WHAT THE BROKER SAYS

Fountain Set, which was founded in 1969 and listed on the Stock Exchange of Hong Kong in 1988, is one of the world's leading producers of cotton knitwear. It makes dyed yarns, knitted fabrics, dyed fabrics, printed fabrics and garments from manufacturing bases at Dongguan, Guangdong, and in Indonesia and Sri Lanka. Fabrics account for about 95 per cent of sales.

G.K. Goh has maintained its 'hold'' recommendation on the stock. Fountain Set is boosting its fabric capacity to tap the trend to outsource production and an expected shift in garment manufacturing to China. It wants to add capacity at an annual rate of 10-15 per cent over the next five years but the pace will depend on United States compliance with World Trade Organisation rules on the removal of garment tariffs.

Margins are expected to rise gradually because of continual investment in more efficient equipment, installation of power generation equipment and greater economies of scale.

Over the past two years, the stock has enjoyed a re-rating as earnings growth hit a peak in 2002. G.K. Goh expects growth to moderate from 2004. Fountain Set is trading at 11.6 times one-year forward price-earnings, just short of a record high point, and G.K. Goh says it would buy the shares at HK$6.25 and below.

Its prospective return on equity of 16.3 per cent trails its leading peers and its return on invested capital of 13.3 per cent also lags due to a relatively high gearing averaging 50 per cent over the past three years.

G.K. Goh sees an execution risk in Fountain Set's embryonic business of infants' and children's clothes. Capacity under construction is due to open in 2005 when global tariffs and quotas on garment exports will be scrapped. Garments could rise from 5 per cent of sales in 2002 to 8 per cent in 2004. It also fears that new processes may stretch the abilities of management and that there is a potential for overcapacity in the industry.