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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