Valuetronics Research

Haven't been writing much this year due to school and internship commitments, and I'm back! Recently did some research on Valuetronics, which at this current price I feel has some value...

Valuetronics’ current price of $0.62 represents a potential 26.6% upside, based on a 12-month target price of $0.785. The target price was derived based on a blended discounted cash flow (DCF) and relative valuation approach.

Company Overview

Valuetronics is an electronics manufacturer headquartered in Hong Kong. It operates in two segments, the Consumer Electronics segment and the Industrial & Commercial Electronics segment. The CE segment accounts for c.37% of revenue, and c.63% of revenue is derived from the ICE segment. The company’s products include smart lighting, printers, automotive products and medical equipment.


FY2020 Q1 Earnings Review

Trade tensions continue to adversely impact Valuetronics, as revenue declined by 7.1% from 704.0 mil HKD to 654.3 mil HKD, while gross profit margin expanded slightly from 15.6% to 15.1%. Net profit fell from 49.7 mil to 48.1 mil HKD, while net profit margin increased from 7.1% to 7.4%.



Investment Thesis

Trade war fears overblown, new factory in Vietnam to mitigate tariff impact – US-China trade tensions has an adverse impact on Valuetronics, given that c.45% of the company’s revenue is derived from US shipments, and approximately half of the company’s shipment from China to the US is subjected to the 25% tariff imposed by the US.

However, Valuetronics has been working to mitigate the adverse impact of tariffs by building up its production facilities in Vietnam. Mass production has started since June 2019, and shipments have been made from Vietnam to the US market. The company also intends to acquire a plot of land in an industrial park in Vietnam to build a manufacturing campus, further boosting production capacity, and diversifying its production base beyond China.

Rebound in demand for smart lighting – Valuetronics produces smart lighting for Phillips, under its Consumer Electronics segment. Demand for smart lighting is set to increase globally, which would potentially drive a rebound in revenue for Valuetronics’ CE segment, which has seen revenue declining over the past two years.

As of 2018, the global smart lighting market stood at US$6.87 billion, and is forecasted to grow at a CAGR of 22.67% from 2019 to 2025 (Source: IndustryArc). The main driver of this demand is the trend towards smart homes and smart cities, and the increased emphasis on sustainability issues. The Asia-Pacific region accounted for 37.36% of the global smart lighting market in 2018, and is likely to continue to see sustained demand, due to rising disposable incomes among the population. Valuetronics is well positioned to benefit from this trend, given that its production facilities are based in China and Vietnam.

Solid net cash position reduces downside risk, facilitates acquisitions – Net cash position constitutes c.66% of its market capitalisation. With an ex-cash P/E ratio of 2.9x, the market is severely under-pricing the company’s future earnings. The cash pile also supports potential acquisitions, as the management has guided that it intends to deploy the cash pile for growth opportunities, in line with the group’s strategy to explore M&A opportunities in North America.

Catalysts

Positive developments from the US-China trade negotiations – Valuetronics has been on a downtrend since its peak of $1.08 in early 2018, mainly due to fears of tariffs impacting its products exported from China. Progress in US-China trade talks would provide tailwind for Valuetronics.

Key Risks

Escalation of US-China Trade War – Currently, c.50% of Valuetronics’ revenue is derived from shipments to the US, and around half of this is subjected to the 25% tariffs imposed on electronics manufactured in China.



Foreign Exchange Risk – Valuetronics reports its financials in HKD, while being traded in SGD on the SGX. Currently, the HKD is pegged to the USD and allowed to fluctuate within the 7.75 to 7.85 range. With the recent political uncertainty, there is some risk that the HKMA may be unable to defend the peg. In the unlikely scenario that the HKMA adjusts the band upwards, there would be currency risk if the HKD weakens against the SGD.

Valuation

The Discounted Cash Flow valuation for Valuetronics was $0.83, using a conservative terminal growth rate of 1.0% on a terminal year free cash flow of c.100 mil HKD, after accounting for c.80 mil HKD of annual capex. Weighted Average Cost of Capital (WACC) was derived to be 8.81% using the Capital Asset Pricing Model. Valuetronics does not have any borrowings, hence its WACC is entirely dependent on its Cost of Equity.



Based on relative valuation, Valuetronics trades at a discount to its peers. While Venture Corp is significantly larger than Valuetronics based on its market capitalisation, at current valuations, the market has imposed an unfairly high small-cap risk premium on Valuetronics. Based on a consensus forward earnings of $0.073 for Valuetronics, a forward P/E of 10.1x based on its peer group mean implies a valuation of $0.74. Relative valuation metrics for comparable companies in the electronics manufacturing sector are shown in the table below. 




Conclusion

Using a simple average of the two valuation methods, a target price of $0.785 is obtained. This represents a 26.6% upside from the current price of $0.62.



