Jadason Enterprises Limited - CIMB Research 2017-06-30: Good Times Are Here Again

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JADASON ENTERPRISES LTD J03.SI

Jadason Enterprises Limited - Good Times Are Here Again

• Jadason successfully turned around at net profit level in 3Q16.
• We forecast EPS CAGR of 68.6% for FY16-19F, driven by orders from a major customer. Jadason is currently the sole supplier to this customer.
• Having undergone extensive restructuring, Jadason is now the cheapest printed circuit board (PCB) drilling provider in Dongguan that can handle large volumes.
• Potential re-rating catalysts are: 
  1. better quarterly results, 
  2. exit from SGX watch list, and 
  3. resumption of dividend payments.
• Initiate with Add and target price of S$0.17, based on 12.34x FY18F P/E (+2 s.d. above average forward P/E during the last earnings recovery cycle in 2004-2007).

Turnaround established 

• Jadason has firmly returned to the black since 3Q16. Net losses bottomed at S$1.2m in 2Q16, followed by three consecutive quarters of positive net profit (3Q16: S$1.3m, 4Q16: S$1.3m, 1Q17: S$0.3m). 
• Key factors aiding the turnaround were right-sizing its workforce, improving productivity, higher use of automation and a large S$12.9m impairment on its production equipment in FY15.

Strong earnings recovery ahead 

• We believe Jadason is headed for a strong earnings recovery over FY17F-18F. This is likely to be driven by new orders from its customers, in particular, customer A (which cannot be named due to non-disclosure agreements). 
• We understand that customer A has won large orders from a mobile device customer that is looking at a 2H17F product launch. Jadason will be the sole provider of the outsourced PCB drilling required by customer A.

What is different this time round? 

• The huge asset impairment and restructuring efforts by Jadason over the years now position the company as the cheapest PCB drilling supplier in the Dongguan region.
• Short-term competition is non-existent as Jadason is not only the cheapest supplier, but also the only one that can satisfy customer A’s large capacity requirements. At the same time, we believe there is room for gross margin expansion, given the lower depreciation and reduced material content from customers sending Jadason laminated PCBs.

Re-rating catalysts 

• We believe that potential short-term share price re-rating catalysts are: 
  1. strong 2H17F earnings performance as business from customer A kicks off at end-Jun 2017F, 
  2. exit from SGX watch list, which could widen the base of investors, and 
  3. resumption of dividend payment on the back of strong profit recovery.

COMPANY BACKGROUND

Jadason then 

• Jadason Enterprises Limited (Jadason) commenced its business in 1980 and is a leading supplier of equipment for the printed circuit board (PCB) industry in Asia. The company has an extensive network that covers Singapore, Malaysia, Thailand, China, Hong Kong, Taiwan and Japan. Jadason also fabricates some of the equipment used in the PCB manufacturing process.
• To support its equipment sales and to better service its customers, Jadason has established a service network covering all the locations in which the group has a marketing presence. The group also provides PCB drilling services in Dongguan and Suzhou. Through a subsidiary company in Dongguan, Jadason provides mass lamination services to PCB manufacturers operating in China. 
• Jadason was listed on the SGX on 13 Jul 2000 at an IPO price of S$0.20. Peers listed on the SGX include Multi-Chem Limited and Eucon Holding Ltd. Today, Eucon is looking to diversify into other businesses, while Multi-Chem is focusing on its IT security business. Based on its 2016 annual report, Multi-Chem had 129 computer numerical control (CNC) drilling machines in China as at end-Dec 2016. On 21 Mar 2017, Multi-Chem announced that it sold off 103 CNC drilling machines in China, leaving the group with just 26 CNC drilling machines in the country.

What happened? 

• Jadason has been largely profitable since its listing in 2000. Its woes started in FY12 when the company slipped into net losses that persisted until FY15. The key culprits behind the losses were the weak global economy, the slowdown in the Chinese economy and lower capex by customers in the mobile devices and mobile services infrastructure industries in China. 
• Rising labour costs and difficulty hiring workers also negatively affected production efficiency and led to higher operating costs.

