Hi-P International - CGS-CIMB Research 2020-09-08: Manufacturing Services Provider

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HI-P INTERNATIONAL LIMITED (SGX:H17)

Hi-P International - Manufacturing Services Provider

• Hi-P International is a manufacturing service provider with capabilities ranging from product design to complete product build.
• Given its net cash balance sheet as at end Jun 2020, M&A can provide Hi-P with growth opportunities. In 2019, Hi-P International announced one acquisition.
• Initiate coverage on Hi-P International with HOLD and Target Price of S$1.23. Higher order allocation from its major customer is a key earnings catalyst.

Hi-P International - Company Background

• Hi-P International (SGX:H17) started out in 1980 as a tooling specialist in Singapore and has since grown to become an integrated contract manufacturer. The group provides one-stop solutions to customers in wireless telecommunications, consumer electronics, computing and peripherals, Internet of Things (IoT), medical devices and industrial devices.
• Hi-P International’s capabilities range from product development and design to parts manufacturing (plastic injection parts, metal stamping parts, printed circuit boards) to complete product assembly.
• Hi-P International has 13 manufacturing plants globally located across five locations in the People’s Republic of China (Shanghai, Chengdu, Xiamen, Suzhou and Nantong), Poland, Singapore and Thailand. Hi-P International has marketing and engineering support centres in the People’s Republic of China, Singapore, Taiwan, Germany and the US. The group’s customers include companies involved in mobile phones, tablets, household and personal care appliances, computing and peripherals, IoT, medical devices and industrial devices.

Hi-P International's Segmental breakdown

• Hi-P International’s three main operating segments as end Jun 2020 are:
  1. Precision plastic injection moulding (PPIM);
  2. Mould design and fabrication (MDF); and
  3. Provision of sub-product assembly and full-product assembly services (Assembly).
• In FY19, the PPIM segment contributed 63% of revenue, followed by the Assembly segment with a 29% contribution. The MDF segment accounted for 8% of FY19 revenue. In terms of operating profit breakdown, the PPIM segment contributed 88% of FY19 operating profit while the Assembly segment and the MDF segment contributed 6% and 7% of FY19 operating profit, respectively.
• The PPIM segment is also the most profitable segment. In FY19, this segment’s operating profit margin was 10% versus 6% for the MDF segment and 1% for the Assembly segment.
• In terms of revenue breakdown, based on the geographical location that customers are billed in, the People’s Republic of China accounted for 46% of FY19 revenue. The US and the rest of Americas accounted for 31% of FY19 revenue. In FY19, approximately 21% of Hi-P International’s revenue was both billed to customers located in the US and shipped to the US.

Hi-P International's major customers

• In FY19, five major customers accounted for 87% of Hi-P International's revenue in the PPIM segment. At the group level, these five customers accounted for 55% of Hi-P International's FY19 revenue.
• In the Assembly segment, seven major customers accounted for 74% of the revenue in FY19. At the group level, these seven customers accounted for 21% of FY19’s total revenue.
• Management guided that one major customer (a wireless and computing device company) accounted for slightly less than 50% of FY19 revenue. Another three companies involved in personal care and lifestyle products each accounted for 7-8% of FY19 revenue.

Hi-P International's historical financial trends

• Key highlights:
  • Hi-P International reported record revenue of S$1.4bn in FY17 followed by two years of y-o-y revenue decline. Net profit registered a record S$121.5m in FY17 followed by two years of y-o-y net profit decline.
  • Hi-P International’s record performance in FY17 was due to the strong recovery in the global economy as well as robust demand from its key customers and new customer wins. In FY18 and FY19, Hi-P International’s financial results were negatively affected by the uncertainties caused by the US-China trade war. Against this backdrop, customers turned more conservative and increased cost-down requests on suppliers. Hi-P International also faced intensifying competition from local players in China.
• Given the record net profit in FY17, Hi-P International paid a Dividend Per Share (DPS) of S$0.06 that year. FY18 DPS was S$0.05 while, for FY19, DPS was cut to S$0.028 as net profit fell. See Hi-P International Dividend History.