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REVIEW OF 'PRINCIPLES FOR NAVIGATING BIG DEBT CRISIS' BY RAY DALIO




Principles For Navigating Big Debt Crises is a series of 3 books by Ray Dalio, the founder of Bridgewater Associates, a global asset manager and the largest hedge fund in the world. My blog post would be reviewing the first book of the 3-part series. I was interested in this book because I felt that it would be good to learn from the lessons of the 2008 financial crisis (this is covered in detail in Part 2, which includes detailed case studies of the debt crises). I did not experience the 2008 crisis from the perspective of an investor, and the only market correction I’ve experience was during late 2015 and early 2016, due to fears of a hard landing for the Chinese economy, as well as crashing oil prices; and perhaps also early this year as well as the recent volatility in the markets. I believe that as even these relatively mild corrections can be rattling for many investors, I can’t help but to wonder how we would react in the event of a crash of similar magnitude to that of 2007 – 2009, when equity prices declined by more than 60%. It has only been about 10 years since the Great Recession, but it seems as though complacency has begun to set in again.

Today, people are still irrational as ever, as evident from the cryptocurrency hype last year, driving Bitcoin to $20,000 before the bubble burst. Greed and fear of missing out drives investors to pile money into ‘investments’, (or rather, speculation) in hope of making a quick buck. Undeniably, there are those who made huge returns through cryptocurrencies, and the underlying blockchain technology is set to bring about many practical benefits. However, as described in the book, bubbles form when the boom encourages new buyers who don’t want to miss out to enter the market (although the book is focused on debt fuelled bubbles, which wasn’t the case for crypto).

Given that we are still in the longest bull market since World War Two, many of us have questioned whether the next crisis would be approaching. This book describes how debt cycles are formed, and that by studying many cases, we would be able to see patterns that repeat itself over time.

The key points that the book covered were 1) the deflationary debt cycle, 2) the inflationary debt cycle (currency crises), and 3) the spiral to hyperinflation. The deflationary debt cycle is probably best characterised by the 2008 subprime mortgage crisis, while hyperinflation is what Venezuela is experiencing now.

The book begins by discussing how “debit” and “credit” underpins our entire economy, and that having too little growth in debt can be as bad as having too much debt, because of the forgone opportunities. Dalio includes a good analogy using the Monopoly game as a simplified example of how debt cycles are formed. Bubbles occur when unrealistic expectations and reckless lending results in high levels of bad loans, and when increasing amounts of money is borrowed to service debt payments.

Dalio listed seven measurable characteristics of bubbles as follows:

1) Prices are high relative to traditional measures

2) Prices are discounting future rapid price appreciation from these high levels

3) There is broad bullish sentiment

4) Purchases are being financed by high leverage

5) Buyers have made exceptionally extend forward purchases to speculate or protect themselves against future price gains

6) New buyers have entered the market

7) Stimulative monetary policy threatens to inflate the bubble even more, and tight policy to cause its popping

However, Dalio notes that debt ratios of the entire economy may not be adequate as compared to specific debt service abilities of the individual entities, which are often lost in the averages.

For policymakers to manage debt crises, Dalio notes that the following methods have been employed – the four levers:

1) Austerity – cutting government spending and raising taxes. Dalio believes that this is a mistake during depressions

2) ‘Printing’ money – guarantee liabilities, providing liquidity, supporting the solvency of systemically important institutions and recapitalising/nationalising systematically important financial institutions.

3) Debt defaults/restructuring – balance the benefits of allowing broke institutions to fail with the risks that failures can have detrimental effects on other creditworthy lenders and borrowers. Ensure that the pain is distributed across the population, and spread out over time.

4) Redistributing wealth – through taxes, politically attractive but rarely impactful.

Dalio notes that the four levers have to be moved in a balanced way to reduce intolerable shocks; balancing the inflationary forces against the deflationary ones. Additionally, it is much harder for policymakers to manage debt crises when the majority of the debt are denominated in foreign currency.

Overall, I picked this book because I believe we all want to be able to spot the peak of the bubble – and adjusting the position of our portfolios. Imagine shorting CDOs in 2008, as depicted in “The Big Short” movie. While Dalio described the typical indicators of spotting bubbles, the book didn’t exactly cover how investors should react during a debt crisis; instead, it was more about what policymakers could do to mitigate the effects of debt crises. 

However, I still feel that this was a worthy read, as it allowed me to understand more about the macroeconomic factors affecting our economy, as compared to the individual company level or industry level analysis that I have been familiar with. My blog post has mainly covered the deflationary debt cycle, as I had found it challenging to fully appreciate the chapters about inflationary depressions and currency crises, and I did not want to write any misinterpretations of what these chapters cover. I’ll be reading the detailed case studies in Part 2 of the series in the coming weeks.

I’d recommend anyone interested in understanding debt crises from a macroeconomic perspective to read this book. Lastly, if you have read a good book regarding investing or personal development in general, please leave a comment below and I’d be glad to check them out. Thanks in advance!

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