Tech Manufacturing Services - CIMB Research 2017-07-04: Upside Potential Intact For Our Top Picks

Semiconductor Equipment Tech Manufacturing Sector AEM HOLDINGS LTD AWX.SI JADASON ENTERPRISES LTD J03.SI MEMTECH INTERNATIONAL LTD BOL.SI VENTURE CORPORATION LIMITED V03.SI CEI LIMITED AVV.SI VALUETRONICS HOLDINGS LIMITED BN2.SI UMS HOLDINGS LIMITED 558.SI SUNNINGDALE TECH LTD BHQ.SI

Tech Manufacturing Services - Upside Potential Intact For Our Top Picks

Industry forecasters Gartner and SEMI believe the semiconductor equipment up-cycle will last until 2018F, with automotive and Internet of Things (IoT) as long-term themes.
We believe further re-rating for tech manufacturing services stocks would have to come from positive earnings surprises, M&As or special dividends.
We opine that an M&A between Memtech and Sunningdale would have merits.
Our top picks are AEM, Jadason, Memtech and Sunningdale.

Singapore tech manufacturing services coverage

What do they do?

We highlight eight tech manufacturing services stocks under our coverage in this report. We address investors’ concerns about whether their share prices already reflect all the positives or is there further re-rating potential.
We opine that the ultimate driver of higher valuations would be stronger earnings growth in the longer term.
In the short term, M&A possibilities and special dividends could propel share price higher in 2H17F.

Where are we in the cycle?

Of the eight tech manufacturing services stocks that we currently cover, three can be classified as electronic manufacturing services providers, two as suppliers for companies in the semiconductor industry, two are in the plastic injection moulding business and one in the printed circuit board (PCB) drilling space.
As these eight companies serve a diverse industry, we think a better way to assess if their share prices would re-rate is to look at the companies individually, rather than at the overall industry.

What could drive share prices higher?

Potential Re-rating Catalyst 1 - Earnings growth

To identify potential share price catalysts, we looked at the historical valuation of the stocks under our coverage and the reasons investors rewarded them with higher valuations in the past.
We note that earnings growth is the potential key share price driver in the longer term. while short-term re-rating catalysts are special dividends and M&As:
1. AEM – Looking at its forward P/E in the past 10 years, we note that, in FY09, its P/E multiple rose above the 10x mark as losses before impairment charges and taxation declined 34% yoy. Given that we are projecting a 3- year EPS CAGR of 74.8% (FY16-19F), we believe our target 10x FY18F P/E multiple is reasonable. Better-than-expected earnings could drive share price higher.
2. UMS – We note that, over the past 10 years, UMS’s higher P/BV multiples are directly correlated with rising ROEs. Given our current projection of rising earnings in FY17-19F, leading to better ROEs, UMS’s share price could move higher if earnings beat our expectations.
3. Memtech – Over FY07-09, Memtech enjoyed P/E multiples of circa 20x, as earnings grew 85% yoy in FY09. Strong earnings growth is needed to drive P/E multiple expansion during its current earnings cycle.
4. Sunningdale – Similar to UMS, Sunningdale exhibited a historical trend of direct correlation between rising ROEs and higher P/BV multiples. We note that Sunningdale has traded above 1.0x P/BV in the past (FY07).
5. CEI – Its forward P/E valuation history has been volatile over the past 10 years. In FY08-09, CEI’s forward P/E hit 19.8x, more than 2 s.d. above its historical mean. This was likely due to the distortion caused by the 50% yoy earnings collapse in FY09, followed by the 123% yoy rebound in earnings in FY10. Over FY11-12, CEI’s forward P/E valuation receded to 1 s.d. above historical average, as earnings fell 33% yoy in FY11. We do not expect CEI’s earnings growth to return to the high double digits it enjoyed in the past.
6. Valuetronics – We observed that its P/E multiple expanded to 1-2 s.d. above the historical average when earnings growth was at the 25% level. P/E multiple expansion is unlikely in the next few years, as we are only projecting 3-year EPS CAGR of 13.5% (FY16-19F). However, a potential second automotive customer (still a work in progress) may be significant enough to drive P/E multiple expansion.
7. Venture – We note that Venture traded 1 s.d. (19.3x) to 2 s.d. (23.3x) above its 10-year historical average forward P/E multiple (15.2x) in FY07-11. Notably, its earnings growth in FY07 was 25% yoy and 31% yoy in FY10. Sustained strong earnings growth of 25-30% yoy over the next three years could lead to P/E multiple expansion, in our view.
8. Jadason – Based on its 10-year trading history, we could not identify any clear P/E trends as the company was mainly loss-making or eking out marginal net profit in the past 10 years.

