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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Valuetronics is cheap.
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