Valuetronics Holdings Ltd - CIMB Research 2017-07-04: Two Are Better Than One

Valuetronics Holdings Ltd - CIMB Research 2017-07-04: Two Are Better Than One VALUETRONICS HOLDINGS LIMITED BN2.SI

Valuetronics Holdings Ltd - Two Are Better Than One

  • Our recent plant visit in Shenzhen reaffirms our positive stance on Valuetronics (VALUE), even as the stock is up 67% YTD, as we see several catalysts ahead. Reiterate Add.
  • In our view, the market has not priced in potential sales contribution from second OEM, which may lift our FY19F EPS by 13.9-18.8%, based on our scenario analysis.
  • It is the sole supplier of second-generation wireless LED lighting, which would enable it to benefit from both end-market growth and rising home connectivity worldwide.
  • More efficient use of cash may imply slightly higher dividends and synergistic M&As.

Overall impressed with this multi-skilled EMS provider 

  • We visited Valuetronics' two plants in 19-20 June and were impressed by the facilities and full range of electronics manufacturing services (EMS) capabilities, from surface mount technology (SMT) for the printed circuit board (PCB), plastic mould fabrication and tooling, to finished product assembly. 
  • We also like its ongoing automation efforts, as well as its expanding product portfolio and customer range for both CE and ICE segments.
  • We expect further upside to its share price with catalysts in sight.

Share price driver #1: maiden sales to second OEM in FY19F 

  • At the Daya Bay plant, we observed several production lines set aside for automotive connectivity modules, each for a different product series and car model belonging to the same automaker, including a new line for its second OEM customer. Assuming successful audit completion by end-FY18F, we think this may add HK$245m-268m to FY19F topline, and provide 13.9-18.8% upside to our EPS forecast. As both projects enter mass production, automotive will continue to be a key driver for the company.

Share price driver #2: delivering value beyond illumination 

  • VALUE’s wireless LED lighting segment started revenue contribution in 2QFY3/17. The company is the sole supplier to its major Dutch customer. This second-gen, smart lighting is currently prevalent in the European and American markets, while Asia is still in the early phase of market development. 
  • Apart from potential end-market growth, we expect VALUE to also benefit from the rising home connectivity, given the global proliferation of smart home gadgets like Amazon’s Echo and NEST’s security camera.

Share price driver #3: cash-rich with inorganic growth potential 

  • VALUE had a cash pile of HK$825m (including AFS assets) as at end-FY17. Apart from c.HK$60m annual maintenance capex and regular dividend payout of c.HK$84m, this war chest could come in handy for: 
    1. possible relocation of Danshui factory (that may incur a total investment of at least HK$100m over a 3-year period), and 
    2. synergistic M&As.
  • Amongst various possibilities, expanding downstream offers a different customer base and we believe it would make the most sense for the company.

A good catch with 4.5-4.9% sustainable dividend yield 

  • Our FY18-20F forecasts and target price of S$0.89, pegged to 11x CY18F P/E (at 10% discount to peers’ average) are intact. Reiterate Add. 
  • Unexpected order cancellation or delays pose downside risks to our Add call. 
  • Potential re-rating catalysts are stronger earnings delivery, better-than-expected dividends and M&As. 
  • The stock currently trades at 9.9x CY18F P/E (6.0x ex-cash).

SCENARIO ANALYSIS: When second car brand kicks in

Revving up automotive production 

  • VALUE qualified for automotive supply chain via the TS16949 accreditation in 2015, and subsequently secured its first tier-1 automotive (AU) customer. The company currently designs and develops connectivity modules for a single OEM, which started sales contribution in 2QFY3/16 (Jul-Sep 2015). It is also undergoing audit by another OEM, which is expected to be completed by endFY18F.
  • We saw the preparation of the production line for this new car brand during our recent visit to VALUE’s plants in Shenzhen, apart from other manufacturing and assembly lines dedicated to each new product series and different car models under the existing OEM.
  • Taking reference from the prior sales contribution from the first car brand, we estimate that this second OEM could add HK$245m-268m to the company’s FY19F topline, assuming the audit is successfully completed by end-FY18F. 
  • Our scenario analysis suggests that this could lift our FY19F net profit by 13.9-18.8%, and raise our target price to S$0.99-1.02 (still pegged to 11x CY18F P/E). Other projections in the scenario analysis are largely unchanged, although we adjusted full-year gross margin according to the changes in sales mix.
  • We currently exclude this sales potential from our FY18-20F forecasts as we await greater visibility from the management. As both projects enter mass production, we believe automotive will continue to be a key driver for VALUE, given the longer product life cycle of 5-7 years for automotive components.


