Valuetronics Holdings - DBS Research 2016-12-01: Small Mid Caps Radar Explorations

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VALUETRONICS HOLDINGS LIMITED BN2.SI

Valuetronics Holdings - Small Mid Caps Radar Explorations

• Valuetronics is an integrated EMS provider, whose design and development capabilities offer more value-add than traditional EMS players. 
• The group currently trades at 8x CY17F PE (or a compelling 3x ex-cash PE), which represents c.38% discount to larger peers’ 13x CY17F PE. 
• Strong cashflow generation and net cash of HK$659.2m also provide support for the maintenance of a dividend of 20 HKcts ahead – which translates into an attractive prospective yield of 6.8%.

Company Background

• Incorporated in 1992, Valuetronics is an electronics manufacturing services (EMS) provider, primarily engaged in the design and manufacturing of, as well as supply chain support services (such as direct fulfilment programmes) for higher quality electronic and electro-mechanical products.
• Headquartered in Hong Kong, the group is well supported by a design centre and manufacturing facilities, which are strategically located near Hong Kong and Shenzhen – in Daya Bay and Danshui Town (Guangdong Province, People’s Republic of China).
• After having held relatively steady at the HK$2.2-2.4bn p.a. level over FY12-FY15, Valuetronics’ sales contracted by 19.6% y-o-y to HK$1,952.9m in FYE Mar16 following the group’s strategic decision to exit various business lines – such as the low-margin mass market LED light bulb business, which suffered from a slowdown in demand and years of aggressive price competition and margin erosion.

The group’s principal business segments are currently broadly classified as follows: 

(a) Consumer Electronics (CE) 

• Post Valuetronics’ complete exit from the mass market LED lighting segment in 3QFY16, which led to a sharp 44% y-o-y decline in segment revenues to HK$824.6m in FY16, the company’s CE operations are now predominantly focused on the production of consumer lifestyle products (including shavers, electric toothbrushes and bug zappers) for a leading Dutch MNC.
• However, we believe the worst is likely over for the CE segment, as the recent introduction of Valuetronics’ new smart lighting sub-segment (or wireless lighting products with smart control features, which effectively leverages on the group’s expertise in LED products) helped to deliver strong CE segmental growth of 58.2% q-o-q in 2Q17 (leading to segment sales of HK$261.1m). Thus, this segment is poised to see better traction ahead.

(b) Industrial and Commercial Electronics (ICE) 

• The ICE segment generally commands higher margins and encompasses a host of complex and sophisticated products such as printers, temperature sensing devices, communication products, automotive products and medical equipment. Helped by strong demand, the group was able to grow ICE sales at a firm 21.5% CAGR over the last three years, from HK$628.8m in FY13 to HK$1,128.3m in FY16.
• ICE now accounts for more than half of the group’s revenue.

Performance & Outlook

• While the performance and outlook for individual products are expected to be fairly mixed, we believe the group’s venture into the automotive segment (for the production of in-car connectivity modules) in FY16 should help sustain ICE sales growth at the high single-digit to low teens region over the medium term.
• The continued push for greater connectivity and smart capabilities between users, devices and cities is set to drive the development and adoption of connectivity tools and applications, which could open doors for integrated EMS providers such as Valuetronics, whose design and development capabilities offer more value-add than traditional EMS players.
• Riding on these prospective opportunities under the Internet of Things (IoT) trend, we believe that near-term growth for Valuetronics will likely stem from the following product segments (among others) – whose lifecycle and current contributions to group profit are still in their infancy: 
  1. Data and media connectivity module produced for a Tier 1 automotive system manufacturer, and 
  2. Wireless lighting with smart control features for a Dutch MNC. 
• We also note that business development efforts across the group’s sub-segments are underway and if successful, could significantly enhance its earnings outlook over the medium term.
• Valuetronics has demonstrated resilience across economic cycles through the consistent delivery of positive operating cashflows since 2004. The group does not carry any debt, and currently sits on a strong net cash balance of HK$659.2m (or approximately 58.8% of current market cap) as at end-2Q17, which bodes well for possible inorganic growth opportunities and expectations of dividend payments (including special dividends) ahead.
• While Valuetronics has remained committed to a formal dividend policy of a 30-50% payout ratio since its listing in 2007, we note that the company has paid a consistent dividend of 20 HKcts over the last three years, which resulted in a higher 63% dividend payout in FY16. Assuming Valuetronics maintains a dividend of 20 HKcts, we estimate a prospective yield of 6.8% for FY17F.
• Key risks: 
  1. Sustained weakness in the global economy could dampen overall demand outlook across Valuetronics’ product lines, 
  2. Narrow customer base in CE segment could result in significant fluctuations in business performance, and 
  3. Earnings disappointment from push backs or delays in orders.
• The group currently trades at 8x CY17F PE (or a compelling 3x ex-cash PE), which represents c.38% discount to larger peers’ 13x CY17F PE. An attractive prospective dividend of 20 HKcts, which translates into a 6.8% yield, is also on offer. 
• Further rerating could come from earnings delivery, as Valuetronics ramps up production on its new product pipeline.

Paul YONG CFA DBS Vickers | Singapore Research Team DBS Vickers | http://www.dbsvickers.com/ 2016-12-01

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