Financial Report 2024 | Clearing inventory cycle faces tax rate pressure, Huali Group experiences a double decline in performance for the first time since its IPO

In the inventory clearance cycle of the sports footwear and apparel industry, upstream contract manufacturers are always the first to feel the temperature.

On April 11, Huali Group (300979.SZ) released its 2023 annual report, with a realized revenue of 20.114 billion yuan, a year-on-year decrease of 2.21%; and a net profit of 3.2 billion yuan, a year-on-year decrease of 0.86%.

This is also the first time since its listing in 2021 that Huali Group has experienced negative growth in performance.

On April 12, Huali Group fell 0.52% to 62.75 yuan per share at midday, with a year-to-date stock price increase of 19.21%.

It is worth mentioning that in 2023, the Fuguo Tianhui Selected Growth A Fund managed by Zhu Shaoxing entered the top ten shareholders of Huali Group from the second quarter, continuously increasing its holdings. By the end of 2023, the fund had become the fifth largest shareholder of Huali Group, with a shareholding ratio of 0.47%, and a holding market value of 290 million yuan.

As the global leader in sports footwear contract manufacturing, Huali Group's top five customers include Nike, VF, Deckers, Puma, and Under Armour, with Nike being its largest customer, contributing nearly 40% of revenue.

Since 2022, affected by factors such as inflation, the external consumption environment has not been prosperous.

In the process of clearing inventory at the end, it is not surprising that customers are cutting orders. Huali Group sold 190 million pairs of sports shoes throughout the year, a year-on-year decrease of 13.85%, with its capacity utilization rate decreasing by 4.29 percentage points year-on-year to 86.66%.

Ma Li, an analyst at Zheshang Securities, believes that based on Huali Group's sales volume in the fourth quarter of 2023 increasing by 4.9% year-on-year to 54.59 million pairs, which has significantly reversed the declining sales performance in the previous three quarters, combined with the latest inventory levels of major customers represented by Nike gradually returning to normal, she believes that the downstream destocking cycle has basically come to an end.

However, judging from the latest performance of major customer Nike, it may still take some time to see the turning point in the industry's destocking cycle.

In the three months ending on February 29, 2024, Nike achieved a revenue of 12.429 billion US dollars, a year-on-year increase of 0.31%, but a quarter-on-quarter decrease of 7.29%; while net profit decreased by 5.48% year-on-year and 25.73% quarter-on-quarter.

A textile and apparel analyst from South China expressed to TradeWind01 that as of 2023, looking at the performance of overseas sports footwear and apparel companies, except for a few such as lululemon, On Running, and Deckers with better inventory-to-sales ratios, most others are at relatively high levels.

The analyst mentioned above stated that based on historical experience, it usually takes about 5-6 quarters for the industry to go from entering the destocking cycle to inventory recovery.

In terms of regions, in 2023, the revenue share of the U.S. market, accounting for as high as 85.88% of Huali Group's revenue, decreased by 0.23% year-on-year, while the second largest European market decreased by 12.3% year-on-year The sluggishness of the terminal consumer market has not stopped Huali Group from expanding its production capacity against the cycle.

In 2023, Huali Group completed the acquisition of Hero Heart International Limited for $63 million (approximately RMB 456 million).

Under Hero Heart International, there are Vietnam Yongchuan Footwear Co., Ltd. (referred to as "Vietnam Yongchuan") and Jia Da International Holdings Co., Ltd. (referred to as "Jia Da International"). The acquisition of Vietnam Yongchuan will provide Huali Group with an annual production capacity of 10 million pairs of sports shoes from the Vietnam factory, while Jia Da International is a shoe trading company responsible for the procurement of raw materials for Vietnam Yongchuan and the sale of finished products.

In 2021, Hero Heart International achieved a revenue of $117 million (approximately RMB 847 million) and a net profit of $18.84 million (approximately RMB 136 million). From January to August 2022, Hero Heart achieved a revenue of $107 million (approximately RMB 774 million) and a net profit of $16.18 million (approximately RMB 117 million).

Based on Hero Heart International's net profit of RMB 136 million in 2021, Huali Group acquired PE at 3.3 times, adding goodwill of RMB 128 million to Huali Group.

More than 80% of Huali Group's production capacity is located in Vietnam, where tax policies have been raised since 2024.

In November 2023, the Vietnamese National Assembly passed a resolution on "Imposing Additional Corporate Income Tax as Required to Prevent Global Tax Base Erosion (Global Minimum Tax)", under which Vietnam will impose additional corporate income tax at a rate of 15% on multinational enterprises with a combined turnover of at least EUR 750 million (approximately RMB 58.17 billion) in two out of four consecutive years starting from 2024.

In its annual report, Huali Group stated that the Vietnamese government has not yet introduced specific detailed tax policy guidelines, and it expects a certain increase in future tax burden, but the impact will not be significant.

TradeWind01 called Huali Group to inquire about the quantified impact of the tax rate adjustment on profits, but the call was not answered.

Previously, the Vietnamese government offered a special tax rate of 10% for investment projects that are specially encouraged, with a tax exemption period of 4-15 years. For enterprises with an investment amount of $300 million or annual sales of $500 million, or providing more than 3,000 jobs, the Vietnamese government provides special tax incentives of "four exemptions and nine half reductions".

The "four exemptions" mean that under specific conditions, enterprises do not need to pay income tax in the first four years of profitability, while the "nine half reductions" mean that after the tax exemption period, enterprises can enjoy a half reduction in corporate income tax for up to nine years.

From 2021 to 2023, Huali Group's overall income tax rates were 24.89%, 21.08%, and 20.71%, respectively.

To diversify policy risks, Huali Group is expanding its production capacity in Southeast Asian countries outside Vietnam. It is expected that in the first half of 2024, a new factory (finished shoe factory) in Indonesia will gradually start production Compared to its peers, Huali Group's main OEM products are mainly mid-to-low-end products, and the challenge of increased taxes and fees may be greater for its profitability.

According to information obtained from sources close to Huali Group by Xinfeng (ID: TradeWind01), the average selling price of Huali Group is lower compared to Yuyuan, Fungtai, and other peers. The latter two are around $20 in 2023, while Huali Group is around $15.

Under the dual pressure of clearing inventory at the terminal and changes in tax rates, the effectiveness of Huali Group's counter-cyclical expansion remains to be observed