• Valuetronics’ 3Q19 core PATMI of HK$59m (+5.4% y-o-y) beat consensus’ expectations but was in line with ours. Key positives were higher GPM and robust ICE growth.
• We see slower FY20-21F growth and potential order loss, as customers reconfigure their supply chain in view of the ongoing US-China trade war.
• Downgrade to HOLD, with 6% dividend yield as its near-term share price support.

9MFY19 Core PATMI at 78%/82% of Our/consensus’ Expectations

• The 7.5% y-o-y dip in 3Q19 revenue did not come as a surprise, given the higher 3Q18 base for consumer electronics (CE) prior to the inventory destocking issues of VALUETRONICS HOLDINGS LIMITED (SGX:BN2)’s major smart lighting customer. This was mitigated by a 12.2% y-o-y growth in the industrial & commercial (ICE) segment, which led to a more favourable product mix and better gross margin (GPM) of 15.9% (3Q18: 14.4%, 2Q19: 14.9%).
• 3Q19 core PATMI increased 5.4% y-o-y to HK$59m, in line with our full-year forecast but slightly above consensus.

CE: Potential Risk From Global Supply Chain Rebalancing

• While inventory level at its wireless lighting customer has normalised and sales recovered 60% q-o-q, Valuetronics’ CE revenue was flat q-o-q (-26.4% y-o-y) at HK$295m.
• Part of the weaker demand is attributed to its customer’s de-risking plan, as reconfiguration of their global supply chain has led to Valuetronics missing out on a major portion of their new product roll-outs. If this accelerates, we see potential earnings risk for FY20-21F.

Higher Printer Sales a Boost to ICE Margins

• ICE sales continued to record double-digit growth (9M19: +16.1% y-o-y), thanks to stronger demand for auto connectivity modules and new printer orders. Apart from a more favourable revenue mix, we think product margins have also improved due to the higher value-added level, which supported the overall gross margin expansion in 3Q19.
• There was little contribution from new customers, and we expect management to share more details on the order outlook for its ICE customers in 4Q19F.

Seeks to Diversify Manufacturing Footprint

• Driven by ongoing US-China trade tensions, the group remains on the lookout for manufacturing options outside China. Management views partnerships as the most cost-effective option for presence in Southeast Asian countries, while its net cash of HK$755m (as of end-Dec 18) would be useful for suitable M&A opportunities in North America.

Downgrade From Add to HOLD on Lower EPS and TP

• We cut our FY20-21F EPS by 9.2-9.3% to reflect more conservative growth assumptions, and our target price falls to S$0.73, now pegged to 8.5x CY19F P/E (prev 10x) which is at 25% discount to global industry average. Refer to the PDF report attached for earnings revision details and comparison to its global peers.
• Downgrade to HOLD on more muted earnings outlook in the near-term, but underpinned by its 6% dividend yield and strong balance sheet (zero borrowings).
• Downside risks to our Hold call are macro slowdown and worsening trade tensions.
• Re-rating catalysts: new customer wins and synergistic M&As.

Falling Victim to Trade Tensions

• Between Valuetronics’ ICE and CE businesses, we think the ICE segment would be less affected by the US-China trade war, given the
  1. higher switching costs from the possible need to re-qualify processes and re-train personnel, and
  2. better pricing these products command that allows for the absorption of higher tariffs.
• Management had previously guided that 20% of its total sales could be affected by a US-China trade war in the worst-case scenario, directly or indirectly, such as margin pressure or potential loss of customers as they relocate their manufacturing bases.
• Already, we are starting to see Valuetronics’ major CE customers (consumer lifestyles, smart lighting) embark on their de-risking plans, based on takeaways from their recent results briefings. Some of the measures undertaken by these CE customers include regional consolidation of manufacturing footprint from 50 to 30, and adjustments to supplier base.

Source: CGS-CIMB Research - 13 Feb 2019