Hi-P International - DBS Research 2017-05-23: Powering Ahead

Hi-P International - DBS Vickers 2017-05-23: Powering Ahead HI-P INTERNATIONAL LIMITED H17.SI

Hi-P International - Powering Ahead

  • Riding on the strong growth trajectory for smartphones and IoT.
  • New customers and new product launches coupled with big rise in capacity utilization to drive growth.
  • Potential takeover target for global players looking to build a base in Asia.
  • Initiating coverage on Hi-P with BUY rating and target price of S$1.07 based on 12x FY18F earnings.



One-stop contract manufacturer. 

  • Hi-P provides one-stop solutions - from product development, component manufacturing to complete product assembly - to customers in various industries.
  • Broadly, Hi-P’s products can be classified into three broad categories: 
    • Wireless (smartphones), 
    • computer peripherals (Internet of Things [IoT]) and 
    • consumer electronics.


Riding on the growth trajectory for smartphones and IoT. 

  • The Smartphone and IoT segments are expected to continue to do well in the next one to two years. Hi-P is capitalising on this trend, with the ramp-up in production. Hi-P is expected to expand production, in particular at its Suzhou plant, in preparation for orders from its new customers, and also new products from existing customers. Overall utilisation rate for 1Q 2017 was below 40%. 
  • With the expected ramp-up in production, we expect utilisation rate to reach 60-70% in the next 1-2 years.


Potential takeover target. 

  • Hi-P could be an attractive target for global companies looking to build a base in Asia. 
  • To date, there is still no concrete succession plan announced by its Executive Chairman & Chief Executive Officer, Mr Yao Hsiao Tung, who has a 61% stake in the company.


Initiate with BUY; target price of S$1.07 based on 12x FY18F earnings. 

  • Hi-P is currently trading at 9.7x FY17F PE and 9.1x FY18F PE. We believe a valuation of 12x FY18F PE is fair, pegged to a 10% discount to the peer average, given its smaller scale. 
  • We derive a TP of S$1.07, which translates to an upside of 30% from the current price.



Company Background 


One-stop contract manufacturer. 

  • Hi-P started out in 1980 as a tooling specialist in Singapore and has since grown to become one of the region’s largest and fastest growing integrated contract manufacturers today. The group provides one-stop dedicated solutions to fulfill its customers’ needs – from product development, component manufacturing to complete product assembly.
  • Hi-P’s customers include many of the world’s biggest names in mobile phones, tablets, household & personal care appliances, computing & peripherals, lifestyle and industrial devices.
  • Products classified into three broad categories Broadly, Hi-P’s products can be classified into three broad categories - Wireless (smartphones), computer peripherals (Internet of Things (IoT)) and consumer electronics.

Volatile wireless and IoT products offset by more stable consumer electronics.

  • Compared to consumer electronics products, wireless and computer peripherals products tend to have a shorter shelf life, and thus, there is a need to constantly test and launch new products, which could increase revenue and earnings volatility as as initial contributions tend to be small. 
  • Consumer electronics, which include coffee machines, mixers, shavers and electric tooth brushes, tend to have longer shelf lives and thus, provide more stability to revenue and earnings.

Fourteen manufacturing facilities. 

  • The group has 14 manufacturing plants globally located across six locations in the People’s Republic of China (Shanghai, Chengdu, Tianjin, Xiamen, Suzhou and Nantong), Poland, Singapore and Thailand. Hi-P has marketing and engineering support centres in China, Singapore, Taiwan and the US.

Manufacturing plants organised based on products and services 

  • For management and reporting purposes, Hi-P is organised into manufacturing plants based on their products and services, and has three operating segments as follows: 
    1. Precision plastic injection molding (PPIM) 
    2. Mold design and fabrication (MDF) 
    3. Provision of sub-product assembly and full-product assembly services (Assembly) 
  • Hi-P monitors the operating results of its manufacturing plants separately for the purpose of making decisions about resource allocation and performance assessment.

Materials and labour are main cost components. 

  • Materials form the bulk of total costs, at 40-50% of total costs. Labour is the next key item, making up about 30%.

Forex exposure. 

