Venture Corporation - CIMB Research 2017-10-03: Re-rating Likely To Continue

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VENTURE CORPORATION LIMITED V03.SI

Venture Corporation - Re-rating Likely To Continue

• Venture Corp is witnessing strong earnings momentum in 4Q16-2Q17, driven by customers in test & measurement/medical/others and networking & communications segments.
• We expect seasonality to persist in FY17F, with Venture experiencing stronger earnings in 2H17F vs. 1H17.
• Fischer Tech sale proceeds provide potential DPS upside of S$0.10 for FY17F. On top of the base DPS of S$0.50, we estimate FY17F DPS could rise to S$0.60.
• After rolling over to a higher FY17F EPS and applying a higher P/E multiple of 17.3x (0.5 s.d. above historical 10-year average of 15.2x), our Target Price rises to S$20.87.

Profits matter, not size 

• Founded in 1984, Venture is a global provider of technology services, products and solutions. The company has always been focused on profitability and has never incurred losses since its listing in 1992. 
• Today, the group has a well-diversified customer base and manages a portfolio of more than 5,000 products and solutions, while continuing to expand into new product categories. Venture competes on its ability to bring value addition to customers rather than on pricing.

Could re-test FY07 record-high net profit in FY18F? 

• Venture has enjoyed strong earnings momentum in the past three quarters, driven by its success with customers in the life science/medical/others fields. 
• Growing demand for data connectivity could also provide growth opportunities for Venture as its networking & communications segment has market-leading customers in this field. 
• We expect 2H to be stronger than 1H for FY17F, in line with the past three years’ trend. We also expect the positive momentum to lift FY18F earnings above the FY07 record high of S$300m.

New DPS baseline possibility 

• For the past 13 years, Venture has maintained a DPS of S$0.50 (except in FY10-11 when DPS was S$0.55). The average dividend payout ratio over these past 13 years was 82%, much higher than our current dividend payout ratio assumptions of 55%/48%/44% in FY17/18/19F, based on the continuation of S$0.50 DPS. 
• Barring higher returns on its capital, Venture will have the financial muscle to raise DPS to a higher level. With the sale of its stake in Fischer Tech, S$0.60 DPS for FY17F is a possibility, in our view.

Ready for business (as ever) 

• Venture has always made long-term plans for its business. On 5 Jul 2016, Venture completed the acquisition of land at 318 Batu Kawan Industrial Park. This leasehold property (30.6 acres), which has a 60-year tenure expiring on 18 Feb 2074, was acquired for RM33.3m. 
• Venture currently does not need to add capacity aggressively but with this property addition, Venture is well prepared for further customer wins or additional manufacturing requirements from customers.

Rolling over to FY19F and raising P/E multiple 

• We raise FY17-19F EPS by 3.2-5.5% to reflect Venture’s strong order momentum from its customers. 
• Given its 25% EPS CAGR over FY16-19F (based on our estimates), we raise our P/E multiple to 17.3x (0.5 s.d. above its historical 10-year average of 15.2x), from 15.2x previously, and roll over to FY19F P/E. This leads to a higher target price of S$20.87. Maintain Add. 
• A potential catalyst is stronger orders from customers. A key risk to our view is pullback in customers’ orders.

Re-rating Likely To Continue; A Successful Transformation 

Exiting the price-sensitive consumer products market 

• Venture Corporation Ltd (Venture) was listed on the SGX on 27 Apr 1992.
• Revenue hit a record high of S$3.9bn in FY07 before declining for four consecutive years as the group exited the price-sensitive and lower value-added consumer products business. Revenue fell 2.3% yoy in FY08, 9.8% yoy in FY09, 21.6% yoy in FY10 and 9.1% yoy in FY11.
• Since exiting the price-sensitive consumer products market segment, Venture has been engaging customers with less price-sensitive products. More importantly, Venture is able to add value for its new customers and become their manufacturing partner. This transformation can be seen in the printing & imaging segment’s contribution to revenue has declined from 40.3% in FY09 to 6.3% in FY16. 
• The test & measurement/ medical/ others segment’s contribution to revenue has grown from 12.3% in FY09 to 43.3% in FY16. Venture secured its highest number of customer wins in the test & measurement/medical/others segment over FY08-16.
• Over FY09-16, revenue CAGR for the printing and imaging segment was a negative 25.2%, whereas the test and measurement/medical/others segment saw revenue CAGR of 16.8%.
• The key milestones for the test and measurement/medical/others segment were in: 
  1. FY11 – Venture doubled the number of companies it worked with in the medical and life science area.
  2. FY12 – started work with Illumina Inc (ILMN US, Not Rated).
  3. FY13 – Illumina launched the desktop genome sequencer.
  4. FY15 - In late 2015, Venture was once again selected to work alongside Illumina on a ground-up development project, which since been launched in early 2017.

