During the past couple of months, Singapore-listed China companies, or S-shares, have been severely clobbered amidst the gloomy backdrop of an ongoing credit crunch, lower-than-expected consumer demand as well as margin erosion resulting from higher material and labour costs.

Nonetheless, that did not deter Zhongguo Pengjie Fabrics (Pengjie Fabrics) from making its Mainboard debut on 11 August. But like most of the other new kids on the block, the Shandong-based company is currently trading underwater, at a 24% discount over its $0.23 offer price.

Despite the weak market sentiment, Pengjie Fabrics’ IPO has notably attracted the interest of a number of institutions, including CITIC Securities Brokerage (HK), Sunmax Capital and funds under the discretionary management of Daiwa SB Investments (Singapore).

Just Another Textile Play?
Although Pengjie Fabrics also serves the textile industry in the PRC, the company is rather different from other industry peers listed on the Singapore Exchange (SGX), such as China Sky Chemical Fibre (China Sky) and Li Heng Chemical Fibre (Li Heng), according to Liu De Jie, Executive Chairman of Pengjie Fabrics.

“Within the textile industry, there are quite a number of sub-sectors, in which the end product and raw materials used are entirely different,” Liu told Shares Investment (Singapore) during an exclusive interview. Indeed, while chemical fibre is the key raw material for players like China Sky and Li Heng, Pengjie Fabrics’ operations revolve primarily around cotton.

Established in 2003, Pengjie Fabrics specialises in the production of yarns, mainly combed cotton yarns and loom-state fabrics, which are widely used in the manufacture of high-end apparel and home furnishing items. Known for its quality products and stringent quality assurance measures, the company also produces yarns made from various natural and synthetic fibres, including modal yarns, bamboo yarns, luminous yarns and thermal yarns.

As at 31 December 2007, the company’s yarn production plant has a maximum production capacity of 17,303 tonnes per annum, while its loom-state fabric production facility has a maximum production capacity of 26.8m metres per annum.

Healthy Financials
In line with growth of the PRC economy, Pengjie Fabrics’ financial performance has been robust throughout these years. From FY05 to FY07, the company’s top- and bottom-line surged at a compounded annual growth rate of 56.4% and 65.4% respectively.

For the full year ended 31 December 2007, Pengjie Fabrics posted a 20% year-on-year increase in net profit to Rmb67.3m largely attributable to a 40.1% revenue jump to Rmb486.6m. Gross margin, however, dipped slightly from 20.4% to 19%. This resulted from reduced gross margin for yarns, which was in turn due to a rise in purchase of finished goods from third party manufacturers to fulfil demand as the company’s utilisation rate had reached close to its maximum level.

Determined to prop up its gross margin, Liu commented that the company has earmarked $6m of the IPO proceeds for the expansion into the production of compact spinning yarns, which will be carried out in phases over the next three years.

Utilising recent technology that improves yarn quality and enhances the efficiency and effectiveness of yarn production, compact spinning yarns generally command a higher gross margin as compared to conventionally spun yarns. Liu also added that commercial sale of its compact spinning yarns has started on a small scale in January this year.

Meanwhile, plans are also on the cards to diversify into the production of higher margin wide loom-state fabrics, via the acquisition of machinery and/or an existing business. Setting aside another $12m of the IPO proceeds particularly for this purpose, Pengjie Fabrics expects to have an estimated annual production capacity of 25m metres of wide loom-state fabrics. It also anticipates the sale of such fabrics to begin by the second half of 2008.

In terms of valuation, Pengjie Fabrics, which is trading at slightly below 5 times historical PE, is comparable to the rest of its SGX-listed industry peers, which are trading at between 4 to 6 times historical PEs. Even so, the company’s trading volume has been nothing but thin as investors stayed on the sidelines, preferring not to go head on with the raging bears.

Driven by rising affluence and awareness of fashion trends, there has been an increasing demand for high-end apparel in the PRC. Furthermore, with PRC’s accession to the WTO, the quota restriction on the import of garments and apparel manufactured in the PRC to US and Europe, where high-end apparel are in huge demand, have been abolished since 1 January 2005. All these certainly bode well for Pengjie Fabrics, which is well positioned to capturethis burgeoning segment of the market.

Financial highlights

Caption 1: Liu: Within the textile industry, there are quite a number of sub-sectors, in which the end product and raw materials used are entirely different
Caption 2: Capacity expansion to drive further growth