Sales from PHILIPS drive OEM growth: Fair value at S$0.38

SYNOPSIS : Counter remains undervalued. Recent market weakness offers a good opportunity to accumulate. We maintain our BUY recommendation on attractive valuation.

3Q08 RESULTS HIGHLIGHTS

Total revenue growth in the OEM segment was in line with our expectation. Slower sales growth from customers like DYMO was more than offset by the strong surge in contributions from PHILIPS. ODM sales growth was slightly below expectation as sales from KitchenAid plunged. Overall, revenue was up 31.6% yoy to HK$239.5m. Gross margins were compressed to 18.95% compared to 21.36% previously. This was largely due to the change in product mix as well as the provision for economic compensation due to the change in the PRC labour law. Management revealed that direct labour cost took up circa 4% of COGS and the change in labour law would at most impact the company’s gross profit by 0.5% going forward.

We continue to like the Group’s capability to contain operating costs. Both distribution and administrative expenses grew less than proportionately to the increase in sales. However, earnings before interest and taxes only grew 4.8% yoy attributable to the exchange loss of HK$1.1m brought about by the settlement of Japanese yen trade payables. Accordingly, this filtered down to bottom line and net profit only saw an increment of 2.6% yoy to HK$21.57m.

BALANCE SHEET ANALYSIS

Cash remains strong with about 40.2% of market capitalization backed by net cash, translating into a cash value of 8.04 cents per share. Part of this large cash hoard will be for capital expenditure on the new factory. At balance sheet date, the Group was debt-free and management has no intention to raise debt in the near future. Inventory days decreased to 46 days from 53 days previously. Working capital days deteriorated from 30 days to 41 days for 3Q08 attributable largely to the decrease in payables turnover days.

OUTLOOK

Major customer, namely PHILIPS, KitchenAid, DYMO, GRACO and TRANSACT, account for some 70.9% of 3Q08 revenue (76.3% in 3Q07). Management intends to build a more diversified client portfolio to decrease its reliance on the aforesaid major customers. Revenue contributions from ODM customer, KitchenAid, continues to decline, as the company does not plan to roll out new major products in the short term. However, this was more than offset by the increase in OEM orders from PHILIPS. In our view, such growth is unlikely to persist beyond FY09 unless manufacturing contracts for new PHILIPS product ranges are won. In November 2007, a PHILIPS team had completed a R&D capability audit in Valuetronics and the results were positive. Currently, the company had begun the initial stages of joint-developing a low-end electric shaver for PHILIPS Zhuhai. We believe that this could pave the way for future collaborations in jointproduct developments between the 2 companies. This will in turn drive the Group’s ODM business in the future.

We understand from the management that some of their customers have turned cautious going forward due to the deteriorating economic conditions in the United States. However, this is unlikely to have any major impact on 4Q08. We have factored in an expected slowdown in orders in FY09 and reduced our growth assumptions slightly.

VALUATIONS & PEER COMPARISON

Our FY08 revenue and net profit forecast are revised upwards to HK$888.38m and HK$87.58m respectively (previously HK$828m and HK$82.45m) due to strong growth in sales to PHILIPS in the OEM segment. The counterʼs current price of S$0.20 translates into a forward FY08 PER of 4.57x and a FY09 PER of 4.48x based on our forecasted earnings. This is attractive compared to the peer average of 6.03x.

Utilizing the forward 3-year average recurrent cashflows and a required yield of 10%, the fair value of Valuetronics is pegged at S$0.38 (taking into account the weakening HKD against SGD), unchanged from our target price of S$0.38 previously. Our target price of S$0.38 translates into a forward PER of 8.47x based on forecasted FY08 earnings. At the last traded price of S$0.20, this counter is undervalued and it offers a potential upside of 90.0% with downside cushioned by its net cash position of 8 cents a share. We maintain our “BUY” recommendation.

[This article is contributed by NRA Capital Pte. Ltd., a licensed Financial Adviser by the MAS. Readers of this content are bound by the same terms & conditions of our website www.netresearch-asia.com .]