Hi-P International (HIP SP) - Maybank Kim Eng 2017-07-12: An Apple A Day

Hi-P International (HIP SP) - Maybank Kim Eng 2017-07-12: An Apple A Day HI-P INTERNATIONAL LIMITED H17.SI

Hi-P International (HIP SP) - An Apple A Day


Broad exposure to global electronics brands 

  • Hi-P started operations in the 1980’s as a tooling house for electronics firms and has over the decades evolved into an ODM and EMS solutions provider. 
  • From our recent company visit, we understand that market leaders like Apple1 , Seagate, Colgate and Keurig are amongst its roster of customers in wireless communications, computing and peripherals and consumer electronics sectors. 
  • Management is optimistic in delivering profit growth with new product launches and better operating efficiency.

( 1 https://images.apple.com/supplier-responsibility/pdf/Apple-Supplier-List.pdf)

New segments, M&A now a part of growth strategy 

  • Hi-P’s medium-term growth strategy is to expand to EMS for automotive and healthcare segments. Given the long certification lead times involved in these sectors, management plans to accelerate market entry through M&A with ticket sizes up of to cSGD100m each over the next two years. M&A will largely be funded by internally generated cash and treasury shares (80.7m), although the company is open to taking on some debt too. 
  • For the near term, i.e. FY17, management expects sales to be flattish YoY but is guiding for net profit growth from a shift in product mix towards higher component manufacturing (low revenue, high margin) over assembly work (high revenue, low margin). 
  • Overall capacity utilisation stands at 30-40% currently but is forecast to rise to c70% levels in 3Q17 ahead of the year-end holiday season.


The ghosts of Yota have been buried 

  • The chapter on assembling Yotaphone2 (which led to FY15 losses from SGD74.4m in inventory write-offs alone) was closed in Jan-2017 with an out-of-court settlement of USD17m. 
  • Management indicated residual inventory had been sold and there was zero additional provisioning risk from this project. This was a key learning lesson for Hi-P leading to the implementation of ERM systems and adoption of a risk-weighted total exposure approach to evaluate clients.


Valuation

  • The stock is thinly followed. Based on the FY17 EPS forecast of a single consensus estimate, Hi-P trades at 11.8x forward P/E vs its Singapore peer basket of c14.5x.


Company Profile 


Business 

  • EMS provider with 13 manufacturing sites across four countries. In China, these sites are in Shanghai, Nantong, Suzhou, Chengdu, Xiamen, and Tianjin.
  • Products are classified into three categories: Wireless, Computer Peripherals, and Consumer Electronics.
  • Revenue exposure is roughly a third in each segment. Top 5 customers make up more than 50% of sales. Example of products in each segment: 
    • Wireless: Manufactures buttons and internal metal structures for a global smartphone maker.
    • Computer peripherals: Manufactures keyboards for a global computer maker; HDD parts for Seagate.
    • Consumer electronics: Manufactures components and box builds for various brands/products (e.g. coffee makers, cleaning robots and electronic shavers). Involved in ODM for a few customers (Keurig, Colgate) in this segment.

Company Milestones 

  • Founded in 1980 as a tooling house. Added component manufacturing in the mid-90s, module assembly capabilities around 2003-04 and evolved to a full fledged ODM & EMS provider around the start of this decade.
  • Listed on Singapore Exchange in Dec 2003.
  • Created the Yotaphone 2 ODM in 2014. In FY15, Yota failed to take delivery of inventory. Hi-P commenced arbitration proceedings against Yota, claiming a total sum of USD126m, substantially comprising finished goods.
  • Implemented SAP ERM system in 4Q15 to increase operating efficiencies and monitor and manage customer risk exposure.
  • Out of court settlement with Yota in Jan 2017. Yota will pay USD17m to Hi-P (USD15m received, USD2m to be received in quarterly payments from Sep 2017 onwards), while Hi-P retains the right to sell remaining inventory and keep proceeds. Management guided that inventory has been fully sold/used up since.


Investment Pros and Cons 


The Growth Proposition 

  • Leveraged to growth trends of end customers. For clients like Apple, Hi-P can benefit from higher volumes due to frequent product upgrade cycles. Consumer electronics clients typically have longer life cycle products but growth is steady with minimal incremental capex requirements.
  • ODM and R&D capabilities provide some competitive advantage to get involved in product planning stage with their customers. Management indicated it is in early planning stages for some IoT-enabled devices.
  • M&A related growth optionality from the automotive and medical devices segments.

The Value Proposition 

  • Key products in the wireless segment are on the cusp of a production ramp-up.
  • Early-stage ODM with global firms like Keurig (and others) could translate to better long-term revenue visibility in the consumer electronics segment.
  • Hi-P trades at 11.8x FY17 consensus vs. c14.5x for its Singapore listed peer basket (and 17x for the MSCI Singapore Small Caps Index).
  • M&A will likely be all funded internally with cash generated and existing treasury shares.

Key Risk Factors 

  • Poor growth track record in recent past. Bottom line turned around in FY16 after five consecutive years of decline.
  • It is a relatively small firm and the EMS industry has characteristically poor pricing power. This makes it reliant on scale and operating leverage to deliver profit growth.
  • High customer concentration risk as its top five account for more than 50% of sales. The non-payment episode with Yota in 2015 is a prime illustration of such risks. Presently, top 5 customers make up more than 50% of sales.
  • Hi-P’s customer profile indicates it is exposed to end demand risk affected by economic cycles and levels of discretionary consumer spending.
  • Competition risk: The global EMS industry is highly competitive. The industry is fragmented with a number of large global players as well as a very long tail of mid-to-small sized firms in various segments of the manufacturing value chain.
  • Competition: To participate in its end-customers’ long term growth trajectory (via newer technological products).


Peer Comparison 

  • Hi-P trades at 11.8x FY17 consensus. Based on 1Q17 results which indicate balance-sheet net cash of SGD119m, Hi-P’s ex-net cash FY17 consensus P/E would be a lower 10x.
  • This is at a c19% discount to its Singapore peer basket of EMS companies which trades at c14.5x on 13% earnings growth expectations.
  • The one-year forward P/E average for a basket of global EMS peers is a higher 15.5x albeit with better 18% underlying earnings growth expectations.






Neel Sinha Maybank Kim Eng | Lai Gene Lih Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-07-12
Maybank Kim Eng SGX Stock Analyst Report NOT RATED Maintain NOT RATED 99998 Same 99998



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