Positive Outlook For Its Customers 

• Based on Bloomberg consensus revenue growth forecasts as at 27 Sep 2017, most of Venture’s customers are expected to enjoy revenue growth in FY18-19F.
• Consensus only expects two of Venture’s customers to see negative revenue growth – International Business Machines Corp (IBM US, Not Rated) for FY18- 19F and Toshiba TEC Corp (6588 JP, Not Rated) for FY19F.
• Over FY12-16, the test & measurement/medical/others segment and the networking & communications segment were Venture’s key revenue drivers.

Test & measurement/medical/others segment 

• Illumina is often cited by Venture as an example of its close customer relationships in the test & measurement/medical/others segment. Venture started working with Illumina in 2012 to reduce the form factor of Illumina’s genome sequencer. In 2013, Illumina launched its desktop genome sequencer.
• In late 2015, Venture was once again selected to work alongside Illumina on a ground-up development project (NovaSeq series of genome sequencer), which has since been launched in early 2017.
• In Jan 2017, Illumina launched the NovaSeq series of genome sequencer, comprising the NovaSeq 5000 and NovaSeq 6000 models. The NovaSeq 5000 was priced at US$850,000 and the NovaSeq 6000 was priced at US$985,000 at the time. According to Illumina, there was a base of 1,900 installed instruments in Jan 2017 that could potentially be replaced by the NovaSeq series of products.
• Based on the transcript from Illumina’s 2QFY1/17 (May-Jul 2017) results conference call with US sell-side analysts, we note the following highlights: 
  1. 2QFY17 demand for NovaSeq beat Illumina’s expectations by more than 30%; 
  2. More than 230 units of NovaSeq have been ordered since its launch in Jan 2017; 
  3. Two-thirds of the orders were for product replacement. In Jan 2017, Illumina highlighted that the potential replacement market for NovaSeq was 1,900 units. Taking this into consideration, Illumina estimates that the potential market for NovaSeq could be in the region of 2,580 units.
  4. Illumina’s quarterly production capacity for NovaSeq hit the 80-unit mark in 2Q17; 
  5. President and CEO of Illumina, Mr Franics deSouza, said that less than 10% of HiSeq customers have ordered a NovaSeq so far. Thus, he still expects Illumina to have the bulk of this replacement wave to look forward to; 
  6. Illumina expects NovaSeq to continue to be a big theme in 2H17F; 
  7. Illumina plans to expand its production capacity for NovaSeq in 3Q17F.

What is the potential revenue opportunity for Venture from NovaSeq? 

• To explore the potential revenue opportunity for Venture from NovaSeq, we made the following assumptions: 
  1. total addressable market for NovaSeq of 2,850 units; 
  2. NovaSeq production capacity of 80 units per quarter, as highlighted in Illumina’s 2Q17 results conference call as a starting point. We assume that Illumina could double this capacity to 160 units per quarter or 640 units per year. On this basis, without further capacity expansion and ignoring adoption rate of customers, this could be a product cycle of 4.45 years (2,850 units/640 units); 
  3. NovaSeq’s cost of goods sold amounts to 30.9% of revenue. Based on Illumina’s 2Q17 results announcement, total product cost was 30.9% of the total product revenue generated. We use this 30.9% as an approximation for the cost of goods sold for NovaSeq for Illumina. The actual ratio could be higher as Venture is a manufacturing partner (rather than a price-taker supplier), with the ability to add value to Illumina.
  4. Illumina’s cost of goods sold is where the revenue opportunity for Venture lies, as Venture constitutes part of the production chain for Illumina’s NovaSeq.
  5. Venture is Illumina’s sole manufacturing partner for this product, given that the addressable market for NovaSeq is in the region of 2,850 units (rather than in the millions).