Jadason today 

• Over the past few years, Jadason has reduced its workforce. In 2007, Jadason employed more than 2,000 workers. The number of workers employed fell to 1,500 for the period 2011 to 2012. As at end-Dec 2016, Jadason had a work force of about 600 workers. 
• In FY15, the company recognised a large S$12.9m impairment on its production equipment due to the persistent weak demand for its PCB drilling and mass lamination services.
• Today, the company’s business is divided into two segments – equipment and supplies (the distribution business) and manufacturing & support services (the PCB drilling business). The group provides PCB drilling services in Dongguan and Suzhou, China. Mass lamination services are also offered by a subsidiary in Dongguan. 
• Jadason operates three production locations in Dongguan and one in Suzhou. The plants in Dongguan are leased, whereas the plant in Suzhou is owned by Jadason. The Suzhou plant sits on a land area of 10,477 square metres with a lease term of 45.5 years from Oct 2004. The Dongguan facilities reside in the Chasan People’s Industrial Zone and the lease is due to expire on 31 Dec 2020F. We understand that Jadason has started making business continuity plans so that production will not be disrupted when the time comes.

KEY BUSINESS SEGMENTS

• The equipment and supplies (E&S) segment accounted for 40% of Jadason’s FY16 revenue. The business activities under this segment include the distribution of equipment and supplies to the PCB industry. Jadason’s distribution network covers Singapore, Malaysia, Thailand, China, Hong Kong, Taiwan and Japan. Jadason also fabricates some of the equipment used in the PCB manufacturing process and distributes Hitachi PCB drilling machines.
• Under the manufacturing and support services (M&SS) segment, Jadason offers PCB drilling services in Dongguan and Suzhou. Through a subsidiary in Dongguan, Jadason provides mass lamination services to PCB factories operating in China. The M&SS business turned around from operating loss of S$25.4m in FY15 to operating profit of S$2.7m in FY16. The E&S business’s operating losses narrowed from S$4.6m in FY15 to S$0.1m in FY16.

GAME CHANGER – Key customer wins major order 

• Jadason’s sales peaked at S$180.9m in FY10 and have been declining since then. We believe that revenue bottomed out in FY16 and Jadason said that it has seen a return in customer orders for drilling services in 1Q17. In its 1Q17 results commentary, Jadason highlighted that its long-term customers guided that they would be increasing their production capacities and, accordingly, Jadason expects its M&SS business to see earnings improvement in 2H17F.
• We understand that one of Jadason’s top two customers has won a significant order from a leading mobile device producer. This customer is now constructing additional factory capacity to cater to the new orders, due for completion by end-Jun 2017F. We understand that this customer has internal PCB drilling capacity but incremental drilling requirements will be entirely outsourced to Jadason. The key reason for this is that Jadason is now one of the most competitive PCB drilling suppliers in the Dongguan area. We project a significant return to profitability for Jadason, assuming that this customer does not delay orders and Jadason does not face execution issues. 
• Operational challenges for Jadason include maintaining a sufficient pool of skilled operators. To this end, the company has already introduced partial automation and beefed up its workforce. We note that PCBs for mobile devices require the drilling of 20,000-40,000 or more holes which would be a boon for Jadason as the company’s revenue model for PCB drilling is on a per hole basis.
• In our view, it would be difficult for competitors to snatch business from Jadason from this customer in the short term, given Jadason’s large scale and price competitiveness. We note that most of Jadason’s PCB drilling machines have been fully depreciated or are close to full depreciation. 
• At the same time, its many years of experience in this industry gives Jadason an edge over competitors, as the group has strong know-how in maintaining these drilling machines and expertise in repairing/refurbishing them. This allows for greater cost efficiency, as the group is able to purchase second-hand machines at discounted prices and redeploy these machines for its own drilling needs after some refurbishment. Its distribution business provides the company with an opportunity to source second-hand PCB drilling machines from its customers.
• We understand that a second-hand PCB drilling machine (depending on working condition) is only one-fifth the cost of a new machine.

RISKS 

Customer risk 

• According to Jadason’s 2016 annual report, two customers accounted for 39% of its FY16 revenue. These two customers are PCB makers based in China.
• Going forward, we expect Jadason’s dependence on one of these two customers to increase as the customer in question is currently expanding its capacity to handle larger order volumes.

