target price of S$0.35, implying 3.8x 2009 PE.