• kennethkohwk

Valuetronics: Ready to launch. 20%++ upside.



Valuetronics is an Electronic Manufacturing Service (“EMS”) provider, which focuses on the design and development of products that meet the ever-changing customers’ needs. They are the preferred choice of some successful global companies involved in consumer electronics as well as industrial and commercial electronics products, with core competencies ranging from tool fabrication, injection moulding, metal stamping, machining, surface mount technology (“SMT”) and finished product assembly on full turnkey basis.


The Group classified its EMS business into 2 reportable segments, namely consumer electronics products (“Consumer Electronics” or “CE”) and industrial and commercial electronics products (“Industrial and Commercial Electronics” or “ICE”).


Here are a sample of what they manufacture:




Extremely undervalued with a very high margin of safety now.

As early as May 16, 2022, after digesting and modeling the previous report, we said in our blog post Verdict on Valuetronics earnings report: Accumulate. It's cheap and bottoming, that "it's cheap and the price of the stock is likely to find a bottom before the next earnings annoucement." Although the share price dropped slightly from $0.53 SGD to $0.44 recently, due to rumblings on China shutdowns etc, it is quickly recovering and we think that at $0.49, any serious value investor will say Valuetronics extremely undervalued with a very high margin of safety.


We think that the situation of Valuetronics is the perfect storm for the classic bottom as many investors as well as analysts have given up on Valuetronics. Trading volume is thin. And until recently, no analyst was willing to give Valuetronics a BUY rating, usually settling for HOLD because supply chain issues in China and the COVID shutdowns created an environment where people had to guess just how badly their margins would be impacted.

Well, the results are out.


What is the impact of demand destruction in the global economy, coupled with supply chain issues in China that are holding down margins?

They reached a stability.

They executed such that net margins have held stable.



It turns out that Valuetronics performed as we expected, that in general revenues will drop due to some demand destruction, margins would still be held down, but this would be offset by an increase in ICE revenues because their Vietnam facility had started mass production months ago. Consumer Electronics revenue dropped due to lesser demand, however, ICE revenues increased 13% due to new clients and demand increase from some. This is good news since ICE revenues have higher margin.


ICE will likely grow into 2024

Yes. Valuetronics now has two large facilities for manufacturing.

I wonder if this fact has been slept over. The completion of the Vietnam campus plus months of execution will set the stage where Valuetronics can likely agressively seek out clients from the USA now. The reason why many investors felt Valuetronics "lost its shine" was because the US-China trade war cast a cloud on them as many wondered how many of their US clients would pull out, and wondered about their growth prospects since it will be difficult to seek out US clients.


All US clients that had to pull out has already done so. Clean slate.


Now the Vietnam Campus is the permission slip to agressively find more US clients.


I think Valuetronics has a good reputation and is a quality manufacturer. I don't think it's a matter of if they get more customers to fill up their capacity, but a matter of when and what terms.


You can already see the trend here.

After a drop in shipment to North America from FY21 to FY22, we have a 13% increase in the last 6 months. No reason why this shouldn't continue, they have capacity to spare in Vietnam.


Management already said so in their earnings commentary:

That's more ICE growth.


Support for ICE margins

Management reported that thay completed consolidation of its various Vietnam facilities into one campus site.

This will improve margins on their ICE side. Later as you will see, ICE margins dropped a little compared with 6 months ago. This will likely normalize margins some.


Finally, and this is very important.


Share buyback of HK$250M or 20% of it's entire market cap at a share price of 0.49 SGD

Valuetronics has a HK$250 million Share Buyback Program announced since 28 Feb 2022 and "intends to continue with the Share Buyback Program. I can't remember when is the last time Valuetronics ever declared such a large buyback program.


On top of this, simply based on 2H22's dividend of 10 HK cents and the recent interim dividend of 4 HK cents, that's essentially a 5% dividend yield.


Put the share buyback and dividend together and they are throwing off >20% of yield to shareholders.


Get in before analysts change their tune.

What boogles my mind is this, see the most recent report on Valuetronics by analysts.


Other analysts are equally unimpressed with Valuetronics, giving a target price lower or similar to RHB.


So I have a question then.


If I believe what you say, and you think "the worst should be over", then how can it be worth only $0.53 sgd? It's impossible from a value investor prospective, a dividend investor prospective, and most definitely as a private equity prospective.


Let me show you the valuation at this moment.


From our model:

Because Valuetronics has never turned in a negative earning in the last 20 years, even during both the 2008 financial crisis and 2020 covid crisis, it's cash and equity gets built up over time.


It's liquid assets increased, while both the share amount as well as share price dropped to the point that it Valuetronics has amassed so much cash on it's balance sheet that it makes up 83% of it's entire market cap.


Assuming that we've hit the bottom of the earnings drop, which is what RHB also thinks, let's take a bad case scenario... let's assume that earnings don't grow for the next couple years. If we annualize the recent earnings for 1H23, that implies a PE annual run rate of 10.5x.


