Better-than-expected Margins; Maintain BUY

• VALUETRONICS HOLDINGS LIMITED (SGX:BN2)'s 3QFY19 PATMI of HKD59.7m, up 3% y-o-y, surpassed our expectations on stronger-than-expected gross margins. The margin surprise came from a favourable sales mix and increased value-add.
• We raise FY19E EPS by 7% but keep FY20-21E EPS largely unchanged, after raising gross margins but cutting FY20-21E revenue to reflect a loss of allocation by its smart-lighting customer.
• Our ROE-g/COE-g Target Price (FY20-22E average adjusted ROE 20%, COE 10.7%, LTG 2%) climbs to SGD1.05 as we roll to 2.1x FY20E P/BV from 1.9x FY19E previously. Refer to the PDF report attached for valuation details. 
• Maintain BUY for attractive dividend yields of 6-7%.

Smart-lighting Dims Near-term

• 3QFY19 sales fell 8% y-o-y, weighed down by a 26% drop in CE revenue to 40% of the total. CE revenue was flat q-o-q, implying that the smart-lighting recovery that began in 2QFY19 has stalled.
• At 10-15% of revenue, smart lighting is expected to weaken further as VALUETRONICS recently lost US geography allocation for the new generation of its customer’s smart bulbs, as the customer diversifies production away from China due to the trade war.

ICE Prospects Intact

• 3QFY19 ICE revenue (60% of total) rose 12% y-o-y, backed by continued growth in automobile and printing. Management remains optimistic, adding that ICE customers generally have higher switching costs than CE. This is due to:
  1. greater design involvement by VALUETRONICS; and
  2. entry barriers like qualification processes for certain customers.

Trade War and Expansion Updates

• VALUETRONICS expects to begin production in Southeast Asia this year for customers keen on diversifying production from China. It also reaffirms its US expansion plans, without sharing timeline and capex.
• The direct impact of the trade war has so far been immaterial, although management cautions about possible indirect effects such as margin pressures and/ or loss of customers. In addition to this, we see risks from slower than expected business momentum as a result of the trade war.
• Refer to the PDF report attached for earning revisions details.

Source: Maybank Kim Eng Research - 13 Feb 2019