RBC Capital Markets initiated its rating on shares of Zuoan Fashion Ltd (NYSE: ZA) at outperform, speculative risk and a price target of $9.
The company is a leading designer brand for casual menswear in China. On a base of just over 1,000 stores, plans call for 150-plus new store openings per year, contributing to at least a doubling of locations over the next several years. We have modeled top-line growth of 33 percent in 2011 and 30 percent in 2012, and forecast 2011 and 2012 EPS growth of 24 percent and 43 percent, respectively, said Howard Tubin, an analyst at RBC Capital.
Tubin said the operating model is somewhat unique relative to the U.S. apparel sector and is more akin to a franchise operation. It supports rapid store growth with less inventory/real estate risk and less capital outlay.
Tubin said the shares afford investors an opportunity to take advantage of the rapidly growing apparel market in China. Already surpassing the United States, China’s menswear market is expected to double to $92.5 billion within five years.
Tubin said trends in the subsector of casual menswear are even more favorable. The casual menswear market (in which Zuoan competes) was $5.4 billion in 2009 and it is projected to almost triple to $16.5 billion in five years, a 23 percent compound annual growth rate (CAGR).
The stock currently trades at about 6 to 7 times of our 2011 EPS estimate of $1.10. While we believe a meaningful discount to the peer group is justified based on some relatively unique risks, we also believe that upside in share price could be meaningful as management executes on its growth plans. The current valuation, in our opinion, represents an attractive entry point, said Tubin.
As Zuoan is a company that does business exclusively in China, Tubin believes there is a discrete set of risk factors that should be conveyed, which include: limited visibility on operations and heavy reliance on management's guidance; the company's dependence on a small group of distributors; an unproven flagship store opening strategy; a corporate structure which includes several entities in several geographies; and fashion trend misses.
The brokerage established its 2011 operating EPS estimate for Zuoan Fashion of $1.10 on revenue of $171.2 million and its 2012 estimate of $1.67 on revenue of $222.6 million.
Zuoan Fashion stock closed Friday's regular trading session at $6.99 on the NYSE.