Hi-P International (HIP SP) - Maybank Kim Eng 2017-07-12: An Apple A Day

HI-P INTERNATIONAL LIMITED H17.SI

Hi-P International (HIP SP) - An Apple A Day

Hi-P started operations in the 1980’s as a tooling house for electronics firms and has over the decades evolved into an ODM and EMS solutions provider.
From our recent company visit, we understand that market leaders like Apple¹ , Seagate, Colgate and Keurig are amongst its roster of customers in wireless communications, computing and peripherals and consumer electronics sectors.
Management is optimistic in delivering profit growth with new product launches and better operating efficiency.

( ¹ https://images.apple.com/supplier-responsibility/pdf/Apple-Supplier-List.pdf)

Hi-P’s medium-term growth strategy is to expand to EMS for automotive and healthcare segments. Given the long certification lead times involved in these sectors, management plans to accelerate market entry through M&A with ticket sizes up of to cSGD100m each over the next two years. M&A will largely be funded by internally generated cash and treasury shares (80.7m), although the company is open to taking on some debt too.
For the near term, i.e. FY17, management expects sales to be flattish YoY but is guiding for net profit growth from a shift in product mix towards higher component manufacturing (low revenue, high margin) over assembly work (high revenue, low margin).
Overall capacity utilisation stands at 30-40% currently but is forecast to rise to c70% levels in 3Q17 ahead of the year-end holiday season.

The chapter on assembling Yotaphone2 (which led to FY15 losses from SGD74.4m in inventory write-offs alone) was closed in Jan-2017 with an out-of-court settlement of USD17m.
Management indicated residual inventory had been sold and there was zero additional provisioning risk from this project. This was a key learning lesson for Hi-P leading to the implementation of ERM systems and adoption of a risk-weighted total exposure approach to evaluate clients.

The stock is thinly followed. Based on the FY17 EPS forecast of a single consensus estimate, Hi-P trades at 11.8x forward P/E vs its Singapore peer basket of c14.5x.

EMS provider with 13 manufacturing sites across four countries. In China, these sites are in Shanghai, Nantong, Suzhou, Chengdu, Xiamen, and Tianjin.
Products are classified into three categories: Wireless, Computer Peripherals, and Consumer Electronics.
Revenue exposure is roughly a third in each segment. Top 5 customers make up more than 50% of sales. Example of products in each segment:
- Wireless: Manufactures buttons and internal metal structures for a global smartphone maker.
- Computer peripherals: Manufactures keyboards for a global computer maker; HDD parts for Seagate.
- Consumer electronics: Manufactures components and box builds for various brands/products (e.g. coffee makers, cleaning robots and electronic shavers). Involved in ODM for a few customers (Keurig, Colgate) in this segment.

Founded in 1980 as a tooling house. Added component manufacturing in the mid-90s, module assembly capabilities around 2003-04 and evolved to a full fledged ODM & EMS provider around the start of this decade.
Listed on Singapore Exchange in Dec 2003.
Created the Yotaphone 2 ODM in 2014. In FY15, Yota failed to take delivery of inventory. Hi-P commenced arbitration proceedings against Yota, claiming a total sum of USD126m, substantially comprising finished goods.
Implemented SAP ERM system in 4Q15 to increase operating efficiencies and monitor and manage customer risk exposure.
Out of court settlement with Yota in Jan 2017. Yota will pay USD17m to Hi-P (USD15m received, USD2m to be received in quarterly payments from Sep 2017 onwards), while Hi-P retains the right to sell remaining inventory and keep proceeds. Management guided that inventory has been fully sold/used up since.

Leveraged to growth trends of end customers. For clients like Apple, Hi-P can benefit from higher volumes due to frequent product upgrade cycles. Consumer electronics clients typically have longer life cycle products but growth is steady with minimal incremental capex requirements.
ODM and R&D capabilities provide some competitive advantage to get involved in product planning stage with their customers. Management indicated it is in early planning stages for some IoT-enabled devices.
M&A related growth optionality from the automotive and medical devices segments.

Key products in the wireless segment are on the cusp of a production ramp-up.
Early-stage ODM with global firms like Keurig (and others) could translate to better long-term revenue visibility in the consumer electronics segment.
Hi-P trades at 11.8x FY17 consensus vs. c14.5x for its Singapore listed peer basket (and 17x for the MSCI Singapore Small Caps Index).
M&A will likely be all funded internally with cash generated and existing treasury shares.

Poor growth track record in recent past. Bottom line turned around in FY16 after five consecutive years of decline.
It is a relatively small firm and the EMS industry has characteristically poor pricing power. This makes it reliant on scale and operating leverage to deliver profit growth.
High customer concentration risk as its top five account for more than 50% of sales. The non-payment episode with Yota in 2015 is a prime illustration of such risks. Presently, top 5 customers make up more than 50% of sales.
Hi-P’s customer profile indicates it is exposed to end demand risk affected by economic cycles and levels of discretionary consumer spending.
Competition risk: The global EMS industry is highly competitive. The industry is fragmented with a number of large global players as well as a very long tail of mid-to-small sized firms in various segments of the manufacturing value chain.
Competition: To participate in its end-customers’ long term growth trajectory (via newer technological products).

Hi-P trades at 11.8x FY17 consensus. Based on 1Q17 results which indicate balance-sheet net cash of SGD119m, Hi-P’s ex-net cash FY17 consensus P/E would be a lower 10x.
This is at a c19% discount to its Singapore peer basket of EMS companies which trades at c14.5x on 13% earnings growth expectations.
The one-year forward P/E average for a basket of global EMS peers is a higher 15.5x albeit with better 18% underlying earnings growth expectations.

Neel Sinha Maybank Kim Eng | Lai Gene Lih Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-07-12

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