Venture Corporation - DBS Research 2018-04-26: Oversold On Market Rumours

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VENTURE CORPORATION LIMITED V03.SI

Venture Corporation - Oversold On Market Rumours

• Venture’s decent 1Q18 net profit of S$83.7m (+72.3% y-o-y) should calm market jitters.
• No let-up in business activity; rising R&D activity and inventory levels despite 1Q lull suggests that Venture could be preparing for more orders ahead.
• Shares are oversold as current price of S$22.57 assumes zero growth.
• Maintain BUY; Target Price lowered to S$27.20 on lower valuation multiple.

Shares oversold but fundamentally attractive.

• Venture’s share price has fallen c.22% since Friday on several rumours relating to Philip Morris International’s (PMI) I Quit Ordinary Smoking (IQOS) devices. Production estimates for HeatSticks – modified cigarettes used in IQOS were cut by c.8% as PMI signaled for slower demand growth in FY18F after a remarkable surge in sales the previous year.
• The decent set of 1Q18 results, which saw 72.3% y-o-y jump in earnings on the back of margin expansion, should calm market jitters. The doubling of R&D expense (a possible leading indicator for the group) and rise in inventory levels to a record S$725m despite the 1Q lull also suggests that Venture could be preparing for more orders ahead.
• While expectations of double-digit growth at key industry clusters continues to provide visibility for Venture’s growth prospects, we have cut our growth assumptions for FY18F/19F by c.5% p.a. to reflect the larger q-o-q revenue decline in 1Q18 vs 1Q17. Given the lower growth, we have lowered our valuation multiple accordingly – from a premium of 19.5x to peers’ average of 17.5x.

Where we differ:

• While we have assumed lower earnings growth vs consensus on more conservative revenue and margin assumptions, we remain positive on Venture’s growth profile, and believe the market has yet to fully price in the group's unique offerings, know-how and hard-to-replicate ecosystems.

Potential catalysts:

• New products and continued expansion into non-traditional markets with higher margins, and new customer acquisitions are potential near-term catalysts. 
• In the medium to long term, acquisition of companies along the manufacturing value chain could increase Venture’s capabilities.

Valuation:

Maintain BUY with a lower Target Price of S$27.20.

• Given lower growth, we believe a valuation multiple of 17.5x (based on peers’ average) would be more suitable, vs 19.5x previously. 
• Against a c.5% p.a. cut to our earnings estimates, this translates to a lower Target Price of S$27.20 based on blended FY18F/19F PE.

Key Risks to Our View:

• Weakening client or global growth prospects. A broad global slowdown is likely to impact Venture due to its vulnerability to business cycles. 
• Potential weakening client’s end-demand and/or the USD could also dampen revenue growth.

WHAT’S NEW - Venture’s decent 1Q18 profit of S$83.7m should calm market jitters

1Q18 net profit up 72% y-o-y despite forex pressures. 

• Venture has proven to be able to navigate volatile exchange rate environments sufficiently well, which was demonstrated once again as the group delivered a decent set of results despite forex volatility.
• 1Q18 net profit surged 72.3% y-o-y to S$83.7m despite flattish sales of S$856m (+1.5% y-o-y) as net margins jumped from 5.8% in 1Q17 to 9.8%. On constant currency (USD) basis, revenue growth would have been higher at c.9.1%.
• Overall, revenue and profits formed more than 19% of our and consensus FY18F forecasts, which is slightly below average 1Q contributions of c.21% over the last two years.

Business as usual for Venture.

• In 1Q18, Venture doubled up on its R&D expense (a possible leading indicator in our opinion) compared to a year ago. Coupled with the rise in inventory levels to a record S$725m despite the seasonal 1Q lull gives us an inkling of current business activity levels, which appears to be growing.

Venture share price hit by PMI’s weaker guidance.

• Venture’s share price plunged 22% after PMI released weaker guidance for IQOS during its 1Q reporting last Friday (20 Apr). On its earnings call, PMI disclosed that IQOS device sales were slower than its “ambitious expectations”, as the pent-up demand envisioned for IQOS devices in Japan did not materialise after sales restrictions were lifted in 1Q18.
• Apart from a -8% adjustment to HeatStick production estimates, PMI maintained its positive stance and confidence in doubling global HeatStick sales in FY18F, but concerns of slowing growth for IQOS in Japan sparked a sell-down in PMI (-16% on Friday), which spilled over to Venture.

Supplier’s weak 1H18 outlook statement and market rumours add fuel to fire.

• An IPO debutant on the SZSE named Venture as a key client, which contributed c.52.73% of its 1H17 revenue of RMB693m (or S$160.6m). On an annualized basis, this would have made up c.10.6% of Venture’s COGS in FY17. According to the company’s 1H18 outlook statement, the pullback of orders for IQOS-related plastic components in 2Q18 could offset other growth areas, resulting in a 0%-15% y-o-y decline in their 1H18 revenue.
• Several reports have surfaced this week, as the street weighted in on PMI’s (specifically, the IQOS) role in Venture’s record FY17 performance. Divergent views have emerged, with contributions to FY17 sales from PMI ranging from 5% to 25%.

Limited disclosures on key clients.

• In observance of strict NDAs and to protect margins, Venture continued to maintain client confidentiality during its post-results briefing and refrained from engaging in client-specific discussions, including PMI issues.
• Instead, management drew attention to several fundamental strengths – a subtle aim at dispelling market rumours:
  1. Diversification strategy; no change in proportion of clients that are still growing. Broad-based growth led by active working relationships with at least 100 of its > 150 customers. Overall, 75% are still growing and 7% are relatively flattish.
  2. Superior margins a reflection of its strong value capture and engineering capabilities:  Given its strong value proposition, Venture’s lucrative partnerships are unlikely to be displaced in the event of pricing competition.
  3. Strict cost controls and multi-sourcing strategy: With a vast network of over 60-70k suppliers, Venture has flexibility in managing its procurement costs and allocations. As such, we believe it is the revelation of above-average margins for its components supplier post-IPO that resulted in lower allocations from Venture, rather than weakness in end- demand.

Concerns over PMI overdone.

• In its FY17 Annual Report, Venture maintained that only one customer made up more than 10% of the group’s revenue, as has been the case in the last five years (and more). While it is plausible that PMI was the single customer contributing more than 10% of Venture’s revenue in FY17, we expect growth from Venture to remain broad-based.
• Venture has typically traded at a premium forward valuation multiple of 19.5x. Even if we assume a lower valuation multiple of 17.5x (in line with peers) given the recent sell-off, Venture’s current share price of S$22.57 implies blended FY18F/19F net profit of c.S$366.6m – a c.2% drop in earnings vs FY17, which is unlikely, in our view.
• Concerns over PMI are overdone, as current levels assume zero growth despite several key clients guiding for low teens growth in FY18F.

Maintain BUY, Target Price adjusted to $27.20 on lower growth expectations.

• We are shaving back revenue growth for the group, given 1Q’s relatively flat revenue, amidst threat of trade wars and currency volatility. Overall, we are cutting earnings by for FY18F-19F by c.5% p.a.
• We have lowered our valuation multiple for the group from 19.5x to 17.5x, on slower core earnings growth outlook for 2018F (from 21% to 16%). Our target price has been adjusted down to $27.20 on blended FY18F/19F earnings.
• Maintain BUY.

Carmen Tay DBS Vickers | Suvro Sarkar DBS Vickers | http://www.dbsvickers.com/ 2018-04-26

SGX Stock Analyst Report BUY Maintain BUY 27.20 Down 32.200