Hi-P International - DBS Research 2018-10-02: Trading On Valuations

HI-P INTERNATIONAL LIMITED SGX:H17

Hi-P International - Trading On Valuations

Scenario analysis on the impact of trade tariff - possible 1 - 3% cut in earnings; worst case 2 - 17%.
Global customer base, about 24% in USA.
Mitigating measures – relocate plants outside China; explore M&A in Europe.
Upgrade to BUY on attractive valuations; Target Price revised up to S$1.30.

Upgrade to BUY on attractive valuations.

Hi-P’s share price has tumbled 46% YTD and 62% from its high of S$2.72 in March 2018. At current PE of 9.3x and 9.2x on FY18F and FY19x earnings respectively, Hi-P is trading at attractive valuations relatively to peers' 15x and 12x.

From a longer-term perspective, it is also below its historical average on a forward PE and P/BV basis. Hence, we upgrade our recommendation to BUY from HOLD on valuation grounds.

Trade war uncertainty remains.

With the majority of its manufacturing plants in China, Hi-P is vulnerable to the trade tariffs. Our scenario analysis shows that FY19F earnings could fall by 17% in a worst case scenario, but there should be minimal impact on our current FY18F numbers.

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Where we differ:

We were the first to conduct scenario analysis on trade war impact.

Potential catalyst:

Stronger-than-expected production ramp-up and demand; better operational efficiency to improve margins.
Further strengthening of USD as bulk of Hi-P’s revenue is in USD while overheads are in RMB.

Key Risks to Our View:

Volatile industry with shorter product life cycle. This presents risks on margins and inventories.
Forex exposure. Bulk of revenue in USD but overheads are mainly in RMB and the reporting currency is SGD.

WHAT’S NEW - Scenario analysis on the impact of trade tariff

Vulnerable to trade tariff with most of its manufacturing plants in China.

Hi-P has 13 manufacturing plants globally located across six locations in China (Shanghai, Chengdu, Tianjin, Xiamen, Suzhou and Nantong), and also in Poland, Singapore and Thailand. Hi-P has marketing and engineering support centres in China, Singapore, Taiwan and the US.
With the majority of its plants in China, Hi-P is vulnerable to the trade tariffs. US companies importing goods from China will have to pay an additional 10% levy now and the tax will rise to 25% from the start of 2019, unless the two countries reach a trade pact.

Consumer Electronics segment most vulnerable to trade tariff.

Hi-P’s business can be classified into five broad segments as follows:

Business Segment	% of revenue (estimate)
Wireless	20%
Computing & Peripherals	20%
Consumer Electronics	38%
Industrial & Medical	2%
IoT & Accessories	20%
TOTAL	100%

Based on the current list of goods affected by the trade tariff, the Consumer Electronics segment is most vulnerable, though not all of Hi-P’s customers are in US. The rest of the segments may not see a direct impact, but may also well be affected by the tariffs because they are involved in the complex supply chains.

Scenario analysis on the impact of trade tariff

Overall, we expect Hi-P to be affected by the current trade tariff, though we are unable to quantify the extent of the impact now. However, not all of Hi-P’s products are affected by the higher taxation as its customers are mainly global customers from different regions.
For FY17, 24% of the products were shipped to US, 59% to China, 7% to Europe and the balance to Asia.

Higher tax burden to be shared among suppliers

Furthermore, Hi-P is unlikely to bear the full tax impact as the tax burden is likely to be shared among the suppliers in the whole technology value chain, and also the end-consumers. Hence, we attempt to assess the impact of the trade tariffs on Hi-P’s earnings based on the following assumptions and scenarios:
- Assumptions
  1. For FY18F, we assume a 3-month impact as the 10% tax tariff was only implemented at end-September; assuming full 25% tax tariff in FY19F.
  2. Only the selling price (ASP) is affected; sales volume remains constant.
  3. All other costs remain constant.
- Scenarios
  1. Only a portion of Hi-P’s products are affected by the trade tariff.
  2. Hi-P bears different amount of the tax burden.