Delisting risk 

• Following three consecutive years of net losses, Jadason was put on the SGX financial watch list on 4 Mar 2015. On 11 Apr 2017, Jadason announced that the SGX granted the company an extension to 3 Mar 2018 to meet the criteria required to exit the watch list. Management has been actively taking steps to remain profitable and to ensure that the listing status is preserved. In order for Jadason to exit the financial watch list, the easiest criteria for it to meet are recording pretax profit during the most recently-completed financial year (based on the latest full-year consolidated audited accounts) and achieving an average daily market capitalisation of S$40m or more over the six months prior.
• Separately, Jadason has three years from 5 Jun 2017 to meet the SGX’s Minimum Trading Price watch list criteria. The conditions stipulated to exit this watch list are maintaining a volume-weighted average price of not less than S$0.20 over the six months prior and an average daily market capitalisation of not less than S$40m over the same period.
• Given the improving business outlook, we believe profitability will also improve, leading to a re-rating in Jadason’s share price and a higher market capitalisation. These factors should increase the probability of an exit from both watch lists, in our view.

Labour woes 

• Jadason highlighted that, in recent years, the group and many other factories in China faced increasing labour cost and difficulty in retaining workers. Turnover of workers at the group’s plants in China was high in FY16 and negatively affected the productivity at these plants. 
• To mitigate this negative impact, the group has diversified its sources of labour supply and put in place schemes to retain workers at its factories. Over the past few years, the group has also progressively invested in automation equipment and processes to reduce manpower requirements and enhance operational efficiency at its factories. 
• We understand that, with training and automation, Jadason has reduced its production workforce from more than 2,000 workers in 2007 to about 600 workers as at end-Dec 16.

OUTLOOK

PCB industry still growing

• In its Jan 2016 update, PCB industry forecaster Technavio predicted that the global PCB market would deliver sales CAGR of around 3% in 2016-2020F. It projects that the advent of the Internet-of-Things (IoT) and wearables (smart watches and smart eyewear) would foster demand for PCBs in the coming years. Technavio also projected that the Asia-Pacific region would account for global PCB market share of more than 85% by 2020F. 
• The high demand for mobile and consumer electronic devices in countries like India, China, Malaysia, Taiwan, Japan, and Singapore are likely to result in substantial growth of the PCB market in the Asia-Pacific region. 

Automotive PCBs present another growth opportunity

• In its Jan 2016 update, industry forecaster Beige Market Intelligence predicted that the global automotive PCB market would be worth US$11bn by 2021F versus US$6.2bn in 2012. Beige Market Intelligence also highlighted that the interior components of a vehicle would contribute the most to driving automotive PCB adoption. 
• As of 2015, the interior components of a vehicle contributed approximately 43% of the total revenue generated by the sale of PCBs for the automotive sector as a whole. Examples of interior components that could drive higher PCB usage in the automotive industry are infotainment systems and air bags (which require electronics). 
• Beige Market Intelligence also predicts that the Asia-Pacific region would be the largest consumer of automotive PCBs in 2021F. 

FINANCIALS 

P&L trends 

• In the past seven years, Jadason’s revenue peaked at S$180.9m in FY10. Post-FY10, revenue has been on a downtrend, falling to the lowest level (since listing in FY00) of S$57.1m in FY16.
• Jadason’s gross margin hit a record high of 22.6% in FY16, after an impairment loss of S$12.9m was recognised in FY15 due to idle machines in the manufacturing and support services business segment. This led to the S$32.1m reported net loss in FY15, marking FY15 as the worst year for Jadason since its listing in the year 2000 as the impairment was recognised separately as an exceptional item in the financial statement.

Balance sheet, cash flow trends 

• In FY12-16, Jadason was in a net cash position. At end-Mar 2017, its net cash position was S$5.9m or 10.2% of its market cap on 18 May 2017. Over the past five years, Jadason was generally operating cash flow positive and annual capex was typically in the S$1.0-1.4m range.
• Jadason has a history of paying dividends. The company paid DPS of 0.5 Scts p.a. in FY10-12 before suspending dividends in FY13-15, when net losses worsened. Although Jadason registered net profit of S$1.8m in FY16, the company opted to be prudent and did not declare any dividends with respect to FY16 results. We believe that dividend payments will resume if the ramp-up in profitability is strong in FY17F.

