Shenzhou International Group is one of the few large-scale and vertically integrated fabric/garment suppliers in Asia, which has a concentration of high-quality customers such as Nike, Uniqlo, Adidas and Puma.

Founded in 1988 and listed on the Hong Kong Stock Exchange in 2005, China-based Shenzhou International Group Holdings has grown from a small factory serving largely one client (Uniqlo from Japan) into the largest vertically integrated knitwear manufacturer (yarn-to-garment) in the world, servicing internationally renowned apparel brands. It offers customized fabrics, dyeing and finishing, printing and embroidery, cutting and sewing, as well as packaging and logistics services.

Its top four clients (Uniqlo, Nike, Adidas and Puma) contribute for the vast majority of its total sales. China is its largest market at 31% of 2019 sales, then Europe 17%, Japan and the US both at 15% and others 22%. Shenzhou can produce various knitwear, such as sportswear (72% of its 2019 sales), casual wear (23%) and lingerie (5%), from its sites in China, Vietnam and Cambodia.

The company aims to adjust its current product mix to manufacture and sell a larger percentage of higher-margin knitwear products such as sportswear with significant added value. In order to achieve this objective, Shenzhou plans to acquire more specialized production equipment for the production of these higher-margin products, increase its production and design capability to produce new fabrics and designs for these products and hire new staff with in-depth market experience in these product lines.

Shenzhou has been expanding strongly into Vietnam and Cambodia in order to help mitigate China’s rising costs and to diversify its supply chain amid the trade war disruptions between the United States and China. Currently, Shenzhou has about 3,000 workers for #2 garment factory in Vietnam and aims to recruit an additional 3,000 workers by end- 2020. Amid tight labor conditions, Shenzhou has offered 10-15% higher wages than peers to attract workers. Execution in these frontier markets is therefore also a serious challenge for the company and it cannot be excluded that they diversify their geographical exposure even more to counter this risk.

Its strengths are its strong R&D capabilities and technical knowhow. Examples of this would be the material technology used in making fabrics with a unique functionality like ‘HEATTECH’ for Uniqlo. Shenzhou is also a near-exclusive supplier to Nike’s Flyknit shoe uppers, including the latest Air VaporMax collection.

Shenzhou enjoys customer stickiness (due to higher switching costs) by providing one-stop-shopping services to the brand owners and offers a better control on quality and costs. Presently, it is responsible for 16-17% of Nike’s apparel procurement, 13-14% of Adidas’, 13-14% of Uniqlo’s and 40% of Puma’s. Hence, Shenzhou is a rare proxy to the top-tier activewear brands and the rising athleisure trend. Obviously, the concentration of exposure to these high-quality international players is also a risk to monitor as a slowdown in some of these key customers’ sales can have a material impact on the company.

Shenzhou has consistently delivered double-digit earnings growth over the past five years. With a strong order book, 100% utilization and 10-15% capacity growth per year, double digit earnings per share compound growth over 2018-2020 can be expected. In terms of balance sheet, the company has a sizeable net cash position, solid returns of above 20% return on equity and return on invested capital, a high-quality growth profile and dividend and free cash flow yields of 2% and 3%, respectively.

In terms of sustainability, which is often a very big issue in this particular sector, Shenzhou does very well. Indeed, it has a ‘low risk’ rating at Sustainalytics, which covers the company from an ESG point of view. Its overall risk is lower since it is materially exposed to fewer ESG issues than most companies in its universe. The company has not had any ESG-related ESG controversy so far, which is exceptional in this industry.

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