If you use Enterprise Value / Earnings to account for the excess cash on it's balance sheet, that's a PE ex cash (annual runrate) of 1.8x. This means that if you bought the entire company and took it private, you would make back your entire investment in less than 2 years. This is absurd.


This is the lowest it's ever been... that's more than 2 sigmas from normal.


And, this is assuming that earnings don't grow.


We think a couple factors are dynamically interacting with Valuetronics that will impact their margins and revenues, and we think there are simply more pros than cons going forward, and coupled with an insanely low valuation, that is a very high reward to risk ratio for potential investors.


Valuations:

Let's talk about PROs and CONs.


CONS:

1. Recession fears: perhaps there will be more demand destruction.

2. Supply chain issues persist, and get worse. However, we don't think it will get much worse and should start to slow improve. We can see macro hints like shipping rates decreasing.


PROS:
1a) Margins are starting to stablize.

After Gross and Net margins gradually dropped since 2020 due to a combination of some US clients pulling out, COVID shutdowns, and now inflation and supply chain constraints; we see that the last two quarters show a stablization of margins.


More importantly, look just 2 years ago. Their net margins stood between 7-8% before it dropped to the 5% range. That gives us a sense of where margins could eventually improve to when things normalize.


1b) As mentioned above, management said they recently consolidated their Vietnam facilities in their campus, this will be a tailwind for margins.


2) ICE revenue likely to grow.

Yes, there might be some demand destruction to their existing clients, but this will be offset again as they hunt for more customers to manufacture for. They have already stated they are confident that "the Group is confident that some of these leads will convert into new business in the financial year ending 31 March 2024 (“FY2024”)."


3) Cash in king in a recession.

Some people think Valuetronic's cash is idle. I argue that cash is worth more going forward.

If we are considered we are headed into a recessionary environment with high interest rates, even more a premium should be given to Valuetronic's cash bank.


Not only will they earn more interest income over time, the cash introduces opportunity and a competitive advantage.


If a recession hits, everything gets cheaper. Stocks, real estate, capital goods. Valuetronics is in position to make strategic acquisitions.


The next point is not talked about much, but the excess cash confers an advantage as they look for customers. Valuetronics never has to deal with banks for loans, they are fully self-funded. Secondly, they "are" a bank! Which manufactoring partner wouldn't like to manufactor with someone that doesn't need a bank loan, won't go into liquidity issues, and can even offer great credit terms to them?


4) The Share Buybacks already causes earnings and dividend per share growth.

Even if earnings don't ever grow organically (which is unlikely), the net earnings and dividends paid out will increase by 20% just on the strength of their share buybacks. Going back 7 years ago, Valuetronics's net cash % was about 40% to 50% of market cap. Now, it's is at 80%. it's possible they can return more than just 20% buybacks in the future.


Summary


When the cycle turns back to normal / as time passes, here are the upside catalysts and potential impacts on Earnings per Share:

1) Margin normalization: +15%.

2) Macro demand improves: +15%

3) Finding new ICE clients: +15%

4) Share buybacks: +15%.


Potential earnings improvement: ~ 60% when things improve back to normal.


Add in excess cash on Valuetronics's balance sheet and shares can be worth more than 80% over time.

So what I will do is use an extremely unfair conservative valuation. Just based on PE alone, a rerate to PE of 13x implies a 20% share price gain. This doesn't even account for the massive cash on it's balance sheet. That's already a target price of about $0.60 right now. Don't forget that Valuetronics can likely have share buybacks year after year if they chose because they horded so much cash. Just on the basis of those buybacks, EPS and dividend payouts will increase.


Another way to value it is on P/B. It was already 1.3 P/B valuation during COVID, a return to that is also a 30+% increase in share price.


I think it's reasonable to say that Valuetronics can be worth at least $0.60 now based on the data we have today.


If they show EPS growth next half, I won't be surprised if the price surpasses that.


However, Valuetronics is no longer a darling to the analysts, and it may take time before they get on board and be bullish. But who knows, perhaps they will change their tune with this earnings report. As i publish this blog post, as with the last one, the analysts haven't reported yet. Hopefully, this gives you perspective to help you make your own investment decision before the public is influenced by the analysts.


Until then, investors have to be patient and simply be content with a growing dividend that's already at 5% as of now.


Upside Catalysts:

1) More ICE clients in 2024 (management is confident there will be more).

2) Margins revert to normal (net margin 7-8% 2 years ago, vs 5.5% now)

3) Eventual revenue increases as demand returns.

4) Automatic EPS and DPS increase due to share buybacks.

Bonus: due to high-interest rates, their interest income doubles from $1M SGD to $2M SGD. haha.


Downside Catalyst:

1) Deeper recession next year. 2) More supply chain issues. (but looks like it's improving)


Take care everyone!



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