COMPETITORS 

• Competition for Jadason comes from the in-house drilling capacity of PCB makers and the various smaller-scale PCB drilling companies (10-30 machines per shop) in China. 
• SGX-listed peers Eucon Holding Ltd and Multi-Chem Limited have largely exited he PCB drilling business.

KEY ASSUMPTIONS

• Our FY17F-19F forecasts are based on the following key assumptions: 
  1. Revenue growth in FY17F-19F will be driven by an aggressive expansion in the installed base of PCB drilling machines. We assume that the number of drilling machines in use will rise 50% yoy to 150 machines in FY17F, followed by a 27% increase in FY18F to 190 machines, before moderating to a growth rate of 11% to 210 machines at end-FY19F.
  2. The key driver of this increase in machine capacity would be new orders from a customer involved in mobile devices (details cannot be revealed due to non-disclosure agreements).
  3. Jadason would not face any significant teething problems and drilling yields will be within historical range, given that Jadason has been in this business for many years.
  4. Jadason’s PCB drilling machines would be optimally utilised, with downtime only for product change or maintenance. Given the lack of competitors that are able to offer large-scale PCB drilling support and the low cost that Jadason provides, we do not foresee any severe price reduction demands from customers during our FY17F-19F forecast period.
  5. Decline in cost of goods sold due to lower depreciation. Jadason took a massive S$12.9m impairment on its plant and machinery (mainly PCB drilling machines) in FY15. The net book value of its plant and machinery at end-FY15 would have been S$26.5m instead of S$13.6m if there had been no impairment. At end-FY16, the net book value of Jadason’s plant and machinery was S$14.5m. The drilling machines that were impaired are still production-worthy though. At the same time, Jadason is expanding its machine capacity via the purchase and refurbishment of second-hand machines. We believe these two factors will lower the cost of goods sold for Jadason as depreciation expenses will be lowered. As such, even though we forecast that gross margin will expand from 22.6% in FY16 to 24.0% in FY17F, before widening to 25.0% in FY18F and 26.5% in FY19F, Jadason could garner better gross margins than we project.
  6. Low tax rates in FY17F-18F. The normal corporate tax rate for Jadason’s China operations is 25.0%. However, due to the years of losses, Jadason still has unutilised tax credits that can be used to offset profits. Although we do not have the details of the tax treatment possibilities, we opine that it is unlikely that Jadason must pay the full tax rate of 25% in FY17F-18F. As such, our net profit forecasts are shored up by our assumed low tax rates of 5.0% in FY17F and 10.0% in FY18F (FY16 tax rate was 2.6%). We assume that the 25.0% corporate tax rate will only kick in in FY19F.
  7. Dividend payout ratio of 50% in FY17F-19F. In our view, Jadason is likely to hold on to cash for M&A opportunities or as a buffer against any unexpected downturn. In the past, Jadason paid DPS of 0.5 Scts when the company was profitable.

VALUATION & RECOMMENDATION

Initiate with Add 

• Given our strong EPS CAGR projection of 68.6% for the FY16-19F period, we value Jadason at S$0.17. This is based on 12.34x P/E (+2 s.d. above average forward P/E during the last earnings recovery cycle in 2004-2007, when Jadason’s earnings accelerated significantly) applied to our FY18F core EPS estimate of S$0.013. 
• In 2004-2007, re-rating lifted Jadason’s forward P/E to a peak of 14.78x. If this strong re-rating is repeated, we estimate Jadason’s share price could hit S$0.19, based on 14.78x P/E applied to our FY18F core EPS of S$0.013. 
• The key risks are order pullback or delays by Jadason’s key customer.
• Execution risk is a possibility but we view this as a low-risk event as Jadason has been involved in PCB drilling since the year 2000.

William TNG CFA CIMB Research | http://research.itradecimb.com/ 2017-06-30

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