Networking & communications to indirectly benefit from rising demand for device connectivity 

• In the networking & communications segment, we note that Venture has been designing and manufacturing optical modules, subsystems and systems for its customers in the broadband and specialty fibre-optics market. 
• On the quest for better performance, many OEMs have introduced fibre-optic transmission technology, as well as 100G and beyond in their portfolio of high-speed optical products. Venture has been able to support many of these OEMs, such as Oclaro Inc (OCLR US, Not Rated), as they build, introduce and deploy their optical connectivity and integrated technology in the global market.
• With the rising connectivity of devices and more data/video being made available, we believe Venture will indirectly benefit from increased demand for its customers’ products.

Share Price Catalysts 

M&A potential? 

• Venture has very strong free cash flow generation thanks to management’s focus on profitability, working capital management and prudent capex. Over FY12-16, free cash flow rose by a CAGR of 18.80%, outpacing the 4.75% revenue CAGR and 6.64% net profit CAGR over the same period.
• Ventures’ historical EV/EBITDA has also declined from a high of 10.8x in FY13 to 8.0x in FY16. At the same time, free cash flow yield for the past three years has stayed above 5.00%.

Venture’s shareholding structure is fragmented. 

• Based on Bloomberg data as at 30 Sep 2017, Mr Wong Ngit Liong (Chairman and CEO of Venture) is the single largest shareholder with a 7.07% stake. Six unrelated fund management outfits own 29.74% of Venture in total.
• We understand that Mr Wong is around 75 years of age and from Venture’s 2016 Annual Report, we note that there are no immediate family members of a Director or the CEO working in a managerial role in the company.

Higher dividends ahead? 

• Venture started paying S$0.50 DPS in FY04. Over the past 13 years, there were only two years (FY10-11) when the DPS was not S$0.50. Therefore, we have assumed S$0.50 DPS as our base dividend forecast. However, given its earnings growth, our implied average dividend payout ratio for FY17-19F is just 49%, much lower than the historical average payout ratios of 82%/87%/94% in the past 13/10/5 years.
• Barring unforeseen capex and M&A opportunities, we think Venture does have the financial muscle to raise its DPS. Venture’s last acquisition was in 2006, when the company acquired then listed GES International.
• For FY17F at least, Venture has the capacity to raise DPS to S$0.60, in our view.
• Venture holds an 18.77% stake in Fischer Tech Ltd (FISC SP, Not Rated), which is undergoing a buyout by a private equity firm. We estimate Venture’s gross proceeds from this buyout offer amount to S$0.11 per share. Based on Fischer Tech’s latest announcement, shareholders will receive payment for their shares by 13 Nov 2017 if there are no unexpected delays.

Valuation & Recommendation 

Forecast changes 

• In the past three years, Venture has experienced stronger earnings in 2H than in 1H. Over FY14-16, 2H accounted for 55% of full-year net profit. We believe this trend will continue in FY17F. 
• Given the expected positive order momentum (with Bloomberg consensus forecasting that 80% of Venture’s top 50 customers will continue to enjoy positive revenue growth in FY18-19F), we raise our revenue forecasts for Venture by 1.2-2.2%, resulting in upward revisions of 3.2-5.5% to our FY17-19F net profit forecasts.

Rolling over to FY19F 

• Our valuation basis rises to 17.3x FY19F P/E (0.5 s.d. above its historical 10- year average of 15.2x) from 15.2x FY18F P/E (historical 10-year average) previously, as we roll over and raise our target P/E multiple. Given the upward revision to FY19F EPS, rollover and higher P/E multiple, our new target price is S$20.87. Maintain Add.
• For bullish investors willing to pay upfront for Venture’s potential earnings growth momentum, we note that 1 s.d. above the historical mean P/E (19.4x) would imply a potential valuation of S$23.39 for Venture. Based on 19.4x P/E multiple and our expected 3-year EPS CAGR of 25% (FY16-19F), we estimate Venture’s P/E-to-growth ratio would be 0.77x.

William TNG CFA CIMB Research | http://research.itradecimb.com/ 2017-10-03

CIMB Research SGX Stock Analyst Report ADD Maintain ADD 20.87 Up 15.800