• We initiate coverage on InnoTek (SGX:M14) with an ADD rating and Target Price of S$0.579.
• We forecast prospective dividend yields of 3.95% over FY20-22F which are backed by its strong net cash balance sheet.
• Accretive M&A are upside share price catalysts.

InnoTek - Background

• SGX Main board-listed InnoTek (SGX:M14) is a precision metal component manufacturer serving the consumer electronics (TV and display), office automation (OA) and automotive industries.
• With five manufacturing facilities in China, InnoTek’s wholly-owned subsidiary Mansfield Manufacturing Company Limited provides precision metal stamping and machining, tool and die design and fabrication and sub-assembly work to Japanese and European end-customers.
• InnoTek’s stamped components are used in printers and copiers, TV frames, TV bezels, chassis frames and in-car seat frames, guide rails and exhaust systems. Its end-customers include Sony Corp (6758 JP), Canon Inc (7751 JP), Ricoh Corp (7752 JP), Continental AG (CON GY), Imasen Electric Industrial Co (7266 JP), Kyocera Corp (6971 JP), Konka Group (000016 CH), Innolux Corp (3481 TT) and Wistron Corp (3231 TT).
• In FY19, two customers accounted for 30% of its revenue (vs. 38% in FY18). In FY17, three customers accounted for 41% of revenue.
• Precision stamping is primarily carried out in Mansfield’s plants in China, located in Dongguan, Suzhou and Wuhan. As at end Dec-2019, Mansfield has more than 600 stamping presses, with capacity ranging from 25 tonnes to 1,100 tonnes. Other production equipment include computer numerical control (CNC) machines, electrical discharge machines (EDM), and wirecut machines. Tooling, die design and fabrication, as well precision machining, is carried out in Dongguan.
• On 11 June 2018, InnoTek officially opened a new plant in Thailand, Mansfield (Thailand) Co. Ltd, located in Thailand’s Rayong province. The plant mainly serves Japanese OA customers that have relocated production from China to Southeast Asia.

InnoTek - Major Shareholders

• The major shareholders of InnoTek are Advantec Holding SA (Unlisted) (with a 36.64% stake) and its CEO, Mr. Lou Yiliang (with an 11.36% stake).

Industry Outlook

Slower economic growth in 2020F

• In its Apr-2020 World Economic Outlook (WEO) report, the International Monetary Fund (IMF) forecasted that the global economy is projected to contract sharply by 3% in 2020 (due to Covid-19), much worse than during the 2008–09 financial crisis. In a baseline scenario, which assumes that the pandemic fades in the second half of 2020 and containment efforts can be gradually unwound, the IMF projects that the global economy could grow by 5.8% in 2021 as economic activity normalises and policy support by governments take effect. The IMF cautions that there is extreme uncertainty around its global growth forecast.
• Other than China, IMF projects (in its Apr-2020 WEO report) that the USA will enter a recession with a 6.1% y-o-y GDP decline. The Euro area will see a 7.5% y-o-y GDP decline, while Japan will experience a 5.2% y-o-y GDP decline. Even though the IMF is projecting a 1.2% y-o-y GDP growth for China in CY20F, that is still a sharp fall in comparison with China’s 6.1% y-o-y GDP growth in CY19.

Weak global automotive demand

• According to industry forecaster IHS Markit’s May 2020 update, the global auto industry is expected to witness an unprecedented and almost instant stalling of demand in CY20F, with global auto sales forecast to plummet more than 12% y-o-y from CY19 to 78.8m units. This represents a downgrade of 10m units, compared with the pre-coronavirus IHS Markit forecast in Jan 2020. According to IHS Markit, a fall of 12% for CY20F would be considerably worse than the two-year peak-to-trough decline of 8.0% during the global recession in CY08-09.
• IHS Markit’s expectations for China have been downgraded by 2.3m units for CY20F, with light vehicle sales forecast to post 22.4m units for the year, down almost 10% y-o-y. IHS Markit expects China to show signs of bottoming out through the second half of CY20F, but IHS Markit cautions that the scale of the economic slowdown will likely lead to some destroyed demand. For Europe, IHS Markit forecasts that automotive demand for CY20F could be 15.6m units (- 13.6% y-o-y). The IHS Markit forecast for the US market for CY20F is a 15.3% y-o-y decline to 14.4m units.

