Sunningdale Tech Ltd - DBS Research 2017-05-25: Rising SUNN

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SUNNINGDALE TECH LTD BHQ.SI

Sunningdale Tech Ltd - Rising SUNN

• Initiating coverage on Sunningdale with BUY and TP of S$2.62, based on 13x FY18F (vs larger US peers’ 20x).
• Leading global manufacturer of precision plastic components, with lower customer concentration risk vs local peers and offers higher growth vs the bigger boys.
• Competitive edge in advanced manufacturing capabilities, global presence and diversification still under-appreciated. 
• Robust growth outlook underpinned by positive underlying demand trends.

Leading manufacturer of precision plastic components. 

• Ranked among the largest high-precision plastic solutions providers globally, Sunningdale’s competitive advantages lie in its advanced manufacturing capabilities, global manufacturing footprint, and scale. 
• The group also stands out for its diversified MNC customer base – majority of its customers contribute between 3-5% each to group sales, which greatly reduces customer concentration risk commonly seen among small-mid cap peers.

Beneficiary of the broad-based substitution for functional plastics and positive underlying trends in Automotive, Consumer/IT and Healthcare sectors. 

• Owing to improved plastic material properties (i.e. strength and durability), and higher cost efficiency, precision plastic components are increasingly replacing their metallic counterparts in a wide range of industrial applications – particularly in the automotive, consumer goods and healthcare sectors. 
• The underlying demand outlook across the group’s three key end-sectors is also positive and forecast by industry experts to grow in the high single-digit to low- double digit levels p.a. into 2020.
• A beneficiary of these trends, Sunningdale’s core earnings are projected to grow steadily at 9% CAGR over FY16-18F. Plus, given its track record and strong business fundamentals, we believe that Sunningdale is well- poised to take on complex projects that may surface across the Automotive, Consumer/IT and Healthcare space to deliver further growth.

Initiating coverage with BUY; TP of S$2.62 based on 13x FY18F earnings. 

• Current trading at undemanding valuations of under 10x PE and 1x FY18F P/BV despite recent re-rating in the tech sector. 
• Given world class engineering capabilities, global presence and diversification, we believe Sunningdale deserves to trade closer to larger US peers’ 20x FY18F PE and at a premium over local precision plastic peers. 
• We derive a TP of S$2.62 for Sunningdale, based on 13x FY18F PE, which still represents a substantial 35% discount to US peers.
• Decent 3.1% yield is also on offer but could surprise on the upside as dividends have been on a steady uptrend over FY14-FY16.

Company Background 

One of the largest high-precision plastic solutions providers globally. 

• Established in 1984, Sunningdale provides one-stop turnkey plastic solutions, with capabilities ranging from product & mould designs, mould fabrication, injection moulding, micro-precision engineering, complementary finishings, through to the precision assembly of complete products.
• The group is mainly focused on four business segments - Automotive, Consumer/IT, Healthcare, and Mould Fabrication, which contributed 36%, 40%, 7% and 17%, respectively, to FY16 sales.

Serves three diversified end-sectors – Automotive, Consumer/IT and Healthcare. 

• While mould fabrication is reported as a standalone business segment in Sunningdale’s sales breakdown, we note that mould fabrication services provided by the group essentially supports one of three end- sectors – Automotive, Consumer/IT and Healthcare.
• Therefore, on an adjusted basis, including contributions from mould fabrication, we estimate that the Automotive sector is Sunningdale’s largest source of revenues (45.7% in FY16). 
• The Consumer/IT sector follows closely, with an estimated 45.1% share of FY16 revenue. Meanwhile, contribution from the Healthcare sector remains small, and is estimated to have contributed less than 10% to FY16 sales.

Automotive sector to lead growth ahead. 

• Under this segment, Sunningdale mainly produces faceplates for automotive audio systems and climate controls, speedometers /clusters, steering switches and exterior antenna covers.
• Tapping onto ongoing outsourcing trends from the US, Europe and Japan, steadily increasing demand for in-vehicle plastic components and fairly long product life cycles, the automotive industry continues to offer strong growth opportunities for the group.
• As Sunningdale gradually ramps up on new projects secured over the last few years, we see revenue from the Automotive sector growing by 8-10% p.a. into FY18F.

Stable outlook across remaining sectors. 

• While outlook in the broader Consumer/IT space remains subdued, we think that modest growth (of 2% p.a. into FY19F) in the near-term will likely be led by ongoing business development initiatives and healthy order backlogs from end-FY16.
• After delays in 2H16, the recent commencement of a new healthcare project – which generally has longer product life cycle of 10-15 years - should provide some degree of earnings visibility.

