Venture Corporation - Maybank Kim Eng 2018-08-06: Strong Execution On Controllable Factors

VENTURE CORPORATION LIMITED SGX:V03

Venture Corporation (VMS) - Strong Execution On Controllable Factors

Management expressed concern over heightened business uncertainty from the US/China trade war, as well as the adverse impact of customer M&A, and product/platform transitions. Accordingly, we take a more cautious stance and cut FY18-20E EPS by 8-12%.
We remain positive on VMS long-term as the company continues to report strong results and the shares remain undervalued with +50% upside to our revised Target Price. Our ROE- g/COE-g Target Price is reduced 11% to SGD25.77, now based on 3.1x FY18E P/B vs. 3.4x previously.
Venture Corp (VMS)’s 2Q18 PATMI increased 40% y-o-y on the back of strong margin improvement, partially due to higher R&D spending by clients. Strong execution on many fronts, including nimbleness in mitigating the direct impact of a trade war and shortage of components also contributed to the healthy performance; 2Q18 net profit was in line with our and consensus estimates.

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2Q18 sales fell 6%, of which we estimate around 5ppt was due to the weaker USD against the SGD on a y-o-y basis. Customers Oclaro and Cavium are undergoing M&A, which may result in lower orders in the short term.
On the trade war, management has recently feedback that customers have turned more cautious than in Apr-18. A further escalation of the dispute is a key risk to our forecasts.
While quarterly fluctuations are expected, management aims to improve on the 10.3% net margin (+3.4ppt y-o-y) through consistent value creation and cost control.

The latest tariff lists affected only 2% of VMS’ sales. As VMS has helped affected customers implement workarounds, the current negative impact is zero.
VMS has also stocked up ample supply of passive components that are experiencing a market shortage to ensure production is unhindered. In fact, VMS is already winning business from customers routing production away from China to its facilities in Malaysia and Singapore.

Through strong delivery on factors VMS can control, the company has achieved four consecutive quarters of > 9% net margin. With this new level of profitability, VMS is on track to achieve a second year of 17-18% ROE in FY18E, a strong improvement from the trend over the better part of the last decade, when ROEs were mostly single digit.

Despite a set of 2Q18 results that met both our and street’s forecasts, we cut FY18-20E EPS by 8-12% on the back of a more uncertain demand outlook. While we acknowledge management’s comments that VMS may be a net beneficiary of the US-China trade tensions, we believe our tempered expectations are in line with VMS’ view that some short-term revenue volatility may arise. Our ROE-g/COE-g Target Price is based on FY18-20E average ROE of 17.8% and COE of 7.1%.
The interim DPS of SGD0.20 was a pleasant surprise as VMS typically only announces dividends at the end of the fiscal year.

Venture Corp (VMS)’s 1H18 PATMI was in line with our and street estimates, and made up 43% of our FY18 forecast. The typical earnings split in any given year is 40-45%:55-60% in 1H:2H.
Venture Corp (VMS)’s 2Q18 net profit rose 40% y-o-y despite a 6% y-o-y drop in sales. This was achieved on the back of stronger margins, which management attributed to recognition of major R&D milestones, and positive mix of products with design and/or other value-added content.

Venture Corp (VMS)’s 2Q18 revenue fell 6%, of which we estimate around 5ppt may be attributed to the weaker USD against the SGD on a y-o-y basis. VMS cautioned that some volatility may arise in the near future, citing customer M&A, customer product/ platform transitions, components shortage, and also the possibility of a further deterioration of the trade war and.
In a recent interaction before the earnings black-out, VMS acknowledged that some customers have turn cautious amid the uncertain environment, compared to the generally still upbeat tone spotted at the end of April.
The acquisition of Oclaro by Lumentum has just been approved by the former’s shareholders, while the acquisition of Cavium by Marvell has been completed in July. This could imply short-term reduction in orders from these customers amid post-merger integration rationalisation of suppliers. Both Oclaro and Cavium are well-known customers of VMS.

Based on present visibility, VMS expects little to no direct impact from the trade war and the current shortage of passive components. VMS has stocked up an ample supply of passive components, such as multilayer ceramic capacitors (MLCCs) to mitigate production delays, which could otherwise stymie growth.
Regarding the trade war, only 2% of its revenues are directly affected by the tariff lists, and VMS has been able to fully help its customers implement workarounds. In fact, VMS is already winning business as some companies seek an exit from China to capitalise on the company’s Malaysia and Singapore footprint. However, we remain concerned that an escalation of the trade war may have indirect knock- on effects that could negatively affect VMS’ sales outlook.

This was also the fourth consecutive quarter where VMS was able to achieve above 9% net margin. Looking ahead, management will strive to improve on this based on consistent effort to create value and manage costs. However, we do not rule out the possibility of quarterly fluctuations due to changes in product mix.
We view that increased R&D and a proactive and innovative approach in serving customers would enhance VMS’ profitability over longer run.

Lai Gene Lih Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2018-08-06

SGX Stock Analyst Report BUY Maintain BUY 25.77 Down 28.830