3Q19 in Line; 2020 Recovery Priced In; Downgrade to SELL

• While we are more optimistic of FY20E earnings growth, fundamentals appear priced in. Hence, we downgrade to SELL, although ROE-g/COE-g Target Price is raised to SGD1.34 as we roll forward to 1.5x FY20E P/B.
• HI-P INTERNATIONAL (SGX:H17)'s 3Q19 PATMI was in line, declining 3% y-o-y despite a 5% increase in revenue, in part due to persistent pricing pressure. See Hi-P International Announcements.
• We cut FY19E EPS by 4% to factor in Hi-P International’s revenue guidance to “lower” from “similar”, but FY20-21E EPS is higher by 2-3% to account for increased volumes. Accretive M&A is a key upside risk.

Pricing Environment Remains Difficult

• Revenue growth was due to a broad-based increase in volumes. Aside from pricing pressure, increased labour content for more complex processes resulted in a 1.3ppt y-o-y erosion in gross margin to 14.2%.
• Pricing pressure is expected to persist in 4Q19, and possibly even in 2020, as the supply chain scrambles to fill slack capacity amid a still uncertain outlook.
• Still, Hi-P International is more optimistic of 2020 volumes, driven by growth from the key wireless customer and Keurig, amongst other customers.

SEAMCO Strategic Fit Over Longer Term

• Hi-P International remains focused on M&As for quick access to good customers in automotive and healthcare fields. The merger of Hi-P International and SEAMCO should allow Hi-P International to bid for more projects from Customer D (UK-founded consumer electronics company). SEAMCO’s strong thermoset capabilities may also be a value add for Hi-P International’s other customers.

Wait for Better Margin of Safety

• We recommend investors to wait for better entry to account for FY20E uncertainties. Aside from pricing pressure, the need for increased/ more complex processes may affect profitability.
• Slower than expected economy or weaker than expected consumer confidence may also affect end-market demand for Hi-P International’s products. Conversely, material project wins and/ or accretive M&As are upside risks to forecasts.

Earnings Revisions for Hi-P

• We lower FY19E earnings as a result of Hi-P International downgrading FY19 revenue guidance to “lower” from “similar” previously. Hi-P International feedback that gains from operating efficiencies is not expected to overcome effects of pricing pressure in 4Q19. See Hi-P International Announcements. The weakening of the USD (revenue) against CNY (China operating costs) may result in FX losses, as Hi-P International’s exposures are not fully hedged.
• Notwithstanding, we raise FY20-21E earnings by 2-3% as we expect higher volumes from its key wireless customer’s 5G phone in 2020, as well as due to increased allocation, as well as increased allocation from its other customer, Keurig.
• Interim DPS fell 20% to SGD0.8cts. For FY19E, we continue to expect SGD3cts DPS (FY18: SGD5cts, see Hi-P International Dividend History). We are comfortable with this as it allows room for Hi-P International to prioritise future M&A activities, on top of ongoing business needs such as capex and working capital.
• Our ROE-g/COE-g Target Price of SGD1.34 is now based on 1.5x FY20E P/B (prev: 1.5x FY19E P/B). This is in turn based on a FY20-22E average ROE of 14.6%, and LTG of 2%. See Hi-P International Share Price; Hi-P International Target Price.

Source: Maybank Kim Eng Research - 31 Oct 2019