Possible 1-3% cut in earnings; worst case 2-17%.

From the analysis, assuming a likely scenario that 25% of Hi-P’s products are affected by the tax tariff, as 24% of its customers were from US based on FY17 revenue, and Hi-P’s share of 50% of the tax burden, this would shave 0.3% and 3.1% off FY18F and FY19F revenue respectively. Net earnings would be reduced by S$0.3m and S$2.5m, translating to PE of 9.3x for FY18F and 9.5x for FY19F.
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On a worst-case scenario, assuming 75% of Hi-P’s goods are affected and the group bears the full impact of the trade tariff, this would lead to a 2% and 17% reduction in net profit. PE of 9.5x for FY18F and 11.2x for FY19F is still lower than peers’ average of 15x on current year's earnings and 12x on next year's earnings.
See the table of impact on revenue and earnings by assumptions and scenarios in the PDF report attached.

Mitigating measures for Hi-P

We expect Hi-P to put in place some measures to mitigate the impact of the trade tariff. Possible measures include negotiating with its US customers, relocating capacity outside China, or leveraging the complex global supply chain to adjust how their internal costs are charged among subsidiaries to potentially lower the tariff charge.

Relocate plants outside China, including Thailand.

As Hi-P already has existing manufacturing plants outside China, to relocate some of its capacity out of China is much easier, compared to some of its competitors that do not have plants outside China. Among the plants outside China including Poland, Singapore and Thailand, we believe that Thailand is the most plausible option given its relatively lower cost of production compared to the other two regions.
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Alternatively, Hi-P can also ship the products from China to other regions to be assembled before shipping to its US customers.

Explore M&A targets in Europe.

Other than Asia, Hi-P could also explore M&A targets in other regions like Europe, as it currently does not have a presence in Europe yet, and Europe is also not affected by the trade war issues.

Earnings and Recommendation

Maintain forecasts for now.

Our current forecasts have already accounted for the trade war uncertainty. We have earlier cut our earnings by about 40% since the trade war started.
We would review our numbers after the release of the company's 3Q results, when we have more clarity on the impact from the trade tariff.

Upgrade to BUY on attraction valuations; Target Price revised up to S$1.30.

Hi-P's share price has tumbled 46% YTD and 62% from its high of S$2.72 in March 2018. At the current price of S$1.02, it is only 24% above our initiation price of S$0.82 in May last year. At current PE of 9.5x and 9.4x on FY18F and FY19x earnings respectively, Hi-P is trading at attractive valuations relative to peers' 15x and 12x.
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From a longer-term perspective, in terms of forward PE trading band from 2004, Hi-P is trading below its historical average of 11x. On a P/BV basis, at 1.4x, it is also below its long-term average of 1.65x. Hence, we upgrade our recommendation to BUY from HOLD on valuation grounds.
Our revised Target Price of S$1.30 (Previously S$1.21) is based on peers’ average of 12x (Previous peg to 30% discount to peer average of 16x current year earnings) on next year’s earnings, and rolling forward our earnings peg to FY19F numbers. The 12x valuation peg is also close to Hi-P’s 12-month forward historical average.

Benefitting from the strengthening USD.

Near-term catalysts include the further strengthening of the USD. The bulk of Hi-P’s revenue is in USD but overheads are mainly in RMB and the reporting currency is SGD.
Hi-P reported a forex gain of S$1.7m in 2Q18 (vs forex loss of S$13m in 1Q18) due to the appreciation of USD against the RMB and SGD. Our currency strategist expects the USD to continue its upward trend to 1.42 vs SGD and 6.95 vs RMB by 4Q 2018.

Lee Keng LING DBS Group Research | https://www.dbsvickers.com/ 2018-10-02

SGX Stock Analyst Report BUY Upgrade HOLD 1.30 Up 1.210

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