Innovalues - Maybank Kim Eng 2015-10-05: VW Opens Up Value Window

Innovalues - Maybank Kim Eng 2015-10-05: VW Opens Up Value Window INNOVALUES LIMITED 591.SI 

Innovalues - VW Opens Up Value Window 

  • VW’s emission scandal has affected global auto valuations, adding on to China-slowdown woes. 
  • Innovalues not spared but this opens up buying window. 3Q15 likely in line, with high confidence of a 4Q rebound. No change to EPS. 
  • Maintain BUY. TP reduced to SGD1.02 from SGD1.18 on lower peer average valuation of 12x (from 14x). 

What’s New 

  • VW’s cheating on emissions tests has affected the entire auto supply chain. 
  • Regulators worldwide are clamping down. The US Environmental Protection Agency is testing not just VW cars but all diesel cars. Valuations have fallen worldwide. 

What’s Our View 

  • Still, we remain positive on Innovalues. We think its 30% retreat from its peak reached after 2Q15 results opens up a buying window. Valuations have retreated to 7x FY16 EPS and 5.6% dividend yields. 
  • The direct impact from the VW scandal is expected to be minimal, unless wider repercussions emerge for the entire auto industry which would affect the supply chain. However, longer-term implications should be positive, as we believe more hardware sensors will be needed to prevent similar cheating. This could benefit Sensata and Innovalues. 
  • Furthermore, initial customer caution in 3Q after the tip-over in China’s auto sales since June should be waning as the industry and government respond with sales-boosting measures. We expect revenue growth to resume in 4Q, after a softer 3Q. We still expect YoY growth in 3Q earnings from better margins and FX gains. 
  • We maintain FY15-16 EPS. However, we lower our TP to SGD1.02 from SGD1.18 as the VW incident has reduced peer valuations from 14x average to 12x. Our TP is pegged to parity with peers. 

Exposure to VW 

Direct exposure minimal 

  • Management estimates that Innovalues’ direct and indirect business with VW accounts for less than 10% of its revenue. It has exposure mainly through Hilite, with direct VW/Audi business accounting for less than 1% of its revenue. Although VW is a customer of Hilite, we understand that the parts supplied by Hilite are only used for VW’s petrol engines, not diesel engines, and only for engine and transmission systems, not exhaust systems. 
  • Innovalues supplies metal housing parts for Hilite’s engine and transmission systems, such as engine control valves used to help reduce fuel consumption, optimise engine performance and meet global emission regulations. It also supplies parts for solenoid assemblies used in dualclutch transmission systems. In addition, it started to directly supply transmission parts to VW/Audi late last year. 

Possible overhang from indirect exposure 

  • However, this is only its direct exposure. There may be indirect ramifications as regulators clamp down on VW. They could either temporarily stop sales, as Switzerland did with VW’s Euro 5 diesel cars, or demand more vigorous checks. 
  • VW itself has admitted that 11m of its cars worldwide have been fitted with the cheat device. The greater concern is whether petrol cars, which make up the vast majority of cars sold worldwide, and other car makers could be implicated. The US has already warned that it intends to perform real-world testing of all diesel passenger cars sold in the US, not just VW or its related brands. 

What next? 

Hardware sensors likely to be needed 

  • In the longer term, regulators are likely to monitor emission levels more stringently. Car makers will be pressed to work towards a real reduction of emissions. In addition, there could be pressure to allow consumers themselves to monitor their vehicles’ emission levels. This can be done through dashboard readouts directly connected to hardware sensors that cannot be circumvented by software. 

Sensata’s CPOS could be right tool for the job 

  • As it happens, Sensata’s Cylinder Pressure Only Sensor (CPOS) makes it possible to measure directly the combustion process in a diesel engine. It enables diesel automakers to eliminate up to 90% of harmful pollutants and boost fuel economy. 

Innovalues would benefit 

  • Innovalues is a supplier of the CPOS metal housing to Sensata. Estimating from the size of the metal housing for this part vs other parts such as MSG and APT, unit pricing is likely to be higher. As it only started to supply this part to Sensata last year, monthly production volume is still low. But with the urgency provided by the VW scandal, we would expect future increments to be exponential rather than linear.
  • Current volumes suggest a < 1% contribution to FY15 EPS from CPOS housings, assuming blended margins. But this could rise to 2% in FY16, by our estimates, even before factoring in any upside in response to the VW scandal. In comparison, we estimate that MSG housings account for 20% of its FY15 EPS, forming the bulk of Innovalues’ business with Sensata.

2H15 outlook 

  • Despite recent uncertainties, we maintain our FY15 EPS. 3Q15 results are expected in November. 