Hi-P International - Key corporate developments

Trade war

• In response to the US-China trade war, Hi-P International expanded its manufacturing space in its wholly-owned subsidiary in Thailand.
• On 20 Mar 2020, Hi-P International announced that it has increased the share capital of its wholly-owned subsidiary, Hi-P (Thailand) Co Ltd (Unlisted), from THB70m to THB150m. In its 2Q19 results announcement, Hi-P International guided that the expansion of its Thailand plant as well as new project launches in its Thailand plant have commenced as scheduled. See Hi-P International Announcements.

M&A

• On 31 Oct 2019, Hi-P International completed the acquisition of a 100% stake in South East Asia Moulding Company Pte Ltd (SEAMCO - Unlisted), a manufacturer of high-volume and high-precision engineering plastic components. With the acquisition, Hi-P International is able to tap SEAMCO’s strong capabilities in processing ultra-precision thermoplastic and thermoset components and gain access to a renowned blue-chip multinational customer.
• Hi-P International acquired SEAMCO for approximately S$42.8m. In terms of valuations, this translated into a historical FY18 acquisition P/E of 4.37x and a historical FY18 acquisition P/NTA of 12.2x. Hi-P International revealed that SEAMCO’s FY11/18 net profit and net tangible asset (NTA) were S$9.8m and S$3.5m, respectively. See Hi-P International Announcements.

Hi-P International management’s 2H20 & FY20 guidance

• In its 1H20 results announcement, Hi-P International guided that it forecasts:
  1. Higher revenue and similar profit for 2H20F compared to 2H19;
  2. Higher revenue and profit for 2H20F compared to 1H20; and
  3. Higher revenue and similar profit for FY20F compared to FY19.

Hi-P International - Upside Risks

Higher orders from major customer

• A major upside earnings risk is higher-than-expected orders from its major customer in the wireless and computing device space. This could occur if existing competitors are not able to meet this customer’s quality, pricing and delivery requirements.

Earnings contribution from SEAMCO

• Hi-P International completed the acquisition of a 100% stake in South East Asia Moulding Company Pte Ltd (SEAMCO - Unlisted), a manufacturer of high-volume and high-precision engineering plastic components in October 2019. Management has guided that the group hopes to grow its business with SEAMCO’s key customer.

Hi-P International - Downside Risks

Customer concentration risk

• In FY19, five major customers accounted for 87% of the revenue in the PPIM segment. At the group level, these five customers accounted for 55% of FY19 revenue. In the Assembly segment, seven major customers accounted for 74% of the revenue in FY19. At the group level, these seven customers accounted for 21% of FY19’s total revenue.
• Management guided that one major customer (a wireless and computing device company) accounted for slightly less than 50% of FY19 revenue. Another three companies involved in personal care and lifestyle products each accounted for 7-8% of FY19 revenue.

Foreign exchange exposure

• Hi-P International has transactional currency exposure arising from sales or purchases that are denominated in a currency other than the respective functional currencies of group’s entities, primarily S$ and renminbi (Rmb). The foreign currencies in which these transactions are denominated are mainly United States dollar (US$). Approximately 91% (FY18: 93%) of the group’s FY19 sales and 36% (FY18: 39%) of the group’s FY19 purchases are denominated in US$. The group’s trade receivables and trade payables at the end of the reporting period have similar exposure.
• Hi-P International also holds cash, short-term deposits and short-term loans denominated in a currency other than the respective functional currencies of group entities for working capital and capital expenditure purposes. At the end of the reporting period, such foreign currency balances were mainly in US$.