  • About 90% of total revenue is in USD.
  • Materials, which account for the bulk of total costs, are also in USD but overheads are mainly in RMB and the reporting currency is in SGD. In 1Q 2017, Hi-P reported net foreign exchange loss of S$5.2m, mainly due to the weakening of USD vs SGD.

China accounted for more > 50% of FY16 revenue 

  • In terms of geographical breakdown, Asia accounted for 64% of FY16 revenue; China made up 55% of total revenue.


Growth Strategies 


Strive for sustainable growth with a diversified customer base, and sharpened competitive edge. 

  • Over the years, Hi-P has built a base for its business and established strong relationships with its customers, especially the key ones. 
  • In light of the ever changing industry, Hi-P is constantly investing in sharpening its competitive edge to ensure that it provides its customers with best in class capabilities across the value chain. For example, in its metal Computer Numeric Control (CNC) processes segment, it continues to garner momentum as it has refined its capabilities and boosted productivity levels. Despite its early struggles in ramping up this segment, Hi-P is now well-positioned to capture business opportunities with existing and new customers.
  • Hi-P has also made a conscious effort to diversify its customer base. It has learnt from its past experience not to depend heavily on one single key customer. Its strategy in this area has borne fruit. Hi-P now has a relatively balanced contribution in terms of revenue and earnings from all its key business segments.
  • With a much stronger foundation, Hi-P now has the bargaining power to seek businesses to enhance its long term outlook, and also to negotiate for better terms, even with its key customers.

Improving operational efficiency and tightening cost controls.

  • To mitigate the impact of the uncertain business landscape, Hi-P strives to drive operational efficiency and strengthen its business model. One of its goal is to adopt a leaner business model. In this line of approach, Hi-P has channelled its efforts into tightening cost controls across all facets of its operations.
  • Despite the challenging environment, especially rising labour costs in the region in the past few years, total operating expenses as a percentage of sales has been trending down.

Optimising capacity utilisation; ramping up production for new customers and new products. 

  • Hi-P is expected to expand production, in particular at its Suzhou plant, in preparation for orders from its new customers, and also new products from existing customers. 
  • Overall utilisation rate for 1Q 2017 was below 40%. With the expected ramp-up in production, we expect utilisation rate to reach 60-70% in the next 1-2 years, as the group optimises capacity utilisation across all its manufacturing locations.

Expand customer base to other industries. 

  • Hi-P’s existing customers are mainly from the wireless (smartphones), consumer electronics and computer peripherals (IoT) segments. We would not rule out the possibility of the group expanding to other industries like automotive and medical devices, in order to diversify and reduce customer concentration risk, and to smooth out the seasonality effect, especially for smartphones.

Riding on the growth trajectory for Smartphone and IoT markets. 

  • According to the independent research firm International Data Corporation (IDC), the worldwide smartphone market will see a total of 1.53bn units shipped in 2017, up 4.2% from 1.47bn units shipped in 2016.
  • Thereafter, shipments will reach 1.77bn units in 2021, translating to a compound annual growth rate (CAGR) of 3.7%. The report also highlights that shipments will increase in 2017 and 2018 due to the plethora of new phone releases from major brands during this period.
  • In another study by the IDC, after a slowdown in 2016, the overall wearables market is expected to return to a strong growth path. New vendors and an expanded number of retail outlets will drive worldwide wearable device shipments from 102.4 million in 2016 to 237.5 million in 2021, a five-year CAGR of 18.3%.
  • For the IoT segment, according to IDC, global IoT spending will experience a CAGR of 15.6% over the 2015-2020 forecast period, reaching $1.29tr in 2020.
  • Overall, the positive outlook for the various segments bodes well for Hi-P as a handful of its key customers are in these segments. Hi-P is capitalising on this trend, with the ramp-up in production at its various manufacturing plants.

M&A activities – both as predator and prey. 

  • With a strong cash position, we would not rule out the possibility of the group expanding to other industries like automotive and medical devices via acquisitions, in order to diversify and reduce customer concentration risk, and to smooth out the seasonality effect, especially for smartphones.
  • Hi-P could also be a takeover target as to date, there is still no concrete succession plan announced by Executive Chairman & Chief Executive Officer, Mr Yao Hsiao Tung, who has a 61% stake in the company.
  • Furthermore, with its entrenched relationship with key customers, which include some of the world’s biggest names in mobile phones, tablets, household & personal care appliances, Hi-P could be an attractive target for global companies looking to build a base in Asia.