TV demand to fall in CY20F

• In its 31 Mar 2020 update, Omdia (a global technology research firm) slashed its CY20F global television shipment outlook by nearly 10 percentage points and expects the market to undergo a sharp downturn due to coronavirus mitigation measures initiated by governments worldwide.
• According to Omdia’s forecasts, global television shipments will fall by 8.7% y-o-y in CY20F, declining to 203.5m units, down from 222.9m units CY19. Omdia previously forecasted shipments to rise by 1.1% y-o-y to 225.4m for CY20F. According to Omdia, the decline in TV demand is due to mandates in countries all over the world to restrict individual movement. These restrictions represent a major disruption to consumers’ normal lives and customary shopping habits.
• Also, in Omdia’s view, the suspension of the normal sport calendar — in particular the postponement of the 2020 UEFA European Football Championship and the Tokyo 2020 Summer Olympic Games — has put much of the promotional activity in the television business on hold.

Poor outlook for Office Automation (OA)

• For CY20F, Canon Inc (7751 JP) has guided that its office automation equipment revenue will decline y-o-y due to the work-from-home response to Covid-19. Given the uncertain environment, Canon has not provided a full-year guidance.
• A similar trend was also witnessed by Konia Minolta Inc (4902 JP), which guided that customers are delaying the timing of product purchases and equipment installation and, at the same time, there are limited opportunities for Konica Minolta to engage in face-to-face sales negotiations with customers. Konica Minolta has also refrained from providing a full-year guidance.
• Ricoh Co Ltd (7752 JP) has also experienced difficulties in expanding the sales of new products and services, owing to such factors as declining purchasing demand and an inability to install machines in the field. On top of that, lower business activity in offices reduced the use of mainstay multifunctional printers, cutting sales of consumables and other offerings. Ricoh expects the Covid-19 pandemic to affect its FY21F performance. The company has not provided any full-year guidance due to the uncertain environment.

InnoTek - Historical Track Record

• Over FY09-19, InnoTek’s revenue fell from a high of S$375.2m in FY10 to a low of S$186.7m in FY19, registering losses of S$18.4m in FY12 and S$16.3m in FY15. There was a clear net profit recovery over FY16-18, due to a change of management and restructuring efforts. FY19 net profit fell 17.7% y-o-y to S$16.7m, due to a broad-based decline in demand.
• On 2 Nov 2015, Mr. Lou Yiliang was appointed executive director of the group and CEO of Mansfield. Mr. Lou has significant experience in the consumer electronics and home appliances business in Asia. Under Mr. Lou, InnoTek continued to further drive cost efficiencies and improve the group’s capabilities and technology as he noted that the group had fallen behind its peers in capabilities such as mould making, machining and line management skills.
• On 1 Mar 2017, Mr. Lou was appointed CEO of InnoTek. On 27 Apr 2017, Mr. Neal M. Chandria was appointed chairman of the board of directors.
• The precision component and tooling segment is the major revenue contributor for the company (FY19: 76.2%, FY18: 66.4%).
• In terms pf pre-tax profit breakdown, the precision component and tooling segment accounted for 41.3% of FY19 pre-tax profit, while the precision machining segment accounted for 58.7% of FY19 pre-tax profit.

InnoTek Has Been in a Net Cash Position for the Past Five Years

• From S$34.9m in FY15, InnoTek's net cash position (including marketable securities) has grown to S$69.3m as at end Dec-2019.
• As a percentage of market cap, InnoTek’s net cash (including marketable securities) as at end Dec-2019 accounted for 80.6% of its market cap.
• InnoTek has been FCF-positive since FY16. The company did not pay any dividends in FY15 as the group recorded a loss of S$16.3m that year. Over FY16-19, DPS has grown from 0.5 Scts to 1.5 Scts.

