Hi-P International - DBS Research 2017-10-03: Ramping Up

Hi-P International - DBS Vickers 2017-10-03: Ramping Up HI-P INTERNATIONAL LIMITED H17.SI

Hi-P International - Ramping Up

  • Re-rating of tech stocks continues; Technology best performing sector in the Singapore market.
  • Wireless and IoT to ride on uptrend; building base for Consumer Products.
  • Expect earnings momentum to remain strong.
  • Tweaked FY17F and FY18F earnings up by 3% p.a.; maintain BUY with higher S$1.67 Target Price.

Riding on the growth trajectory in the smartphone and IoT markets. 

  • Hi-P is in a sweet spot now as more than half of its earnings are derived from the Wireless (smartphone) and Computer Peripherals (IoT segment, e.g. smart home) segments, which are expected to continue to do well in the next one to two years. 
  • The strong earnings momentum since 2H16, on the back of operational efficiency, new customers and new product launches, further reinforces our conviction.

Optimising capacity utilisation. 

  • Capacity utilisation has improved from < 40% in 1Q17 to about 60% to 70% now. With the continued ramp-up in production, we expect utilisation rate to peak at about 70% (based on 24/7 basis) by 4Q17. 

Where we differ: 

  • We are the only broker covering Hi-P. We believe the market under-appreciates the potential of the capacity ramp-up and Hi-P’s strong cash-generating capabilities. The strong results in 1H17, which is traditionally a much weaker period compared to 2H, should help to allay the market's scepticism on Hi-P. 

Potential catalyst: 

  • Stronger-than-expected production ramp-up and demand would help to boost sales while better operational efficiency would help to improve margins.

Ramping up. Re-rating of tech stocks continues 

Technology outperforming the overall market 

  • The Information Technology sector has been the best performing sector, both on a one-month and three-month basis, and even on a longer one-year period. The drivers to Technology’s stellar outperformance include a more favourable global macro outlook and improved market sentiment fueled by positive manufacturing data. 
  • Factory output for August registered the 13th month of consecutive growth. 
  • (See relevant article: Tech Sector Led in Sep, Venture now Biggest Stock in the STI Reserve List dated 03-Oct-2017)

Hi-P – Strong share price performance post 3Q17 results, among few to declare special DPS, share buyback.

  • In terms of earnings delivery, a handful reported strong quarterly results. To reward shareholders, some of them have declared higher dividend while others embarked on share buyback programmes. One example is Venture Corporation. CEO Mr Wong started buying back Venture’s shares in the last few months, sending a positive vibe to the market. Venture's share price has surged > 20% post 3Q17 results.
  • Hi-P declared 19 Scts special DPS post-delivery of a strong set of 3Q17 results. The share price was still above the pre-dividend announcement level after the shares went ex-dividend for the 19 Scts DPS on 28 August 17, which we believe, signals a strong conviction on the stock. In the past 10 years at least, Hi-P had not declared any special dividends.  
  • Besides declaring a special dividend, back in mid-June, Chairman Mr Yao has also bought back the 22% stake in Hi-P from Molex, the then second largest shareholder in Hi-P.     

What to expect next 

Macro picture still looking good 

  • According to independent research firm International Data Corporation (IDC) Worldwide Quarterly Mobile Phone Tracker, August 29, 2017, the Smartphone and IoT segments are expected to continue to do well in the next one to two years. The worldwide smartphone market in 2017 is expected to grow 1.7% y-o-y; thereafter, shipments will register a compound annual growth rate (CAGR) of 3.3% in 2021.
  • For the IoT segment, global IoT spending is expected to grow 16.7% y-o-y in 2017, reaching just over US$800 billion. By 2021, global IoT spending is expected to total nearly US$1.4 trillion. 
  • Smart home technologies (where one of Hi-P’s key customer is in) are forecast to experience strong growth (19.8% CAGR) over the five-year forecast period.

Continues to ramp up production Capacity

  • Capacity utilisation has improved from < 40% in 1Q17 to about 60% to 70% now. With the continued ramp-up in production, we expect utilisation rate to peak at about 70% (based on 24/7 basis) by 4Q17. 
  • Hi-P is expected to expand production, in particular at its Suzhou plant, to prepare for new product launches from existing customers from the mobile and IoT segments. Construction of the Suzhou plant should begin in 1H 2018. 

Building base for consumer electronics 

  • Broadly, Hi-P’s products can be classified into three broad categories - Wireless (smartphones), computer peripherals (Internet of Things (IoT)) and consumer electronics. All three segments contribute about one-third each to the group’s revenue. 
  • Over the years, Hi-P has been building up the customer base for the consumer electronics segment, as this segment is less volatile, as compared to the Wireless and Computer Peripherals divisions. 
  • Consumer Electronics, which include coffee machines, mixers, vacuum cleaners, shavers and electric tooth brushes, tend to have longer shelf lives and thus, provide more stability to revenue and earnings. Hi-P has about 20 to 30 active customers in the consumer electronics segment. Most of them have been with the company for at least five to 20 years.

Forex exposure - weakening of USD vs RMB and SGD

  • About 90% of Hi-P’s total revenue is in USD. Materials, which account for the bulk of total costs, are also in USD but overheads are mainly in RMB and the reporting currency is in SGD. 
  • In 1H 2017, Hi-P reported net foreign exchange loss of S$5.4m, as the USD depreciated about 5% vs the SGD and 3% vs the RMB. YTD, the USD has weakened 6% against the SGD while the RMB eased 4.5%. 

Earnings & Recommendation 

Management guidance: 

  • Hi-P has recently revised up the guidance for 3Q2017 results. It now expects higher revenue and profit for 3Q2017 as compared to 3Q2016. Hi-P previously guided for similar revenue and profit for 3Q2017 as compared to 3Q2016. 
  • Hi-P reported net profit of S$30.7m on revenue of S$387m in 3Q2016. In 1H2017, Hi-P registered net profit of S$23.5m. The difference between the unaudited profit and the previous guidance for 3Q2017 is mainly attributable to better sales and continuous improvement in operational efficiency. 

Earnings for FY17F and FY18F tweaked higher by 3% each. 

  • We have tweaked FY17F and FY18F earnings slightly higher by 3% each. 
  • We now expect strong earnings growth of 69% for FY17F and 14% for FY18F, on the back of the further ramp-up in production and improvement in margins as a result of operational efficiency and focus on mechanical components, which offer higher margins compared to the higher value EMS segment. 

Maintain BUY with higher Target Price of S$1.67. 

  • We have also pegged a higher PE valuation of 13.2x on FY18F earnings for Hi-P, as peers have re-rated after the strong results from Apple. 
  • We maintain a 10% discount to peer average, given its smaller scale. Our target price works out to S$1.67, up from S$1.45 previously. 
  • Maintain BUY.

Key Risks to Our View

  • Volatile industry with shorter product life cycle. This presents risks on margins and inventories.
  • Forex exposure. Bulk of revenue in USD but overheads are mainly in RMB and the reporting currency is in SGD.

Lee Keng LING DBS Vickers | http://www.dbsvickers.com/ 2017-10-03
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.67 Up 1.450