Excerpts from analyst's report
Maybank Kim Eng analyst: Truong Thanh Hang (left)
♦ Initiate with SELL, TP SGD0.25 (4.4x FY16E P/E). Earnings forecast to decline in next two years.
♦ Major customer spinning off LED lighting business, given fierce Chinese competition, price wars and falling margins.
♦ Stock unlikely to perform until uncertainties blow over. We would be buyers only at SGD0.25 or below.
Facing uncertain future
Philips plans to break up the company into 2 segments - Lighting Solutions and HealthTech (combining Healthcare and Consumer Lifestyle divisions).
Valuetronics faces an uncertain future as its largest customer – a Dutch lighting, consumer electronics and healthcare conglomerate - has decided to split its lighting business from the rest of its businesses, in order to focus on higher-margin, less-challenging segments. Lighting, in particular LED lighting, accounts for 40% of Valuetronics’s revenue and 30% of its gross profit.
Lighting business dimming
Premium LED lighting brands are being undercut by cheaper Chinese products. Valuetronics’s customer has had to cut its prices as it repositions its brand in the consumer mass market.
Valuetronics’s margins in 1QFY15E were affected by the price cuts. Despite its customer’s split, the worst still lies ahead, in our view. We expect Valuetronics’s profits to decline in the next two years.
Industrial not yet ready to compensate
With the slump in lighting, Valuetronics’s Industrial business will have to shoulder the burden of growth. However, we do not think Industrial’s growth will be enough to offset the decline in the lighting-heavy Consumer Electronics division. Some 60% of Valuetronics’s revenue comes from lighting products for its Dutch customer.
SELL with SGD0.25 TP (4.4x FY16E P/E)
Valuetronics trades at 7.0x FY16E P/E vs a sector average of 9.9x. However, with major uncertainties ahead, we believe it is likely to underperform. Our TP assigns zero value to its lighting business and 6-4x P/E to its Industrial and non-lighting businesses, or 60-40% of its peer averages. Overall, we value the group at 4.4x P/E.
Worst case scenario could be much worse
Valuetronics is currently a cash-rich company. It had zero debt as at end-1QFY15. Its cash position of HKD441m amounts to 48% of its market cap. With no big capex plans and only HKD40-50m in maintenance capex pa, we would expect further cash accumulation in FY3/15E-17E, if the current major uncertainty that it is facing with its biggest customer does not loom ominously ahead.
However, the worst case scenario could be much worse than our current forecasts. There is a risk that Valuetronics may have to use its cash to support its customer’s mass-consumer, low-priced strategy. The customer could require it to commit more working capital to increase production and locate finished goods close to its distribution channels. Valuetronics, however, may not be able to book revenue from its increased production until this customer pulls stock from its warehouses.
Recent story: REX target $1.27; VALUETRONICS attractive at 3.3X PE
We have seen this happen before at other companies but have not yet captured the downside risk in our current forecasts for Valuetronics. Still, we caution that such a strategy is a very real possibility for its customer, as LED bulbs are homogeneous products with a long shelf life.