Intense competition

• The precision plastic business, assembly business and precision metal stamping business are support services for many original equipment manufacturer (OEM) businesses and are highly competitive business areas. Despite management’s perception of high barriers of entry, such as high initial set-up cost, technology know-how and established client base, the opportunities in such business areas present an attraction for new players.
• Hi-P International’s success depends on its ability to generate and nurture customer patronage and loyalty, mainly by consistently offering quality products and services at competitive prices and reliable delivery time. Should competitors offer better-quality products or services, better pricing and/or shorter delivery time, Hi-P International’s sales and market share (for various parts for customers) will be adversely affected. Stiff competition and an overall decline in demand for Hi-P International’s products and services will also exert downward pressure on prices and erode Hi-P International’s profit margins, in our view.

Hi-P International - Outlook

Global economy to face negative growth in 2020F

• In June 2020, the International Monetary Fund (IMF) projected the global economy to contract 4.9% in 2020F. This was attributed to the COVID-19 pandemic, which had a more negative impact on activity in the first half of 2020 than anticipated, and the IMF believes that 2H20F recovery is likely to be more gradual than previously forecast. In 2021F, IMF sees the global economy growing 5.4%.

Smartphone unit shipments to decline 11.9% y-o-y in 2020F

• According to the June 2020 update by industry forecaster International Data Corporation (IDC), the worldwide smartphone market will reach a total of 1.21bn units shipped in 2020F, down 11.9% from the 1.37bn units shipped in 2019. From there, shipments will reach 1.48bn units in 2024F. Over 2020-24F, the unit shipment compounded annual growth rate is projected by IDC to be 1.5%.
• IDC noted that the COVID-19 pandemic has affected the smartphone production supply chain and weakened consumer demand. IDC commented that consumers are focusing more on health and combating the pandemic, shifting interest away from their next smartphone purchase and more towards essential goods in the near term. IDC also noted that an increase in consumer spending around both work-from-home and education (remote learning) heading into 2H20 will similarly harm smartphone replacement purchases in many markets heading into the 2H20 holiday season.

Hi-P International - Valuation & Recommendation

• We initiate coverage on Hi-P International with a HOLD recommendation and a target price of S$1.23. Our target price is based on a 1.52x FY20F P/BV multiple derived from the Gordon Growth Model (COE: 8.7%; ROE: 12.7%). We use a Gordon Growth Model-derived P/BV to arrive at our target price given the cyclicality of the business.
• Hi-P International is trading at 1.50x FY20F P/BV (vs. the peer average of 1.67x) given its lower ROE of 13.1% versus the average of 15.8%. Hi-P International is also trading at 11.3x FY21F P/E which is roughly in line with the peer average of 11.7x.
• Given a total return potential of 1.6% relative to our target price, we initiate coverage on Hi-P International with a HOLD rating and a Target Price of S$1.23.
• A downside risk is a deterioration in customer demand which will lead to lower sale and hence lower net profit for Hi-P.
• An upside risk is higher orders from its major customer.
• See Hi-P International Share Price; Hi-P International Target Price; Hi-P International Analyst Reports; Hi-P International Dividend History; Hi-P International Announcements; Hi-P International Latest News. 

Our forecast assumptions for Hi-P International:

• We assume that Hi-P International's FY20F revenue will grow 2.5% y-o-y. Hi-P has guided that FY20F revenue will be higher than in FY19. We expect the revenue growth over FY21-22F to be 5% per annum.
• We forecast FY20F operating profit margin to be 6.6%, FY21F’s to be 6.8% and FY22F’s to be 6.9%. Excluding FY17 (Hi-P International enjoyed an exceptional year in FY17 where operating profit margin hit 10.8%), the average operating profit margin over FY16-19 was 6.9%.
• We assume a dividend payout ratio of 30% over our forecast period of FY20-22F. Hi-P International’s dividend payout ratio in FY19 was 28%.
• See attached 23-page PDF report for complete analysis on Hi-P International.

William TNG CFA CGS-CIMB Research | Darren ONG CGS-CIMB Research | https://www.cgs-cimb.com 2020-09-08

SGX Stock Analyst Report HOLD INITIATE NOT RATED 1.23 SAME 1.23