Description

At a time when Chinese equities are broadly out of favor, we believe that JNBY Group (3306 HK) represents a particularly attractive investment opportunity. Shareholders gain exposure to a highly regarded Chinese fashion brand, benefitting from local demand [HS1] as well as from the growth of a more design savvy middle-class. [HS2] 

Before we jump in, we should start by saying that [HS3] JNBY is very efficiently run by a female-dominated executive team (the CEO, CMO and Creative Officer are all women), a situation that we wish we would see more often in Asia!

JNBY is the leading women’s fashion brand [HS4] in China. Its stable design team operates from its Renzo Piano-designed headquarters in Hangzhou, and has carved out a 33% brand recognition [HS5] [HS6] in its domestic market. Inspired by niche Japanese and French fashion brands, the company has created its own identity and a large following of loyal customers. Even the company’s annual reports have a beautiful aesthetic. The paper quality and layout compares with those published by leading design brands in Europe.

The company stock can be bought at a valuation of 3x EV/EBIT and 6x P/E. JNBY leases its headquarters, outsources manufacturing and relies on a network of trusted distributors, making the business very capital efficient and cash flow generative. Thanks to a shareholder-friendly capital allocation policy and its current low valuation, the dividend currently amounts to a generous 12% (16% on a LTM basis which includes a special dividend).

Although the company has benefited from the closure of borders over the past two years[HS7] , its 5-Year EBIT CAGR of 21% is still pretty impressive.

Interestingly, JNBY operates with a different model in comparison to the majority of its Chinese competitors.

The company directly manages only 30% of its stores. Distributors pay in advance for inventories at 40% of retail price and retain the option to return 10 to 20% of unsold items back to JNBY. More than 80% of stores are located in shopping malls or department stores located in Tier 1 and Tier 2 cities, which speaks to the brand’s relevance and positioning. While we are not retail specialists, the first-year sell-through of 70% strikes us as impressive, even when taking into account that 30% of items are discounted in the process. The company claims that sell-through even reaches 95% over a 3 year period.

JNBY has incorporated the latest technology as part of its sales strategy, again reflecting on the quality of the team and the company’s ability to operate efficiently. It has built a loyalty program with 412,000 active members, half of which spend more than RMB5,000 (about US$900) a year across its brands. This program has been very successful with 70% of sales tracked to members and 40% of this linked to a high-spending subset.

In 2020, the company introduced ERP software allowing inventory sharing between stores. This ensures that the whole inventory can be accessed by instore staff and an unavailable item can be shipped to customers directly. We understand that this led to a7% increase in sales in 2021. More recently, a Quick Manufacturing Process was implemented, which allow the company to produce in-demand items rapidly. Up to 15% of sales are now produced that way. As a result of these initiatives, inventory has actually declined over the past 3 years while top line increased by 44%.

JNBY has a strong online presence, which has reached 16% of sales, built around social media influencers and spokeswoman. The online strategy is tightly linked to JNBY’s existing distribution network and augments rather than cannibalises it.  

The company has had a good track record of increasing its Same Store Sales (SSG) by about 8% up to FY19 when it dropped 3.4%, due to an over diversification in new sub-brands, especially for young men’s fashion. The company refocused its brands strategy in H2 2020 after a period of sales decline (which in turn was reflected in the share price), with SSG quickly returning to historical growth rates. We understand that new brands now go through a more intense trialing stage before being launched.

A good description of the different brands and their positioning can be found on page 10 of the slides deck which can be obtained from the company by contacting the company’s very helpful Investors Relation contact ([email protected]). A more exclusive sub-brand, LESS, has for instance attracted a famous spokesperson, ZHOU Xun, last summer and is healthy growing its line of premium priced items.

The presentation is pretty extensive and provides a lot more explanations on the company’s priorities than found in supplemental disclosure of other Chinese companies. It is well worth the read.

In September 2021, JNBY’s share price was significantly impacted after a news story went viral linked to offensive language displayed on a T-shirt which was part of the childrenswear range. As you can see below, this was pretty bad …

Despite the piece of clothing being part of a 2018 collection, and the media attention quickly dying away after additional safeguards were added to the design process, JNBY’s share price has struggled to recover. It has no doubt also been hindered by the very negative sentiment for Chinese mid-caps and the poor results at brands such as Ningbo Peacebird and China Lilang. More recently, the negative impact of the ongoing lockdowns will also not have helped.

We have been investing in Asia and China for more than 10 years now, and have so far managed to avoid being caught in a fraud. This has partly been achieved by closely tracking the operating cash flows generated by any businesses in the Mainland to its Hong Kong listed entity. On this basis, the fact that JNBY has already paid more than HKD2.3 billion in dividends since its listing in Oct-2016 is clearly very reassuring. We are also pleased to see that JNBY’s auditor has been PWC since 2015 and the company’s ownership is clearly split among the high-quality founding team.

In a paradoxical way, we also pleased to see the company provides a comprehensive and transparent list of connected transactions, even if we object to a number of them. We have engaged with management on this issue, and have highlighted our disproval of the recent loan to one of the founders for buying art for the company’s in house gallery and the latest investments in Venture Capital Funds. [HS8] 

One particular pressing area, which has seen some recent improvement, is the reduction in wealth management products issued and guaranteed by Chinese banks held on the balance sheet. This is a frequently occurring problem when investing in Chinese companies with excess cash on their balance sheet. The capital invested has reduced from RMB 263mm at June-2020 to RMB 30mm at Dec-21 after we pointed to the impairment risks against the relatively small pick-up in interest income. 

The company has a track record of taking rapid corrective actions. We think it will navigate the current lock-downs like the one in Shanghai (online delivery for non-essential items have been forbidden, unlike the 2020 lockdowns) which will end up having a relatively short-term negative impact.

Risks

-          Regulatory crackdown expanding from technology companies to more private sectors

-          Major slowdown in Chinese domestic consumption following an economic slowdown

Disclaimer: This is not investment advice. 

Catalyst

Catalysts

-          The ~12% dividend already goes a long way to fill a 20% IRR target

-          Even a partial mean-reversion from the current 6 P/E to its 5-year average of 12 P/E should bridge the remaining 8% gap