VENTURE CORPORATION LIMITED (SGX:V03)
Venture Corporation - Gaining Profit Share
- Exceptional margins and consistency in capturing a larger profit share of the industry.
- Healthy operating cash-flows and cash holdings to support 4.6% dividend yield.
- Valuation is attractive against its peers due to its superior ROE, margins and balance sheet.
- Beneficiary of the on-going electronics supply chain disruption in China.
- Initiate coverage on Venture Corp with a BUY rating and a target price of S$17.68. Our valuation is based on a 14x PE multiple.
Venture Corp's Company background
- VENTURE CORPORATION LIMITED (SGX:V03) was founded in 1984 as a global electronics manufacturing services (EMS) provider.
- Venture Corp's capabilities expanded from assembly and manufacturing into research, design and development, product and process engineering, design for manufacturability, supply chain management, as well as product refurbishment and technical support across a widely diversified range of high-mix, high-value and complex products.
- Headquartered in Singapore, the Group comprises more than 30 companies with global clusters in Southeast Asia, Northeast Asia, America and Europe and employs over 12,000 people worldwide.
Investment thesis
- Venture Corp enjoys higher profit margins and is consistent in gaining profit pool. Venture Corp higher margins are due to their investment and customer collaboration in research, design and development. A focus on high mix, low volume in niche segments allows Venture Corp to enjoy a 5- fold higher net profit margin of 11% compared to a peer average of 2%. We believe Venture Corp foray into life sciences and genomics has been the main driver of growth in recent years. The customer growth outlook remains intact and should help propel Venture Corp’s earnings. Venture Corp's share of industry net earnings has risen from 4% to 39% over 5 years.
- Strong balance sheet with net cash position to support attractive dividends. As of 2H19, Venture Corp's net cash position is at S$760mn which is approximately 17% of its market cap. Although Venture Corp does not have a formal dividend policy, it is highly committed to paying at least the same amount as the previous year. With a strong cash generation and robust balance sheet we can expect Venture Corp to pay consistent dividends and possibly initiate share buybacks. We forecast Venture Corp to pay S$202mn in dividends in FY19e, this equates to a pay-out ratio of 55% and a yield of 4.6% at current share price. DPS has risen 40% over the past three years.
- Beneficiary of supply chain disruption. The on-going Sino-US trade war has been disrupting the supply chain in China. From our discussion with manufacturers and analysis of various announcements, there is an ongoing shift of the electronics supply chain from China into South East Asia. Venture Corp has approximately 86% of its production in this region, much higher than its US peers. We were also able to observe that the investment approvals in Malaysia for electrical and electronic products has a massive spike recently. Venture Corp is poised to benefit from this extensive relocation due to its existing presence in South East Asia.
- Valuation is attractive. Venture Corp is currently trading at 13x PE. We consider it attractive because, over the last 10 years, Venture Corp typically trades at a PE range of 16x. Venture Corp also boast a superior return on equity, profit margin and debt to equity ratio relative to its US listed peers.
Revenue
- Venture Corp generates revenue by providing technology services, products and solutions. We can essentially split Venture Corp’s revenue streams into two main segments.
- Portfolio 1: Comprises of Life Science, Genomics, Molecular Diagnostics and Related Materials Technology, Medical Devices and Equipment, Healthcare & Wellness Technology, Lifestyle Consumer Technology, Health Improvement Products and Others.
- Portfolio 2: Comprises of Instrument, Test & Measurement Technology, Networking & Communications, Security & Safety, Building Automation, Industrial IOT, Fintech, Advanced Payment Systems, Computing & Productivity Systems, Advanced Industrial Technology, Printing & Imaging, Related Components Technology and Others.
- Design revenue accounts for more than 50% of total revenue. This is a rare feat in the contract manufacturing space. We believe Venture Corp’s ability to maintain a profit margin of 10.6% is due to its extensive capability in R&D which results in value creation and customer stickiness. Venture Corp generally prices its services by internal benchmarks. Venture Corp is also selective with its customers as it aims for quality growth. Among its peers, Venture Corp is ranked 6 out of 7 in terms of revenue while it ranks first in terms of net profit. We believe portfolio 1 will provide growth for Venture Corp as it shifts away from its legacy businesses (portfolio2).
Venture Corp's Key Customers – Positive outlook
- Venture Corp serves more than 100 customers globally. We think Philip Moris, Illumina and Keysight are likely to be Venture Corp’s key customers.
Philip Morris
- Philip Morris (PM) is an international tobacco company engaged in the manufacture and sale of cigarettes, smoke-free products and associated electronic devices and accessories.
- Venture Corp is one of the few manufacturers producing PM’s I-Quit-Original-Smoking (IQOS) product. IQOS is a smoke-free product which heats tobacco units up to a temperature of 350 degrees without combustion. PM claims IQOS produces less harmful chemicals as compared to normal cigarettes.
- Korea and Japan: Despite slight weakness in PM’s sale of Reduced Risk Products (RRP) in Korea and Japan, we believe Venture Corp’s on-going introduction of IQOS products in new markets should offset some of the softness in Korea and Japan.
