Recently, a negative report by another research house was released yesterday, calling for a TP of $0.25, causing share price to tumble down to $0.32+. We believe this negative sentiment is very overblown and belongs to the worst case scenario category, we will address some of the key points below :
1) Will the major electronics company spinning off the lighting segment mean Valuetronics will “lose their business”?
A: Unlikely. The fact is that Phillips is separating their lighting business into a new legal entity. This type of move is common. Separating different margin segments means better overall valuations for their different segments, and segments are more independent in their strategic directions. Valuetronics management has not been impacted by this announcement to date, and have still been operating as usual. Even if Phillips is going to sell off their division on the open market, it also does not mean Valuetronics will lose their business since Valuetronics is a preferred supplier and the main manufacturer of certain LED light bulb types. Who else can make those specific bulb types?
2) If Valuetronics finds the LED bulb production business unprofitable, they do not need to extend more CAPEX to sustain the client’s business, they will simple discontinue it and concentrate on something else
If they do so, they do not have to drain their cash. The key equipments used to produce the LED bulbs are owned both by the client as well as Valuetronics. For those owned by Valuetronics, the equipment is of the nature that it can be used elsewhere. Hence, there will be no significant asset impairment if they choose to transition out. The same goes for the workers, they can be deployed elsewhere.
3) The report values the LED part of the CE segment at 0 x PE
This is very unrealistic esp. at this point in time. It is a fact that LED margins and revenue dropped q/q due to faster than expected competition in the LED market cycle for that client, and it is true that eventually LED sales will continue to decay over time, but this is true of all product cycles, but it will not happen overnight (as I guided in my report). There will be some residual earnings which is worth something, and provide an earnings base while Valuetronics concentrates on growing their other segments – they have successfully doing so with the ICE segment, targeting to gain one major client a year (more than 2% revenue). Year to date growth in ICE this year has been about 30% already.
4) The report also does not take into account the excess cash that Valuetronics has, or the fact that ICE segment has higher than average gross margins!
Either you believe that a portion of the cash is idle and excess and that PV is included in calculation, or you believe they will not want to deploy the cash to investors directly in order to attract more business to them. If cash is idle, remember that Valuetronics has 17-18 SG cents of net cash per share, which is already 55-60% of today’s market cap. If cash is not quite idle, then you must add it as a big competitive advantage to the business. China companies have lower cost base, but hard to find funding/borrowing. Valuetronics is in a low cost base company with no need to borrow at all. They have the cash in order to accept any order a client gives them at short notice without working capital constraints. Hence, they will attract more clients. Even more so, ICE segment has higher than average gross margins at about 17%. If so, then ICE segment cannot be valued at 6x PE (and the whole of Valuetronics is 4.4x PE) which is what the report suggests, which is less than peers of 8-9x. They should arguably be valued more than that due to big competitive advantage with growth potential with the ability to command good margins.
5) Also, don’t forget that the ICE customers are primarily all in the USA
In the global economy today, which economy is doing the best?
6) The report’s valuation is too extremely negative
Assuming the report’s projections are correct, Valuetronics will make 6 SG cents a year for 3 years. Add 17 cents of cash to that, and in 3 years, they will have 35 cents of cash already, which is already higher than today’s share price. In other words, in 3 years, you would have obtained Valuetronics’s manufacturing assets, business, connections to clients for free. Also note that Valuetronics has a history of transitioning out of products to new ones and have never had an unprofitable year in the last 20 years. Even when their licensing business was impaired and loss making, the group wasn’t.
Read Related Report
Valuetronics - Losing the light; Initiate with SELL
Tuesday, 14 October 2014
Tuesday, 14 October 2014
- Maybank Kim Eng Research
Source : Phillip Securities Research