Hi-P International - UOB Kay Hian 2020-08-03: Prospects Overhyped For Contract Manufacturer; Initiate Coverage With SELL


Hi-P International - Prospects Overhyped For Contract Manufacturer; Initiate Coverage With SELL

  • While Hi-P International (SGX:H17) is ascending and widening its reach within the value chain, its lofty valuation does not take into account pricing pressure from clients, slow take-up of products, as well as risk in M&A synergies.
  • We initiate coverage on Hi-P International with a SELL and target price of S$1.11.

Hi-P International - Company Background

  • Hi-P International started out in 1980 as a tooling specialist in Singapore and has since grown to become one of the region’s largest and fastest-growing integrated contract manufacturers today. The group provides one-stop solutions to leading customers in various industries, including wireless telecommunications, consumer electronics, computing and peripherals, IoT, medical devices and industrial devices.
  • Work scope covers the range from product development and design, component manufacturing to complete product assembly.
  • Hi-P International has 13 manufacturing plants globally located across five locations in China (Shanghai, Chengdu, Xiamen, Suzhou and Nantong), Poland, Singapore and Thailand. Additionally, the company has marketing and engineering support centres in China, Singapore, Taiwan, Germany and the US.
  • Trade tensions between the US and China have led to a shift in global supply chains. Correspondingly, Hi-P International recently expanded its global manufacturing footprint significantly, particularly in Thailand, and has achieved positive results. The new facility has secured several projects from a leading US beverage company to manufacture coffee machines, which will help boost revenue in Thailand by > 10x in 2020 (2019: S$29.6m).
  • Further, Hi-P International has also actively sought out new business in other industries including medical and automotive.
  • Apart from back-end industrial machines, Hi-P International has a hand in many end-products including smartphones, tablets, wearable devices, audio speakers, healthcare and personal grooming tools, coffee machines, floor scrubbing robots, as well as internal and external computing and peripherals.
  • Broadly, Hi-P International's products are classified into three categories:
    1. Wireless (20%): Consists of sales related to components and modules for the Apple iPhone, including internal metal parts, power and volume buttons, metal chassis and the sim tray.
    2. Computing peripherals (20%): Metal parts and components for Seagate hard disk drives, Apple iPads and iMacs, as well as the iMac keyboard and Apple Pencil.
    3. Consumer electronics (35%): Hi-P International recognises revenue derived from the full assembly of Keurig coffee machines, electronic toothbrush and shavers by P&G and Colgate, as well as the upcoming contribution from component manufacturing for Dyson’s industrial motors.
  • The remaining 25% stems from accessories including IoT devices such as Amazon Echo, iPhone cases, Apple Watch components and related battery chargers.
  • Geographically, Hi-P International's 2019 revenue composition was derived from the two largest markets China (46%) and the US (31%), while the remaining (23%) stemmed from Europe (6.5%), Taiwan (3.2%), Australia (3%) and Japan (2.6%).
  • Over the past 10 years, Hi-P International has successfully reduced its customer concentration risks, which also significantly lowered its receivables collection risk and revenue dependence. Specific to the precision plastic injection molding segment given it is the largest revenue contributor to the group, Hi-P International had just two major customers which contributed to 72% of total segment sales of S$333m in 2010. This is to be compared to the five major customers in 2019, which amounted to 87% of total segment sales of S$864m.

Hi-P International - Investment Highlights

Downstream manufacturers for Apple facing pricing pressure.

  • On the back of Apple’s success in becoming a leader in technology devices, its stature and global reach has granted it the hegemony to levy stricter terms on its suppliers, such as Hi-P International.
  • Not only are enslaved downstream manufacturers being pressurised to lower prices or face the risk of a re-channelling of orders to competitors, they are also required to make hefty investments in factory equipment to support future products - without being assured a minimum set amount of purchase orders.
  • While the phenomenon is not new, the key difference now would be the ensuing demand for Apple’s upcoming new iPhone in 2020, to be launched amid the negative effects from the COVID-19 pandemic.
  • Although Hi-P International has been reducing its exposure to Apple, the technology giant still accounts for the largest slice of the pie at 47% of revenue and is a key factor to Hi-P International’s margin pressure.

Further pressure from shift into consumer electronics.

  • Over the past decade, Hi-P International has been successful in building up its revenue exposure from the consumer electronics industry. From > 90% in sales derived from the technology sector before, Hi-P International now has 35% of its revenue stemming from consumer electronics.
  • Clients include Keurig, P&G and Colgate, and Hi-P International provides turnkey work that originates at the design stage. More recently, the company added household appliance manufacturer Dyson to its clientele, through an accretive S$42m strategic acquisition in 2019.
  • However, while orders from the consumer electronics industry are stickier and less cyclical, profitability relative to the technology industry is lower and will place further pressure onto Hi-P International’s net margin.

Lower FCF from higher investment spending.

  • Hi-P International is aggressively gearing up towards automation and implementing artificial intelligence-aided system flows, which will effectively reduce reliance on labour and unnecessary admin overheads over the longer term.
  • In conjunction, capex spending over 2020-22F is expected to be markedly higher at $90m each year, from an average of S$54m in 2017-19A. This would significantly reduce FCFF by more than half to just S$50m per year, compared to > S$179m on average in the past three years.

Indicative dividend yield not attractive.

  • While Hi-P International has consistently rewarded shareholders every year since its listing in 2013, the indicative dividend yield is in the sub- 2% range across 2020-22F. Assuming a 30% payout ratio, expected DPS of S$0.023 and S$0.025 translates to unattractive 1.8% and 1.9% yields for 2020 and 2021, respectively. See Hi-P International Dividend History.

Unlikely M&A takeover target or privatisation candidate.

  • Although the low free float (16.4%) could entice larger-scale contract manufacturers to take aim at Hi-P International as a potential acquisition target, it is unlikely that the owner would sell out.
  • As Hi-P International is a legacy for the founder, Mr Yao, we believe the intangibles far outweigh any potential offer price, thereby making the low free float a double-edged sword.
  • Further, a privatisation is highly unlikely given that Hi-P International is in business with Apple, and a public status would be more desirable for that relationship to continue, given the need for financial disclosure.

Hi-P International - Valuation & Recommendation

Initiate with SELL and target price of S$1.11.

Clement Ho UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-08-03
SGX Stock Analyst Report SELL INITIATE SELL 1.11 SAME 1.11