Revenue from mould fabrication can be lumpy q-o-q. 

• The mould fabrication segment primarily involves the design and manufacture of moulds that are later used in the manufacture of plastic injection parts.
• Often driven by business/project requirements, demand for mould fabrication can vary widely between periods. While some mould fabrication projects are one-off, others could ultimately lead to a recurring stream of component manufacturing revenues for the group.

Global manufacturing footprint a plus. 

• Over the last three decades, Sunningdale has steadily expanded its geographical presence through a combination of organic growth and acquisitions – such as precision plastic manufacturer, First Engineering in FY14 and Europe-based SKAN-tooling in FY15, which provided the group with access to India and Europe. 
• At present, Sunningdale has 19 in-production manufacturing locations in nine countries across Asia, Europe, North and South America.
• As the only SGX-listed precision plastic engineering company with a manufacturing presence outside of Asia, we opine that Sunningdale is better able to provide local support to key clients compared to most peers, and could potentially leverage on its global manufacturing presence and existing relationship with MNC customers to capture opportunities in new markets.

Earnings and M&A are Share Price Drivers 

• Historical correlation between share price and trailing 12-month earnings per share (T12M EPS) relatively strong. 
• Sunningdale’s share price performance and T12M EPS from FY2012 displayed a positive correlation of 0.768, which suggests that the group’s underlying share price was closely correlated to earnings growth.

Corporate actions - including M&A - also a share price driver.

• Various corporate actions pursued by Sunningdale over the last five years included new share issuances (such as the private placement of 20% new shares to Yarwood Engineering and Mr Sam Goi in Sep 2014) and M&As, which included the acquisition of precision plastic manufacturer, First Engineering Limited (FEL) and Europe-based SKAN-tooling.
• Share price does not always react positively on M&A announcements - as in the case of the FEL acquisition, which implied that the market could have perceived the deal to be expensive based on the acquisition PE of 19x historical earnings against Sunningdale’s 8.7x, despite its strategic value and earnings accretion.
• While the correlation between M&A and share price tends to be less significant in the short-term, we found that as strategic value (such as growth opportunities and cost savings) from deals are gradually unlocked, earnings-accretive M&As generally have a positive impact on the acquiror’s share price in the medium-to-long term.

Management & Strategy 

Managed by non-founder management team. 

• Key members of the management team have been with the group for over a decade, and each carry over two decades of experience in their respective fields. Under their leadership, Sunningdale’s net profits have nearly quadrupled from S$10.1m in FY03 to S$39.1m in FY16.

Potential to leverage on Chairman Mr Koh’s network. 

• As Sunningdale’s largest shareholder and non-executive Chairman, Mr Koh Boon Hwee also has significant influence over the group’s operations. He also serves as Chairman of private equity firm, Rippledot Capital Advisors – which presented Sunningdale with the First Engineering deal in 2014, and was also involved in several other M&As in the precision manufacturing space (such as Interplex Holdings).

Increasing dividend payments. 

• While Sunningdale does not have a fixed dividend policy, we note that dividends paid have grown steadily alongside earnings growth, from 3 Scts in FY12 to 6 Scts in FY16.

(1) Leveraging on strong business fundamentals to deliver sustainable growth 

Restructuring in Southern China complete. 

• To overcome the challenges of industrial production overcapacity in South China, Sunningdale made a strategic decision in early 2016 to restructure its facility in Zhongshan, China, aimed at streamlining costs and improving capacity utilisation. The exercise was completed in 2Q16.

Investing for the future. 

• While most of the industry is focused on managing costs amid the challenging business climate, Sunningdale is one of few precision engineering companies that continue to actively invest in future growth.
• Recent investments include a 50,000 sqm manufacturing facility in Chuzhou, China aimed at mitigating rising labour costs in first-tier cities, and has acquired a manufacturing site in Penang (Malaysia) which is in close proximity to the operations of a number of Fortune 500 companies (including several of Sunningdale’s existing customers) and in anticipation of the group’s medium-to-longer term capacity requirements.

Growing scale and improving sales mix to aid margin expansion ahead. 

• Sunningdale has delivered consistent margin improvements and growth over the last few years. 
• With the restructuring exercise in Zhongshan and construction of the new Chuzhou plant completed in FY16, the group is now well positioned to leverage on the following initiatives to deliver sustainable growth: 
  1. Strengthen business development activities to further expand its higher-margin (particularly Automotive and Healthcare) product mix 
  2. Development of new engineering capabilities 
  3. Reap cost advantages through growing scale.
• Notwithstanding one-offs (such as foreign exchange and disposal gains) which resulted in record FY16 earnings, we expect core earnings to remain on a positive growth trajectory ahead.