Potential Re-rating Catalyst - Earnings-Accretive M&As

The eight tech manufacturing services stocks that we have highlighted were all in net cash position at end-1Q17. Earnings-accretive M&As by these companies could propel their share prices higher. Valuetronics and Memtech rank the highest in terms of net cash as a percentage of sales at end-1Q17. We believe this allows them to consider earnings-accretive M&As should the opportunities arise.
Alternatively, these companies’ share prices could move higher if they become the target of acquisition by other parties. In particular, we note that in the plastic injection moulding space, Sunningdale acquiring Memtech could have strong synergistic benefits due to the lack of duplication. Memtech has made good progress in penetrating the automotive industry, as well as leading US consumer electronic brands, such as Apple and Amazon. Memtech also has a headstart over Sunningdale in liquid silicone rubber injection moulding technology

Potential Re-rating Catalyst 3 - Special dividends

Another catalyst that could lead to further share price re-rating is the possibility of special dividends.
Based on our free cash flow estimates, we note that Sunningdale could afford to pay a higher DPS than our FY17F forecast as our projected free cash flow per share for FY17F is 2.53x our DPS expectation.
UMS also has a history of paying special dividends when it announces fourth quarter results. We note that in FY13, when UMS reported strong net profit, the company paid S$0.065 in DPS, translating into dividend coverage of 1.08x. Given our projection of record-high net profit of S$40.2m for FY17F, there is a chance that UMS could better our S$0.06 DPS forecast, which includes the historical S$0.01 special dividend.
We also note that Memtech is in a position to propose a special dividend for FY17F as the company sold two assets in China for approximately US$5.7m in Dec 2016.

Risks

The key risks for the tech manufacturing services stocks under our coverage are pullbacks or delays in customers’ orders due to changes in global economic conditions.
The US$ weakening against other currencies is also a risk to the earnings of these companies.

Valuation and Recommendation

Overweight sector rating

The general industry outlook for the tech manufacturing services stocks under our coverage remains positive. However, we argue that as these eight companies that we cover serve a diverse industry, a better way to assess if their share prices would re-rate is to look at them individually, rather than at the overall industry.
We think re-rating would come from
1. better-than-expected earnings potential;
2. earnings-accretive M&As and
3. special dividends.

Our Top Picks

Our current small-cap tech manufacturing services picks with more than 20% upside to our target prices are:
1. AEM (Rating: Add, Target Price: S$3.39),
2. Jadason (Rating: Add, Target Price: S$0.17),
3. Sunningdale (Rating: Add, Target Price: S$2.19), and
4. Memtech (Rating: Add, Target Price: S$1.09).
Of these four stocks, we believe Memtech and Sunningdale offer some margin of safety as both stocks are currently trading below their book values.
Key risk to the sector is order pullback by customers.

Brief Summary of Our Top Picks

AEM: AEM's share price was weak last week. However, our calls to management revealed no fundamental issues. As such, we maintain our Add call and target price of S$3.39 based on 10x FY18F P/E (at 15% discount to its major customer's P/E and 2% discount to peers’ average).
Jadason: We initiated coverage on Jadason with an Add rating on 3 Jul (Monday). Given our strong EPS CAGR projection of 68.6% for FY16-19F, our target price for Jadason is S$0.17, based on 12.34x FY18F P/E (+2 s.d. above its average forward P/E during the last earnings recovery cycle in 2004-2007, when Jadason’s earnings accelerated significantly). We forecast FY18F core EPS of S$0.013.
Sunningdale: We have an Add call on Sunningdale with a target price of S$2.19, based on 1.11x FY17F P/BV (COE: 8.6%, zero growth). Potential re-rating catalysts include better-than-expected cost management and new order wins.
Earnings-accretive M&As could also be a positive.
Memtech: We reiterate our Add rating on Memtech with unchanged FY17-19F forecasts and target price of S$1.09, still pegged to 10x FY18F P/E (at 10% discount to peers’ average). We think Memtech now looks attractive as a potential M&A target, given its cash-generative business, growing customer base and the possibility that its earnings are at an inflection point. Competitors keen to break into the automotive and Beats supply chain without dealing with the high entry barriers (long audit process and strict technical know-how) could do so more rapidly by acquiring firms like Memtech.

Sector Comparison

Company Reports

William TNG CFA CIMB Research | NGOH Yi Sin CIMB Research | http://research.itradecimb.com/ 2017-07-04

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