This deep-dive article on Valuetronics is an excerpt from "5 rising momentum stocks identified using TradersGPS". It is for education purposes only, and not to be taken as advice to buy/sell. Please do your own due diligence before committing to any trade/investment.

Valuetronics is considered a small-cap counter that I have written about previously in this article: 5 Singapore Small Cap Companies worth considering with net cash > 50% of market cap.

At that point of writing, the company has a market cap of around $242m. On the other hand, the company boasts a net cash balance of S$186m. This puts its net cash at 77% of its market cap. The company also paid an FY20 DPS of HK$0.20 which translates to an attractive yield of 6.2% based on the current price.

The company is still very much profitable despite COVID-19 negatively impacting its operations. The company generated HKD 75m in profits for 2HFY20. This improved to HKD 91.5m in its latest 1HFY21 results (despite a 12% YoY drop in profitability vs. 1HFY20). This is achieved on the back of a strong gross profit margin of 17% achieved in 1HFY21, the highest level in recent years. Consequently, the net profit margin of 8.4% is also at the highest level over the past 4 years.

Net cash balance improved marginally from S$186m as of FY2020 to S$194m. The company also maintains its interim DPS of 5 HK cents which is a welcome relief.

Assuming a full year DPS of 20 HK cents, that will translate to S3.4 cents which equates to a yield of approx. 5.2% at the current share price level.

Valuetronics is looking to breach its 52-week high level of S$0.68/share, achieved back in May 2020. If its share price successfully exceeds that level, the next target price will be at S$0.80/share.

Valuetronics’ chart on TradersGPS

The TradersGPS system has a BUY signal for Valuetronics in early 2021, with an indicative entry price of S$0.60/share. However, the counter was still trending in a range and did not manage to break out until 12th Jan 2021 where it appreciated by 10% that day, likely a result of semi-conductor bullishness, although the company, as a contract manufacturer, will not likely see direct benefits in terms of pricing.

Nonetheless, its substantial exposure to the autonomous vehicle industry and smart lighting industry bodes well for the company's long-term growth prospect.

I have previously researched Valuetronics and will like to share this with my readers. This was done when the counter was trading at around S$0.52/share (key figures have been updated).

Value emerging in Valuetronics

I have been following Valuetronics for years and its current COVID-19 driven share price weakness presents an opportunity for the long-term investor to take a position in this well-run integrated EMS provider.

Valuetronic's origin started as an integrated manufacturing service provider for its customers but has since scaled the value chain with more in-depth engagement with its customers in the arena of design and development of products.

This increases the stickiness of its service offerings as the company is NO longer viewed as a run-of-the-mill outsourced manufacturer.

An increasingly diversified company

Valuetronics operates in 2 key divisions: 1) Consumer Electronics (CE) and 2) Industrial and Commercial Electronics (ICE). Revenue between both divisions is now skewed towards the higher-margin ICE division vs. a few years back where the lower-margin CE division dominated the bulk of the Group's revenue.

The subsequent decline of LED lighting demand from Philips resulted in both revenue and earnings disappointment as its share price took a tumble in 2014-15.

With demand from mass-market LED lighting dwindling, the company refocuses its attention on diversifying its revenue base through higher-margin projects from the ICE division. Revenue from this segment subsequently increased from c.30% of Group's revenue to the current level of 67% (based on 1HFY21), with Valuetronics also benefitting from margins improvement due to better sales mix.

Valuetronics revenue breakdown

Valuetronics gross and net profit trend

This division also does not present customer concentration risk with no single client encompassing more than 10% of the Group's revenue.

The future of IoT lighting remains bright

A key breakthrough came from the revival of its CE division when the company started producing IoT lightings for Philips in 2QFY17 and this has resulted in the division's revenue returning to its original heydays seen in FY14-15.

The difference right now is that demand for IoT lighting is only in the early stage, with penetration in the US (the largest market for IoT lighting) only in the mid-teens while other developed countries are only seeing penetration rates in the high single digits to early-teens.

We believe that peak demand will only be reached when the penetration rate hits the c.25-30% level, similar to mass-market LED lighting.

While pricing points are definitely on the higher end, we see adoption rates increasing for such smart lightings that can also be paired alongside voice-command smart appliances such as Google Homes/Amazon Echo to form an "integrated" smart home.

Imagine a home where switches might no longer be relevant and you can command your lighting features (colors, intensity) through a simple voice command. Besides home applications, IoT lightings will also be widely deployed for commercial purposes, particularly in the area of Li-Fi, an emerging technology in which LED lighting provides a broadband internet connection through light waves.

This means that future lighting systems will fulfill 2 functions: 1) basic illumination and 2) high-speed wireless networking. Valuetronics key customer, Philips has vowed to take Li-Fi technology mainstream, having already licensed its technology to OEMs, ensuring that the Li-Fi capability could be bundled in luminaries in many brands.

We believe that Valuetronics will be one of the key OEMs that will have access to Philips Li-Fi technology which remains at the very nascent stage of adoption. How many of us have heard of the term Li-Fi? And would we have thought that our lights will be able to provide us with broadband connectivity that is 100x faster than the traditional Wi-Fi?

The drivers for IoT lighting are aplenty we are likely only at the early adoption stage. Again, while many of us are already using LED bulbs, how many of us have lightings in our homes that can be controlled through voice activation or one that is "smart" enough to turn itself off when no human movements are "sensed" for a set period, thereby conserving energy?

While not falling under the needs category, this is a feature that most homes will want to have in the not so distant future where almost everything can be interconnected.

Connected-autonomous vehicles the future of driving

Cars of the future will be increasingly connected, with smart devices being integrated within the vehicle system, such as Apple CarPlay and Android Auto. Valuetronics currently assemble in-car connectivity modules for Aptiv, a leader in self-driving car technology.

The company first secured Aptiv as its customer in FY2016 and started supplying in-car connectivity modules to one of their automaker customers, GM which is the Big 3 Detroit car-maker. GM, which boasts car brands such as Buick, Cadillac, Chevrolet, Holden, Wuling, and GM Korea, currently has 46 models that are Apple CarPlay enabled and we could continue to see this figure increasing.

By partnering with Aptiv, Valuetronics not only have access to GM's pool of car models for in-car connectivity demand but can also leverage the future trend of self-driving vehicles. It is hence noteworthy that the company remains as one of Aptiv's most valued automotive supplier, is one of nine in a long list of suppliers to receive Aptiv's highest supplier recognition award in FY17.

This is a big picture outlook for Valuetronics. For those who are interested to just trade the counter, there might be an opportunity if the counter can convincingly breach its last high of $0.68/share.

Again, I will be on the lookout for a positive BUY signal from TradersGPS to average into the counter.

If you enjoyed reading this article and various other investment + personal finance articles, do visit New Academy of Finance. Royston has more than 10 years of buy and sell side experience as a financial analyst. He constantly posts interesting, valuable and actionable articles.

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