- The United States: On 30 April 2019, the Food and Drug Administration (FDA) approved the sales of IQOS 2.4 in the United States. In recent news, lawmakers in the United States urged the FDA to immediately pull pod-based and cartridge-based e-cigarettes off the market due to an outbreak of lung disease. IQOS faces less regulatory scrutiny than e-cigarettes. This may have a net positive impact to PM’s IQOS heat not-burn-product as consumers have fewer alternatives available.
Illumina
- Illumina provides sequencing and array-based solutions for genetic analysis. Its products are designed to accelerate and simplify genetic analysis. Illumina’s products include integrated sequencing and microarray systems, consumables, and analytical tools.
- Over the last 5 years, Illumina enjoyed revenue CAGR of 12.4%. The outlook for Illumina is positive as it continues to gain market share in genomic sequencing. Illumina is also enjoying healthy growth in its NovaSeq portfolio of products.
Keysight
- Keysight offers electronic measurement services using wireless, modular and software solutions. In FY18, Keysight achieved revenue growth of 21.6% y-o-y. As of 3Q19 results, Keysight raised its outlook for FY19 with expected revenue growth of 9% to 10% citing strong enterprise demand and 5G.
Expenses
- Majority of Venture Corp’s expense is made up of changes in finished goods, work in progress and raw materials used, making up 81% of FY18’s total expenses (Figure 8).
Staff costs:
- Venture Corp currently employs more than 12,000 workers globally, with staff costs accounting for 10% of FY18’s total expenses. Venture Corp margin expansion is in part the ability to keep employee expenses hovering at a steady rate of 10% of total annual expenses since FY15 despite expanding its operations.
Research and Development (R&D) costs:
- Venture Corp is spending 1.72x more on R&D as compared to peers over the last 10 years. We believe this has allowed it to provide more value add to the customer, entrench the relationship and penetrate earlier into new projects. In FY18, Venture Corp’s R&D expenditure surged 66% to S$83mn while peers were relatively muted at an average of S$23mn. We believe Venture Corp’s consistent R&D efforts will lead to more value creation to support its impressive profit margin.
- We expect R&D expenses to decline from its peak in FY18. Although R&D expense is commonly used to gauge future turnovers of EMS companies, we think for Venture Corp, it may not hold true. The fluctuations in Venture Corp’s R&D expense may be due to timing differences as it is purely customer-driven. R&D expenses are recognised after reaching certain milestones this is done in different phases. The recognition of milestones is decided by customers and could range from 25% of a new product launch (NPI) to 100% of an NPI. Upon completing an NPI, customers may add or modify its products thereby delaying milestones and hence delaying the recognition of Venture Corp’ R&D expenses.
Tax expenses:
- Venture Corp recently initiated a tax optimisation programme which centralised all of its taxes. As of 2Q19, the effective tax rate was brought down to 13.7% from 15% a year ago. We expect the steady-state of the effective tax rate to be in a range of 14% to 14.5% going forward.
- The initiative could potentially save Venture Corp approximately S$2mn in tax expenditure annually.
Robust balance sheet – Dividend support
- Dividend visibility for Venture Corp is backed by its strong balance sheet. As of 2H19, Venture Corp has a net cash position of S$760mn which is approximately 17% of its market cap. Net cash to equity is at 32%.
- With a strong cash generation and a robust balance sheet we can expect consistency in dividend payments and potential share buybacks. We forecast Venture Corp to pay S$202mn in dividends in FY19e, this equates to a pay-out ratio of 55% and a yield of 4.6% at current share price. See Venture Corp's dividend history; Venture Corp's share price.
Outlook
- Venture Corp near term outlook is shrouded by escalating geopolitical tensions and the prolonged trade war. Its focus will be on selected domains that have growth and value creation opportunities. Strong initiatives are in place for building new differentiating capabilities to enhance the Group’s competitiveness.
- With its strong balance sheet, Venture Corp is well placed to capture growth opportunities as and when they arise.
Strong South East Asia presence
- Venture Corp will be a long-term beneficiary from the supply chain disruption in China due to the ongoing trade dispute with the United States. Venture Corp’ exposure in China only accounts for 5% of its total properties. Note that there is less than 2% of turnover directly impacted by the trade dispute.
- Among its peers, Venture Corp has the largest (86%) proportion of its production facility in South East Asia, namely in Malaysia. From our discussion with manufacturers and analysis of various announcements, there is an ongoing shift of the electronics supply chain from China into South East Asia. In addition, we have observed a surge in electrical and electronic investment approvals in Malaysia. Venture Corp is poised to benefit due to its existing production capacity in South East Asia.
Initiate coverage on Venture Corp with a BUY rating Target Price of S$17.68
- Our valuation is based on a 14x PE multiple. Our valuation is conservative given Venture Corp’s superior return on equity, profit margin and balance sheet. We expect Venture Corp dividend yield to be stable at 4.6%.
- See attached 16-page PDF report for complete analysis.
Alvin Chia
Phillip Securities Research
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https://www.stocksbnb.com/
2019-09-30
SGX Stock
Analyst Report
17.68
SAME
17.68