Revenue weaker but earnings saved by margins, FX in 3Q15 

  • 3Q15 revenue is likely to be softer sequentially due to weaker automotive sales. However, we still expect a 32% YoY improvement to SGD5.5m, from better margins and FX gains. This includes a retrenchment charge incurred as Innovalues completed the relocation of its OA production from Shanghai to Malaysia. Gross margins should have been sustained at the high end of its 28-30% guidance. In addition, with 90% of its revenue in USD, Innovalues should have benefited from USD strength. 
  • We project a 5-6% YoY/QoQ decline in revenue to SGD27m, mainly due to lower AU revenue. This factors in softer orders following the tip-over in China’s new vehicle sales since June. Customers were likely to have held back on new orders and not replenished inventories until the smoke cleared. 
  • We also expect the decline to be moderated by higher Office Automation revenue in 3Q. OA revenue is expected to be better this year as printer customers such as HP have been bringing production back from China to Southeast Asia as China’s wages have risen significantly. In major cities, Chinese workers are now estimated to cost twice a worker in Malaysia or Thailand. 

High confidence in 4Q15 reboot 

  • We expect 4Q15 revenue and earnings to rebound. We understand from management that customers have gotten over their initial caution as the situation stabilises. This bodes well for 4Q. Forecasts by major customers are unchanged. With that, we have high confidence that Innovalues will be able to meet our forecast, especially if the momentum can be sustained in October. We project revenue of SGD30m (+11% YoY) and a net profit of SGD6.1m (+12% YoY) for 4Q15. 
  • In response to slumping sales since June, car makers and their dealers in China have been dangling various incentives, including subsidised insurance, zero down-payment financing, interest-free loans and higher trade-in prices to lure car buyers. As a result, car sales in China rose 12% MoM in August, reversing a 4-month slump. In addition, the Chinese government recently slashed the sales tax on small passenger vehicles by half.

2016 outlook 

We also maintain our FY16 forecasts. 

  • Earlier revenue-growth assumptions have been toned down. However, we believe margins will be better as there will be cost savings from the relocation of its OA production to Malaysia. Innovalues is also embarking on its next phase of productivity improvements. The USD, moreover, continues to strengthen against SGD, MYR and THB, providing further uplift.

More demand from Hilite likely for transmission systems 

  • We also expect higher demand from Hilite for transmission system parts in 2016-17 in response to VW’s gearbox investments in China. Production will begin in stages in 2016, before hitting full stride in 2017. 
  • VW has a new gearbox component plant outside Tianjin that opened in 2014. This is still ramping up, according to media reports. The plant was built to produce its DSG gearboxes, with an annual capacity of 450,000. In subsequent phases, production is expected to increase to 1.2m units and include more advanced systems. 
  • Following a power-loss issue experienced by its older Direct Shift Gearbox (DSG) transmission systems, VW is replacing them with more advanced gearboxes. Earlier, it was evaluating whether to stay with in-house DSGs or use external suppliers such as Aisin and ZF. Reports suggest that it has decided to stay with its own redesigned DSGs. It is thus investing in its Tianjin plant to make these more advanced DSGs. Hilite is a key transmission system module supplier to VW. 
  • While the emission scandal could slow down VW’s sales worldwide, it also could add to VW’s urgency to monetise its sizeable investment in Tianjin. VW reportedly invested €265m in Phase 1 of the plant. This should ensure the plant’s ramp-up, which fortunately has not been affected by the August port explosion. 

Cash flows better on project delay; special dividend likely 

  • Hilite is fine-tuning the parts needed for ZF, a key supplier of 9-speed transmission systems for the global auto industry that is becoming more widely used. This could delay the capex decision needed for the project till 2016 and actual investments till 2017. As we have not included any contributions in our FY16 forecasts, no negative impact is expected. 
  • In fact, the delay could improve cash flows, as we had projected some increase in capex from SGD7m in FY15 to SGD10m in FY16. We reduce FY16 capex to SGD7m, leading to projected end-FY16 cash of SGD57m, up from SGD54m in our previous forecast. As FY15 capex could also be slightly lower than expected, we expect better cash this year as well. This gives us cause to believe that Innovalues may declare a special dividend this year, repeating or improving on its 0.8ct special DPS in FY14. We currently forecast a total DPS of 3.2 cts for FY15, including a 0.8 SGD ct special DPS.


TP reduced to SGD1.02 on lower peer valuations 

  • The VW scandal has compressed valuations for many auto stocks, including suppliers such as Sensata. These are the peers we benchmark Innovalues to. 
  • We reduce our valuation for Innovalues from 14x FY16 P/E to 12x, still on par with its peers. Our new TP is SGD1.02, down from SGD1.18.

Gregory Yap Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2015-10-05
Maybank Kim Eng SGX Stock Analyst Report BUY Maintain BUY 1.02 Down 1.18