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Published: March 26, 2010
As the Japanese economy developed in the
1970s and 1980s, U.S. companies such as Coca-Cola (NYSE: KO)
and McDonald's (NYSE: MCD) made major headway into the
hearts and minds of local consumers. But a similar trend may not
emerge in China. Western nations caution that it has been
difficult to crack the fast-growing Chinese market, and local
brands appear to be the biggest beneficiary of that country’s
consumer boom.
That’s good news for China's Deer Consumer Products (Nasdaq:
DEER), which designs and builds kitchen appliances for
global manufacturers and also sells eponymously-branded products
into the local market. And domestic sales are rising at a fast
clip. When you consider the size of the emerging middle class in
China, Deer might have a very long runway for growth.
Deer arrived on the scene just a few years ago, posting $33
million in sales in 2007. Fast forward to 2010, and sales look
set to exceed $150 million. The company initially gained
traction as a developer of juicers, blenders, coffee makers and
other counter-top appliances for customers such as Stanley
Black & Decker (NYSE: SWK), Toastmaster, and Wal-Mart
(NYSE: WMT). But management soon realized that higher profit
margins could be gained by directly selling to Chinese
consumers. They were right.
In 2007, the company had gross margins of around 22%, roughly in
line with private-label appliance makers. Two years later, with
an increasing exposure to direct sales, gross margins had risen
to 25%. And judging by management guidance, they should approach
30% this year.
That leads to a trend that every investor should watch for:
rising sales and even faster-rising profits. Based on current
trends, management expects sales to rise more than +70% this
year, but
net income looks set to nearly double. It’s important to
note that per-share profits won’t grow quite as fast, as the
share count has risen nearly 40% thanks to a 2009 secondary
stock offering. The capital-raise, along with money generated
from operations, has pushed the company’s cash balance up from
$3 million at the end of 2008 to $79 million ($3.40 a share) at
the end of 2009.
With all that money in the bank, management promises that no
more capital raises will be necessary. That also means that
interest from Wall Street analysts will be limited, as research
coverage of small companies often relates to potential banking
opportunities. So management will need to find other ways to get
the attention of investors.
And a sure-fire attention getter is profitable strong growth,
augmented by continuous new contract signings. In recent months,
Deer has:
- Announced a contract to sell high-end espresso makers
under a leading unnamed European brand.
- Poured greater sales efforts into Chinese online sites --
especially through the leading Taobao.com portal.
- Entered into a sales agreement to sell Deer-branded products
in Wal-Mart’s Chinese stores.
- And made modest so-called tuck-in, or complementary
acquisitions of local appliance makers.
To be sure, the bullish 2010 sales
forecasts are a reflection of those deals, and don’t reflect the
organic growth in the Chinese market. Without these kinds of
moves, investors should expect more moderate +15% to +30% sales
growth. Yet as noted above, gross margins are steadily
expanding, so bottom-line growth beyond 2010 should remain
robust.
Against that backdrop, shares trade for about 21 times trailing
profits, and around 15 times projected 2010 profits. As profits
look set to grow at a +20% to +30% clip for the next few years,
that multiple seems quite reasonable. More than likely, the pile
of cash will continually be spent on accretive acquisitions, so
+30%-plus profit growth may be the norm.
Of course, the Chinese economy is white hot right now, and could
cool at any moment. But that would likely prove to be a
temporary hiccup, as the economy should be on a sustainable
growth path for some time to come, particularly with the respect
to a growing middle class. Deer Products looks to be a logical
platform for foreign investors seeking exposure to this rising
Asian tiger.
-- David Sterman
Contributor
StreetAuthority |