Key Risks 


Macroeconomic uncertainty 

  • Prolonged macroeconomic uncertainty would postpone consumer consumption, which in turn would drive down revenue further.

Volatile industry with shorter product life cycle 

  • About two-thirds of revenue is derived from the Wireless (smartphones) and computer peripherals (IoT) segments, which tend to be very volatile, as product life cycles are shorter compared to consumer electronics products. 
  • In light of the ever changing industry, Hi-P needs to invest to develop new products in order to fulfill customer demand.

No pre-commitment for orders 

  • Customers generally do not give committed orders in advance. In certain cases, for top global companies especially, Hi-P would need to invest in manufacturing facilities even before the orders come in. 
  • There is also no certainty that Hi-P would get the orders even after investing in such manufacturing facilities.

Major customers risk 

  • In FY2016, Hi-P had four major end customers, same as the previous year, for the PPIM segment; these four customers accounted for 72% of PPIM revenue and 47% of total revenue (2015: 74% of PPIM and 50% of total). 
  • There were five major end customers for Assembly segment, no change from 2015, with revenue accounting for 66% of Assembly revenue (2015: 62%), and 21% of total revenue (2015: 20%).


Financials 


Earnings momentum from 2H 2016 to sustain.

  • We expect the recovery in earnings since 2H 2016 to continue, on the back of operational efficiency, new customers and new product launches. 
  • Hi-P reported a very strong 2H2016, reversing from a steep loss in 1H2016, mainly driven by improved manufacturing efficiency. 
  • In 1Q 2017, Hi-P registered revenue of S$244.2m (-11.4% y-o-y), mainly due to less high component content assembly products in 1Q 2016. Gross profit margin increased to 13.7% in 1Q2017 from 6.1% in 1Q2016. The improvement was mainly attributed to 
    1. better product mix with lower sales of high component content assembly products, 
    2. improved operational efficiency and cost management, and 
    3. lower inventory provision and scrap expenses. 
  • Overall, Hi-P recorded net profit of S$8.4m in 1Q 2017, vs net loss of S$12.4m for 1Q 2016 

Expect strong cashflow and strong balance sheet. 

  • With the expected ramp up in production for new customers and new products, we expect the group to record strong cashflow.
  • Hi-P has reverted to net cash position after dipping into net debt in FY14 and FY15. Backed by robust core business operations which generated S$267.8m in positive operating cash flow, Hi-P swung from a net debt position of S$190.1m as at 31 December 2015 to a net cash position of S$25.1m as at 31 December 2016. 
  • Balance sheet as at end-1Q17 is in strong net cash position of S$112m.

Management guiding for higher earnings in FY2017 

  • The management has guided for lower revenue for 2Q2017 as compared to 2Q2016 but profit to be comparable.
  • Revenue and profit for 2H2017 are also expected to be higher compared to 1H2017. For FY2017, Hi-P expects similar revenue but higher profit as compared to FY2016.


Valuations 


Re-rate after a weak FY2015. 

  • In FY2015, Hi-P earnings took a hit from its Russian client, Yota Devices, which failed to take delivery of the dual screen smartphone that Hi-P produced.
  • H-P has already concluded the arbitration proceedings with Yota Devices Limited. The stock has since re-rated from 2H2016, on manufacturing efficiency, new customers and new product launches.

Initiate with BUY rating; TP: S$1.07 

  • Hi-P is currently trading at 9.7x FY17F and 9.1x FY18F PE. We believe a valuation of 12x FY18F PE is fair, pegged to a 10% discount to peer average, given its smaller scale. 
  • Target price works out to S$1.07 per share, which translates to an upside of 30% from the current price.
  • Initiate coverage with a BUY rating on Hi-P.






Lee Keng LING DBS Vickers | http://www.dbsvickers.com/ 2017-05-23
DBS Vickers SGX Stock Analyst Report BUY Initiate BUY 1.07 Same 1.07



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