Truly integrated EMS provider 

  • The first stop on our site visit was VALUE’s newer plant in Daya Bay, which started project transfers of major customers in Jul 2008 and officially opened on 26 Feb 2009. 
  • We saw the full spectrum of electronics manufacturing (EMS) capabilities that VALUE has to offer, ranging from surface mounting technology (SMT) and through-hole technology lines for the printed circuit board (PCB), to plastic tool fabrication and injection moulding, as well as full turnkey finished product assembly.

Lean manufacturing, with areas for further automation 

  • Apart from gaining a better understanding of the different processes, we also witnessed VALUE’s emphasis on enhancing productivity, increasing yields and ensuring consistent quality. Such gradual gains in operational efficiency should help mitigate the continual cost-down pressure from customers and address the challenge of rising labour costs, for which we estimate a 2% pt decline in gross margin over FY18-20F, from 15.0% in FY17.
    • We were introduced to the company’s in-house manufacturing execution system (MES), a comprehensive production management system that carries out real-time monitoring and feedback at any determined point of the entire manufacturing process. It was recently upgraded to an intelligent management system (IMS), which led to pass yield improvement from 93% to 98%, especially for products that require substantive assembly, thanks to early detection of defects. A 1% yield improvement could generate 3% cost savings, based on management’s estimates.
    • We also saw a self-improvised production line, comprising five Yamaha robotic arms, which can not only reduce the manpower needed from 13 to four workers, but also possibly replace three old lines. This highly automated line is currently in the testing phase for VALUE’s automotive (AU) customer, and could be extended to its other industrial and commercial electronics (ICE) customer.
    • A switch from the manual insertion and wave soldering method to automatic insertion and selective soldering for producing electronic circuits is likely to save time, enhance precision and minimise soldering wastage.

Possible relocation of Danshui factory after 2020F 

  • Unlike the Daya Bay plant, VALUE’s Danshui factory (established in 1992) is visibly older, on leasehold and dedicated to production for its consumer electronics (CE) segment. Both the Daya Bay and Danshui plants sit on a combined site area of 110,000 sq m. 
  • We previously highlighted in our 4QFY17 results note (see Valuetronics Holdings Ltd - 4Q17 New Orders In Ramp-up Phase) that the current lease for Danshui will expire by end-2020F. Should the lease renewal not materialise (due to ongoing property developments surrounding the site by the local government), the company could relocate its operations to the empty land at Daya Bay or search for an alternative site. We estimate the capex for a new plant would be in excess of HK$100m. 

Thriving in an increasingly-connected environment 

  • VALUE acquired its first order for smart LED lighting in 2QFY17. Wireless LED bulbs are broadly similar to traditional LED ones, except for the requirement to 
    1. download firmware into a micro controller unit (MCU), and 
    2. undergo colour testing (in addition to voltage testing). 
  • Semi-automated production lines are underway to lift production yield from the current 300-350 units an hour, to potentially 1,500 units per hour.
  • Apart from intelligent home lighting, we were also surprised to see increasing connectivity in electric toothbrushes. The company is in the midst of manufacturing high-end electric toothbrushes for its major Dutch customer, which incorporate a Bluetooth function. 
  • Overall, we project FY18- 20F topline growth of 11-13% p.a. for the CE segment.


Optimising cash pile 

  • VALUE had net cash (including AFS assets) of HK$825m as at end-FY17, which we expect to grow in tandem with the increasing profitability and steady cash conversion cycle of 40-50 days, despite slightly higher working capital requirements from key customers. 
  • Apart from forecasted yearly maintenance capex of HK$60m and regular annual dividend payout of HK$84m (dividend policy of 30-50% with DPS of 20 HKcts as our base case), we think the company would have sufficient war chest for potential investment in a new plant (at least HK$100m) and synergistic M&A opportunities. 


Reiterate Add with an unchanged S$0.89 TP 

  • We retain our FY18-20F forecasts, ADD call and target price of S$0.89, still pegged to 11x CY18F P/E (at 10% discount to industry average). 
  • The stock remains attractive, in our view, with its 4.5-4.9% dividend yield (based on our base case of 20 HKcts DPS), debt-free balance sheet and 11-14% EPS growth in FY17-19F, based on our estimates.

NGOH Yi Sin CIMB Research | William TNG CFA CIMB Research | http://research.itradecimb.com/ 2017-07-04
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