Venture Corporation (VMS SP) - UOB Kay Hian 2018-03-01: 4Q17 Bullseye. Consensus To Play Catch-up.

Venture Corporation (VMS SP) - UOB Kay Hian 2018-03-01: 4Q17 Bullseye. Consensus To Play Catch-up. VENTURE CORPORATION LIMITED V03.SI

Venture Corporation (VMS SP) - 4Q17 Bullseye. Consensus To Play Catch-up.

  • Venture’s 2017 core net profit was S$387m (+72% y-o-y), coming in at 102% and 115% of our and consensus estimates respectively. Revenue growth continued to be driven by the TMO segment (+84% y-o-y) which we believe was due to Device I. (Read also: Venture Corporation (VMS SP) - This Changes Everything)
  • The higher R&D revenue in 4Q17 lifted gross margin; we expect it to sustain at 24-25% in 2018. 
  • A read through of Supplier X’s production suggests that 1Q18 core earnings is expected to be similar to 4Q17. No change to our earnings estimates. 
  • Maintain BUY. Target price: S$31.88.



RESULTS


FY17 results: On the mark. 

  • Venture Corporation (Venture) reported 4Q17 headline net profit of S$372.8m (+106% y-o-y). Excluding one-offs comprising S$11.3m gains from the disposal of Fischer Tech, and SS$19.6m allowance for inventories, core net profit was S$387.2m (+72% y-o-y). This represented 100% and 102% of our headline and core estimate of S$371m and 379m respectively. 
  • Results were in line with expectations. The stellar 2017 performance was attributed to strong revenue growth (+84% y-o-y) in the Test & Measure/Medical/Others (TMO) segment, as well as substantial R&D revenue which have high margins.

Revenue growth wholly driven by TMO segment. 

  • It comes as no surprise that the TMO segment continued to drive revenue growth, which we believe was driven largely by the manufacturing of Device I. TMO revenue came in at only 4% below our estimate of S$2.4b. 
  • For 2017, growth areas remained in the Networking & Communications (N&C, +12% y-o-y) and Retail Store Solutions/Industrial Products (RSSIP, +11% y-o-y) segments.
  • Against our estimates, N&C growth was 5ppt lower while RSSIP growth was 5ppt higher. The biggest miss came from Computer Peripherals and Data Storage (-16.3% y-o-y), which revenue growth was 13.8ppt lower than our expectations.

R&D earnings lifted 4Q17 gross margin to 27%. 

  • The quarter noted an exceptional gross margin of 27%, which we understand was boosted by a significant amount of R&D revenue recognised during the quarter. Management alluded that revenue from R&D lifted gross margins although it stopped short of giving the impact. 
  • Our estimate of NPAT excluding R&D points to around S$110-120m of core manufacturing earnings for 4Q17. This implies R&D revenue to be at least S$30-50m, which we find high.

Capex guided to be at least S$75m for 2018. 

  • Management said that capex is expected to be at least S$50m for 2018, excluding the capex for its recent US acquisition.

Higher R&D spend could induce structural shift in gross margin. 

  • At best, we think R&D can lift gross margin by 1-2ppt. That said, there is significant operational leverage here and the gross margin impact could be possibly larger than we estimate. 
  • Venture’s tone on R&D suggest this will be a field they will continue to develop, and might be a recurring theme. Higher R&D spend could induce client stickiness and encourage revenue growth from customers awarding higher volumes, potentially resulting in structurally higher gross margins of 24-25% going forward.


STOCK IMPACT


Core gross margin probably closer to 25%. 

  • At the best, we think R&D can lift gross margin by 1-2ppt. That said, there is significant operational leverage here and the gross margin impact could be possibly larger than we estimate. 
  • Another possibility is that with Device I making up > 30% of total revenue, margins from this product line are pulling up blended margins. 
  • Overall, we think it is a combination of these two and gross margins are likely to make a structural shift towards sustained levels of 24-25%. This translates into a sustained 10-11% net margin going forward.

Supplier X suggests a seasonal capacity ramp-up in 2H17. 

  • Our read-through from Venture’s supplier suggests that S$320m-350m worth of plastic components were sold to Venture in 2017, with roughly 60% of sales just in 2H17. 
  • Based on our understanding, the jump in 3Q17 production represented a seasonal ramp-up for the year-end holidays, with 4Q17 production slightly lower q-o-q. Based on this, we expect 1Q18 core earnings (ex. R&D contributions) to be at similar levels as 4Q17 in the base case. 
  • Admittedly, the 3Q17 ramp-up we envisioned failed to materialise in Venture’s 4Q17 figures; we will try to reconcile this.


EARNINGS REVISION/RISK


No change to earnings forecasts, introduce 2020 net profit at S$531m. 

  • Our thesis of Venture as the manufacturer for Device I has panned out so far, with our 2017 earnings forecast coming in on the mark. 
  • We are keeping our 2017-18 net profit estimates unchanged at S$475m and S$492m respectively. Our net profit estimate for 2020 is introduced at S$531m.


VALUATION/RECOMMENDATION


Maintain BUY and target price of S$31.88, pegged to 19x 2018F PE. 

  • Production of Device I is expected to continue at 2H17 levels into 2018, supporting earnings. With consensus likely to raise estimates, we expect share price to trend higher. 
  • Given the outsized shareholdings of most investors, we recommend investors to gradually topslice above $30 to lock in some gains.


SHARE PRICE CATALYST

  • Approval of Device I by the US FDA in 1H18.




Foo Zhi Wei UOB Kay Hian | http://research.uobkayhian.com/ 2018-03-01
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 31.880 Same 31.880



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