Quarz Capital Management, Ltd. Sends Open Letter to Sunningdale Tech Ltd to Urge Board and Management to Take Immediate Action to Enhance Shareholder Value. Consistent with Our Previous Engagement, We Believe the Execution of Our Proposals Can Deliver a Total Potential Share Price Return of >40% Over The Mid-Term.
Dear Mr. Khoo, Ms. Soh and Members of the Board,
We thank you for your response and the meeting in January where we had an open and constructive discussion on Sunningdale Tech Ltd (the “Company”, “Firm”,” “SUNN SP”, “Sunningdale” or “SUNN”) and strategies to increase shareholder value.
The strong negative market reaction to SUNN’s 4Q18 result is disappointing and clear evidence of what we have highlighted earlier as a significant lack of transparent and quality reported information creating unnecessary uncertainty and shareholder value destruction.
SUNN continues to incur one-off startup costs at its new Penang plant as it accelerates on hiring, training as well as material and equipment preparation to ramp up high volume projects in the Consumer Electronics and Healthcare sectors. The firm also incurs duplicity in operating cost (e.g. rent, labor, equipment) as it retains its production in Shanghai. This is due to the delay in the stringent qualification process which postponed the shift of the entire Shanghai operations to SUNN’s Chuzhou megafactory. We estimate these non-recurring costs at more than S$3 million in 4Q2018.
SUNN’s 4Q2018 and 2018 Core Net Profit from underlying operations without these one-off costs is projected to be more than S$5million and S$24million respectively, considerably closer to consensus estimates.
This result was achieved despite the headwinds from the China-US trade war which disrupted global sentiments and demand especially in the auto segment. The increase in centralization and expansion of SUNN’s production at lower cost Chuzhou will increase production capacity, cost advantages and operating margins. The progressive ramp up of the new Penang plant will reduce the one-off drag and further add to underlying core profit from 2H2019. Despite its recent opening, the new plant has already secured several projects and will benefit from the structural trend of major MNCs increasingly diverting part of their supply chain out of China. We are confident that the increase in production, utilization rate and operating leverage coupled with a lower cost base can bring SUNN’s core profitability back to 2016-17 level from mid-2019 onwards.
It is critical during this transitory period of uncertainty that SUNN’s management and board take responsibility and commit to increase shareholder value by clarifying and providing additional operating information. Of particular importance is to quantify the total gross/operating loss in Penang and the cost of inefficiencies in maintaining duplicate operations and shifting between Shanghai to Chuzhou.
This disclosure enables shareholders to separate one-off ramp up costs from underlying operations and allows for better evaluation of the underlying fundamentals and intrinsic value of Sunningdale.
The blended cost item will not affect SUNN’s competitive advantage as it comprises consolidated costs in both Penang and Chuzhou plants at different stages of ramp up which include various cost items such as shifting, restructuring and qualification costs. Competitors can draw little insight from such a commingled item, yet it serves as a valuable information for shareholders. A conservative estimate of such a metric should be readily available, given Sunningdale’s tight financial control and supervision. Other valuable insights include new projects, and potential profitability and margin targets as the firm ramps up from 2H2019. Management has emphasized the focus on growth strategies and fundamentals to bring more enduring long term value accretion. The increase in transparency and higher quality information will enable shareholders to have greater clarity and forecast on long term profitability and the intrinsic value of the business instead of focusing on volatile quarterly financial reporting.
| We welcome the increase in dividend. Our conservative model reflects SUNN can generate more than S$30million of free cash flow in 2019 as the firm substantially completes expansionary capex and continues to ramp up. This is in addition to the comfortable balance sheet strengthened by the recent factory disposal and potentially higher cashflow from increased production in 2020. We urge SUNN to further increase its dividend payout to shareholders in 2019. The increase in dividend can demonstrate that management is confident and committed to deliver on its growth strategies and enhancing of shareholder value. It also rewards its shareholders for their patience and unwavering support during this transitory period. |
Post the correction, Sunningdale Tech trades (ex-dividend) at a depressed projected P.E 2020E of 8.2x (core net profit of S$31.5million) with EV/EBITDA of 3.5x. SUNN has one of the most significant ramp up in production and profitability due to its new plants and projects from 2H2019 but continues to trade at a severe discount to peers. Quarz continues to retain a substantial stake in Sunningdale Tech and intends to add to its position on further price weakness. We believe that our recommendations as detailed in our previous engagement and this letter can provide a potential total return of more than 40% for all shareholders in the mid to long-term. We call on board and management to take immediate action to address this shareholder value destruction and look forward to continuing to work with the company to increase value for all shareholders.
Sincerely yours,
Mr. Jan F. Moermann Chief Investment Officer, Quarz Capital Management, Ltd.
Mr. Havard Chi, CFA Head of Research, Quarz Capital Asia (Singapore)
| Sunningdale's response to Quarz, dated 6 March, can be viewed on the SGX website here. |