The Hindu Business Line : Hanung Toys: Buy

An investment can be considered in the stock of Hanung Toys and Textiles (Hanung). The company t continues to record strong order flows amid an uncertain export environment. It has so far handled the rupee appreciation well, with its realisations actually improving in recent times. Hanung’s toy export business may also benefit from the possible backlash on Chinese toy manufacturing following Mattel Inc’s recall of 18 million defective products. At the current market price of about Rs 160, the stock trades at about 10 times its likely 2007-08 earnings per share.

Long-term contracts

Entering into a long-term contract with buyers is not a standard practice in the textile industry, as international retailers tend to alter their sourcing plans based on changing fashions. Hanung has managed to enter into two-three year contracts with its clients. It recently bagged a Rs 600-crore order from IKEA, Sweden, with whom it has a long- standing relationship, for exporting soft toys/children’s furnishing. This order is likely to deliver a steady revenue flow over the next four years. It also received a Rs 200-crore order from a US buyer for exporting home furnishings, which is to be completed by December 2009.

In the backdrop of concerns of a slowdown in US imports and an appreciating rupee that might render Indian textile exports uncompetitive, the long-term nature of the contracts provides greater visibility to Hanung’s revenue stream.

Hanung is also well-placed now to cater to these orders. With the help of the proceeds from its IPO in late 2006, it has integrated backward into fabric manufacturing. The new facility has come on stream in July.

Rupee rise

The sharp appreciation of the rupee in the early part of 2007 did not have a significant impact on Hanung’s operating margins on the back of improving volumes. Operating margins in 2006- 07 were up 2 percentage points at 17 per cent.

In the first quarter of the current fiscal as well, margins have improved on the back of improving utilisation levels. Rising contribution from domestic operations and raw material imports, which have provided a natural hedge against the rising rupee, have helped limit the impact of currency appreciation on margins. Imports account for about 30 per cent of revenues.

Hanung has been able to negotiate with its buyers for better prices. About 20-25 per cent of its order from IKEA has been priced in rupee terms.

Higher domestic share

Besides, Hanung’s domestic operations may begin to take up a greater share of revenues from the current 25 per cent. Hanung sells soft toys to retailers such as Lifestyle, Shoppers’ Stop and other departmental “lifestyle” stores. These stores are on a rapid expansion path and are increasingly targeting the children’s segment.

Revenues from domestic operations jumped eight-fold in 2006-07 and increased by 50 per cent in the first quarter of 2007-08.

With the licence to use Disney characters for the manufacture of its toys and home furnishings, Hanung hopes to capitalise on the growing spends in the children’s segment.

Risks

A slowdown in the import of home furnishings following any decline in housing activity in the US or Europe is a key risk to our recommendation. The company has a high client concentration, with IKEA contributing a chunk of its revenues.

Finally, while the recent product recalls from China may have a beneficial impact on Hanung in the near term, toy manufacturers and retailers in the US are under pressure to raise safety standards.

Complying with stiffer norms may come with higher costs for Hanung, which also imports a significant amount of its materials for manufacturing of soft toys from China and Taiwan.

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