Frencken Group (Frencken SP) - UOB Kay Hian 2018-01-22: Proxy To EU Recovery At A Bargain

Frencken Group (Frencken SP) - UOB Kay Hian 2018-01-22: Proxy To EU Recovery At A Bargain FRENCKEN GROUP LIMITED E28.SI

Frencken Group (Frencken SP) - Proxy To EU Recovery At A Bargain

  • A high-tech manufacturer with a diversified portfolio of blue chip customers in various industries, Frencken represents an excellent proxy to Europe’s economic recovery. 
  • At current prices, this “mini-Venture” is available at bargain prices. We believe its recent disposal of PESB is a positive and its ~20% earnings CAGR momentum will continue into 2019. 
  • Initiate coverage with BUY with PE-based target price of S$0.79 based on 12.3x peer average 2018F PE and 3.8% 2018 yield.



INVESTMENT HIGHLIGHTS


Initiate coverage with a BUY and a PE-based target price of S$0.79, implying 33.9% upside. 

  • At 9.1x 2018F PE, Frencken Group trades at a significant 25% discount to its peer average of 12.3x 2018F PE.
  • 70-year track record with diversified portfolio of blue chip clients in various industries. Frencken is a high-tech manufacturer with a 70-year track record, building customer relationships with blue-chip market leaders like ASML, NASA, Philips and GE.
  • The cyclical nature of some of its business segments is soothed by maintaining a balanced spread of exposure to various industries.

Proxy to Europe’s economic recovery. 

  • Europe’s recovery after the crisis is now in full motion with 2018 real GDP growth expected to hit 2.3%, and business and consumer confidence at a decade high. Given that a bulk of Frencken’s blue chip customers are actually Europe-based, Frencken will be a strong proxy to the European economy and as such, we expect demand from Frencken’s customers to continue to grow. 
  • The Mechatronics division (which has the most exposure to Europe) has high fixed costs so a revenue increase will result in a much higher profit improvement.

A bargain for this “mini-Venture”. 

  • Though much smaller in size, Frencken is a well-diversified high-tech contract manufacturer that has characteristics similar to Venture Corp (high mix, low volume, stickier customers due to end-to-end design and development capabilities, and similar end industries like analytical and medical segments). 
  • Frencken is currently trading at 9.1x 2018F PE and 0.9x 2018F P/B vs Venture’s 18.5x FY18F PE and 3.0x FY18F P/B. As such, this “mini Venture” is available at a far cheaper price and we think that the group’s small size gives it more room to grow.

Disposal of PESB a positive. 

  • With the disposal of PESB (which has been performing weakly), management has dispelled any notion of an overhang over the stock. Besides unlocking the value of PESB at a profit. 
  • Management is now able to focus resources elsewhere in the business for more fruitful gains and elevate its growth profile.

2014-2017F ~20% earnings CAGR momentum to continue into 2019. 

  • Frencken has been posting strong earnings CAGR momentum of ~20% from 2014-2017F and we forecast attributable net profit CAGR to continue at 21.5% for 2016-19F on the back of:
    1. broad-based growth across medical, analytical and automotive segments,
    2. resilient orderbook from semiconductor, and
    3. gross margin uplift arising from operating leverage as capacity utilisation increases in tandem with sales orders.

Consistent dividends with positive operating cash flow. 

  • Historically, Frencken has consistently been paying dividends - even when loss-making - and has paid at least 30% of profits when it was profitable. This is thanks to the group’s strong cash generation and we believe Frencken’s dividend will continue, and expect attractive yields of 3.5% and 3.8% for 2017 and 2018 respectively.


VALUATION


Initiate coverage with a BUY and a PE-based target price of S$0.79. 

  • With demand-led growth fuelling the global economy, capital goods investment will likely remain robust as expectations of future profits remain buoyant. We like Frencken for its:
    1. potential growth catalysts,
    2. diversified portfolio of blue chip clients, and
    3. steady payment of dividends.
  • With the disposal of loss-making wholly-owned subsidiary, Precico Electronics, Frencken will not only unlock residual value from the subsidiary but also lift the overhang of its IMS division. 
  • Proceeds from the disposal will also strengthen Frencken’s balance sheet considerably, and will bolster its ability to focus on its automotive segment. We also do not rule out the possibility of a special dividend arising from this disposal.
  • We value Frencken at S$0.79, pegged to peers’ average of 12.3x 2018F PE.
  • Generally, management is cognisant of the cyclical nature of some of its business streams, and the company is answering that challenge by maintaining a balanced spread of exposures to various industries. For example, the cyclical nature of the semiconductor and industrial automation sectors are smoothened by medical and analytical segments.
  • We forecast attributable net profit CAGR of 21.5% for 2016-19 on the back of:
    1. broad-based growth across medical, analytical and automotive segments,
    2. resilient orderbook from semiconductor, and
    3. gross margin uplift arising from operating leverage as capacity utilisation increases in tandem with sales orders.