Key Risks

Margin pressure

• In InnoTek’s view, the industry it operates in is highly competitive with low margins and its customers are able to switch suppliers easily. The loss of one or more of its major customers or a substantial reduction in orders by any major customer will adversely affect the group.
• In FY19, InnoTek’s two major customers accounted for 30% of its total revenue.

Foreign exchange exposure

• InnoTek’s core assets and raw materials are primarily denominated in RMB, whereas manufacturing and related expenses are in the currency of the country of operation. InnoTek has a policy of monitoring foreign currency exchange rate changes closely to minimise any potential material adverse impact on its financial performance. The group also hedges its exchange rate exposure through short-term forward contracts.
• According to its FY19 annual report, Innotek’s key foreign exchange exposure is the USD/HKD exchange rate. We estimate that a 5% rise in the USD vs. the HKD would add S$1.4m to its FY19 pre-tax profit. A 5% decline in the USD vs. the HKD is estimated to lead to a S$1.4m decline in its pre-tax profit.

Country risk

• As InnoTek’s manufacturing facilities are located mainly in China, any unfavourable changes in the political, social, legal, regulatory and economic conditions in China may disrupt its operations and affect the group’s financial performance.

Forecast Assumptions

• Our key forecast assumptions are:
  • FY20F revenue could fall 15% y-o-y due to the impact of Covid-19, before recovering to a 2% growth for FY21F and a 3% growth for FY22F. InnoTek’s 1Q20 revenue fell 23% y-o-y.
  • We assume Covid-19-related uncertainties could lead to an erosion in GPM for FY20F to 21.0% (vs. 21.8% in FY19). We expect GPM to recover gradually to 21.5% and 21.8% for FY21F and FY22F, respectively, as revenue growth stages a modest recovery. We are not expecting significant GPM expansion as CEO Mr. Lou has highlighted in the 2019 Annual Report that it is getting much harder to squeeze further savings, a situation made more challenging due to the disruptions caused by Covid-19. InnoTek has slashed its workforce by 52.4%, from 4,393 in FY15 to 2,090 in FY19.
  • For dividends, our base case assumption is that InnoTek will pay 1.5 Scts DPS for FY20-22F, similar to the DPS for both FY18-19. While InnoTek has the cash to pay a higher dividend, we believe the company will likely adopt a cautious stance given the uncertain business environment.

InnoTek - Valuation & Recommendation

• We initiate coverage of InnoTek with an ADD recommendation and a target price of S$0.579. Our target price is based on 0.78x FY20F P/BV multiple derived from the Gordon Growth Model (COE: 8.0%; ROE: 7.0%).
• We project dividend yields over FY20-22F to be 3.95% per annum. Based on our forecasts, InnoTek’s projected end-FY20F net cash (including marketable securities)accounts for 96.7% of its market cap. We use a Gordon Growth Model-derived P/BV to derive our target price, given the cyclicality of the business.
• Over the past four years, InnoTek traded at a historical average forward P/E of 6.0x and a P/BV of 0.55x. InnoTek is trading at 8.0x/7.0x FY20F/FY21F P/E (vs. the peer average of 10.3x/11.9x). InnoTek is trading at 0.51x FY20F P/BV (vs. the peer average of 1.48x). InnoTek’s FY20F projected dividend yield is 3.9% vs. the peer average of 5.2%.
• Given a total return potential of more than 10%, we initiate coverage on InnoTek, with an ADD rating.
• Upside catalysts are stronger-than-expected customer demand/accretive M&A.
• Downside risk is a deterioration in customer demand due to the escalation of the Covid-19 outbreak.

Source: CGS-CIMB Research - 10 Jun 2020