(2) Lower risk profile vs local precision plastic peers 

Reduced customer concentration risk. 

• The group stands out for its diversified MNC customer base. 
• Apart from a key Consumer/IT client which contributes c.15% of group revenue, a majority of Sunningdale’s customers each contribute between 3-5% to group sales on average, which greatly reduces customer concentration risk commonly seen among small-mid cap manufacturing peers.
• Approximately 50% and 80% of Sunningdale’s FY16 revenue was derived from its top 10 and top 30 blue chip customers, respectively.

(3) Both acquiror and acquiree 

Growing from acquisitions. 

• Sunningdale has made three acquisitions since 2010 – UFE in 2011, First Engineering in 2014 and SKAN-tooling in 2015. On each of these separate occasions, we note that acquisitions were only made after the group moved back into a net cash position. 
• With a net cash position of S$12.8m as at end-1Q17 and completion of its restructuring in South China, Sunningdale could be looking to acquire.
• Judging from its earlier acquisitions, we believe that the group’s criteria for future M&As would likely include precision plastic peers which provide access to: 
  1. New geographies 
  2. Wider product offering within existing Automotive, Consumer/IT and Healthcare verticals 
  3. New clientele.

Takeover potential in the longer term. 

• Sunningdale’s proven record of strong cash flow generation, healthy balance sheet with net cash of S$12.8m currently, and inexpensive valuations – the stock currently trades at undemanding valuations of under 1x P/BV and 10x FY18F PE (vs local peer average of 1.3x and 11x, respectively) could lead to a potential takeover offer.
• Given the group’s advanced manufacturing capabilities, global manufacturing footprint and diversified MNC customer base, we see Sunningdale as an attractive takeover target for private equity (PE) funds or larger top-tier players in the precision plastic field looking to 
  1. acquire advanced manufacturing capabilities, 
  2. have global manufacturing facilities or 
  3. gain immediate access to a diversified MNC customer base.

Key Risks 

Global economic slowdown. 

• With exposure across some of the globe’s main manufacturing regions, a global economic slowdown could pose significant challenges to Sunningdale as several of its industry segments such as Consumer/IT and Automotive are sensitive to fluctuations in the global economy. If so, this could have a significant impact on the group’s sales and profitability.

Fluctuations in raw material costs. 

• Key raw materials for Sunningdale are resin and engineering plastics, which typically represent at least 50% of the group’s cost of sales.
• While prices for engineering plastics (mostly used in automotive and healthcare products) tend to be quite stable, resin (mostly used in consumer/IT products) prices tend to fluctuate with that of crude oil. 
• Despite cost-plus arrangements, the frequency of pricing renegotiations is not fixed, and could at times lead to a higher cost base in the short term, hence weighing on earnings.

Managing currency exposures. 

• Due to its wide geographical presence and broad client base, Sunningdale transacts in various currencies such as USD, RMB, and MYR but reports in Singapore dollar. The largest currency exposure is to the USD, which we estimate represents approximately 40% of the group’s revenue.
• While the group engages in natural hedging (via raw material procurement etc) where possible, unfavourable fluctuations in these currencies could also weigh on earnings.

Valuation 

Trades at a steep 50% discount to US peers despite quality global exposure. 

• Sunningdale currently trades near +1SD of its 12-month forward PE range, but at a 19% and 53% discount to local and larger US peers’ average FY18F PE of 11x and 20x, respectively.
• Given its global manufacturing presence, world class capabilities and diversified blue chip customer base, comparing Sunningdale against local manufacturing peers’ valuations alone would not be fair.

Initiate with BUY; TP of S$2.62 based on 13x FY18F PE (vs larger US peers’ 20x). 

• We believe that Sunningdale’s global presence and diversification warrants a premium over close (but smaller) local peers Memtech and Fu Yu.
• Greater economies of scale on a steadily growing customer base and product portfolio should also aid margin expansion and help narrow the valuation gap between Sunningdale and the bigger boys in the US over time, especially given its already decent scale. Thus, following the recent re-rating in the tech sector, we see a valuation of 13x FY18F PE for Sunningdale as fair - which still represents a substantial discount of 35% and 13% to US and local peer valuations, respectively. 
• Our TP works out to be S$2.62, offering potential upside of 34% and decent 3.1% yield

Singapore Research Team DBS Vickers | Lee Keng LING DBS Vickers | http://www.dbsvickers.com/ 2017-05-25

DBS Vickers SGX Stock Analyst Report BUY Initiate BUY 2.62 Same 2.62