PEER COMPARISON


Fair value at 12.3x 2018F PE. 

  • Singapore-listed peers are currently listed at an average of 12.3x 2018F PE. As a high-tech contract manufacturer with design and development capabilities, Frencken boasts a strong and diverse portfolio of blue chip customers. 
  • With strong growth opportunities in end-markets, we think Frencken offers one of the best growth potential amongst its peers, and pegging its valuation to peers’ average is fair.

Laggard play to catch up. 

  • While Frencken has maintained earnings CAGR of ~20% in 2014-17F with no signs of this momentum slowing down, the market has not rerated it significantly to reflect the growth potential of this consistent winner. 
  • We believe the opportunity is ripe for the taking, as Frencken’s disposal of Precico not only dispels any notion of an overhang over the stock, but also elevates its growth profile as Frencken focuses on a new growth area in its automotive segment.


COMPANY BACKGROUND


Diversified Portfolio Of Blue Chip Clients 

  • 70 years of history culminating in 3,500 employees across the globe. With roots going back to 1947, Frencken Group (formerly known as ElectroTech Investments Ltd) is a high-tech capital and consumer equipment service provider. 
  • Listed on the SGX Mainboard in May 05, the company today operates on a worldwide scale through its established local presence of 17 operating sites and 3,500 employees across Asia, Europe and the US.

Offering one-stop services from conceptualisation to manufacturing. 

  • Leveraging on its advanced technological and manufacturing capabilities, it offers one-stop services along the entire value chain, i.e. from initial product design and conceptualisation, development and prototyping, to engineering, final testing and series manufacturing.

Diversified product and client base. 

  • Frencken’s two business divisions are:
    1. mechatronics – design and manufacture of high precision and complex systems for the medical, analytical, semiconductor and industrial industries, and
    2. IMS – providing integrated contract design and manufacturing services (focused on plastic injection moulding) to the automotive, office automation, consumer and industrial electronics.

Impressive portfolio of European blue chip customers. 

  • A large number of the group’s customers are European giants with global operations (resulting in 48% of 2016 sales coming from Europe). 
  • Backed by its long track record, Frencken has established strong working relationships with market leaders, including blue chips clients like ASML, Applera, FEI Company, GE Healthcare, Kodak, MDS, Neopost Industrie, NASA, PANAlytical, Philips, Panasonic, Seagate, Siemens, Uhlmann and Valeo.


RISK FACTORS


Foreign currency fluctuations. 

  • The group has operations in many parts of the world and is susceptible to the fluctuations of the domestic currency in each country. The group’s exposures to foreign currencies are primarily managed by natural hedges of matching financial assets and financial liabilities denominated in foreign currencies. 
  • The group also enters into forward currency contracts to hedge its uncovered position.

Vulnerable margins. 

  • A manufacturer like Frencken - like its peers - faces constant margin vulnerability from:
    1. rising costs of production, and
    2. downwards selling price pressure. 
  • However, the positive news is that while material costs are a major cost component for Frencken and prices of metals and plastic fluctuate over time, Frencken can pass through the volatility to its customers via re-pricing terms built into its contracts, thus limiting its exposure.

Geography risk via its focus on European customers. 

  • With a large bulk of Frencken’s customers coming from Europe, there is significant geographic concentration risk for Frencken. While it has improved throughout the years, 48% of 2016 revenue was still derived from the region. Nonetheless, this is both a risk and merit as a European recovery is what Frencken is banking on to boost its profits to new levels.






Edison Chen UOB Kay Hian | Yeo Hai Wei UOB Kay Hian | http://research.uobkayhian.com/ 2018-01-22
UOB Kay Hian SGX Stock Analyst Report BUY Initiate BUY 0.79 Same 0.79



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