INNOVALUES LIMITED
591.SI
Fundamentals Unchanged
- Share-price weakness opens up buying opportunities. Management remained bullish in recent meeting.
- Weak China auto sales not affecting it. CNY devaluation positive for Innovalues & customers.
- Maintain BUY & SGD1.18 TP at 14x FY16 EPS. Expect catalysts from better-than-expected margins and new customer wins. 5% yields attractive on single-digit valuations.
What’s New
- We maintain our conviction BUY, EPS and TP despite the recent 40% slide in its share price, along with the market. We recently met management to discuss the company’s outlook and investors’ concerns, which appear centred on:
- the fall in CNY;
- weaker China auto sales; and
- the fallout from Tianjin’s port explosion in mid-Aug 2015.
What’s Our View
- Management remains bullish, expecting a strong end to FY15. It maintains its guidance for 10-15% revenue growth and 28-30% GPM. Innovalues had achieved 49% of our FY15F EPS by end-1H15. Weakness in China’s auto sales in recent months did not faze management as it deemed this the result of its stock-market rout. Moreover, its customers primarily use China as a production base for the US and European markets. In this light, CNY devaluation will benefit both its customers and Innovalues.
- Innovalues is also a net beneficiary of USD strength against SGD and its other operating currencies, MYR, CNY and THB. That said, it needs to pass back some gains to customers, in return for similar protection if the USD weakens. Finally, the Tianjin port explosion has not affected Innovalues or its customers.
- Maintain BUY and SGD1.18 TP, at 14x FY16 P/E or 20% discount to peer average. With its recent share-price decline, core P/E has retreated to even more attractive single digits vs its 26% 3-year EPS CAGR. Yields are also decent at c.5%.
Q&A
Any impact from weakness in China’s auto sales?
Weakness in auto sales in China will not affect us significantly. About 59% of our production is shipped to Chinese destinations, such as Sensata's contract manufacturers in Zhuhai and Changzhou. They will ship these on to the US and Europe. Sensata derives only 18% of its global auto-related sales from Asia and the rest of the world, including China, with 21% from the US and 27% from Europe.
What is your order visibility?
The lead time needed to order materials is 7-8 months, so our customers normally give us a year's projections for our material planning. We always have 12-month forecasts that are updated on a monthly basis.
What are your expectations for the rest of this year?
We told investors during our post-results NDR that 3Q15 revenue will be close to 2Q15 levels. In 3Q, we will also incur a one-off retrenchment charge in Shanghai. But it will be small at CNY700-800k. We have closed down OA production in Shanghai and moved it to Malaysia to save costs. This will benefit us in the long term, as wages in Malaysia are half those of China. We expect strong growth in 4Q15, better than 2Q/3Q.
Can you update us on your new customers?
Audi/VW contributions started last year but we do not expect them to be significant before 2017. BMW is another potential new end-customer we are pursuing with our existing customer, Hilite. Hilite's customer is ZF Transmissions. ZF will be supplying the world’s first 9-speed transmission system to BMW. This can be a fairly sizeable project. We have submitted production samples. Hilite is fine-tuning the parts at the moment. We believe it will source from us if it clinches the project from BMW. But production may only start next year.
How will currency volatility affect you?
We are a net beneficiary of USD strength. More than 90% of our revenue is denominated in USD vs only 30% of our costs as only our raw materials are in USD. The rest of our costs are in the currencies of countries where we have production facilities, primarily CNY, MYR and THB. Hence we will benefit from USD strength. That said, we will not benefit 100% as we will need to pass back some of our currency savings to customers. There is a formula for this pass-back. For every 3% gain in USD, we will pass back 45% of our gain as that is our local cost of production. For example, in 2Q15, we passed back 2.9% of sales to customers as the USD strengthened from SGD1.24 at end-1Q15 to an average of SGD1.32 in 2Q15. The gain of 6.5% is multiplied by 45% to produce 2.9%. Conversely, if USD falls, customers will pass back part of their savings to us. Hence, we are very confident that gross margins can be sustained at 28-30%, regardless of currency moves. Half of our borrowings - SGD8.6m at end-2Q15 - are in USD. The rest is in SGD. About 50% of the SGD27m cash we had at end-2Q15 was held in USD. The rest was in SGD, MYR, CNY and a bit in THB.
Any impact from the Tianjin port explosion?
We do not have production facilities in or near Tianjin. Neither do our customers.
Will your competitors be cheaper with currency weakness?
Our competitors are mainly based in the US and Europe. Our European competitors are more competitive now with the weaker euro. In the past, their prices were 20% higher than ours. Overall, we do not think they will be more competitive than us. Also, due to the inherent volatility of currencies, we think it will not be in their interests to cut prices just on account of a lower currency.
Any cost pressures from raw materials?
No. Our conversion model is based on a cost-plus formula. If material prices rise, we raise our prices. If they fall, we cut them.
Will margins be sustainable?
We expect margins to be sustainable. There is not much change in our revenue-growth guidance from earlier in the year, which is 10-15%. On margins, however, we have done many things to improve our productivity and efficiency. The results have come much faster than expected.
Will customers see your margins and ask for cost-down?
Our margins are good but our ASPs are not the highest in our customers’ supply chains. So we believe our customers are OK with our margins.
What is your guidance for dividends?
We strive to pay out half of our free cash flow, if there is no other need for the cash. In 1H15, we generated SGD20m of FCF, but only declared dividends of SGD4m. If there is no need to keep the extra cash at the end of the year, we will consider paying out more to shareholders. Normally, we only pay special dividends at year-end. We are still exploring M&As but nothing has been firmed up yet.
Gregory Yap | http://www.maybank-ke.com.sg/ Maybank KE 2015-08-28
Gregory Yap | http://www.maybank-ke.com.sg/ Maybank KE 2015-08-28
1.18
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