Valuetronics–A special dividend situation

Valuetronics is a Hong Kong OEM and ODM EMS manufacturer listed on SGX since 2006.

This morning it announced its first quarter results. You can view the announcement here.

Let me just say that this isn’t your normal dividend plays. An EMS manufacturer plays in a very competitive environment where competition is tough.

There are little product differentiation, and what this means is that you may be seduced that during good times the dividends will look juicy, sometimes upwards of 6-12% yield.

As there are little differentiation, the customers will demand you to cut prices, thus shrinking your margins. If you do not deliver well, the customers will just shift over to another OEM.

You may see your nice dividend yield suddenly become 1%, or in the worse case face operating losses.

A OEM would be better off becoming an ODM, where they propose designs to customers so that the customer sees the value add in not having to design themselves. Margins will be better, but depending it is likely the barriers are not high.

A good 6% dividend

What captures you first is a reasonable 6% dividend based on a 8 HKD Cents distribution.

That looks reasonable until you realize that  the dividends have fallen from 17 HKD cents in the prior years.

The distribution is not consistent and follows the profitability of the business.

And usually the distribution falls within 30-50% of net profits.

Termination of licensing business

That would probably lure you to think that the other 50% would be  accumulated as cash.

Not so. There is a certain level of reinvestment required for a production business.

Much depends on whether more sales can be generated, or whether new business segments worked out.

In recent years, Valuetronics have tried to kick start a licensing business. That ended last year when it bled for almost 3 years.  Management deemed that if they continue to operate, more losses will be incurred (instead of the projected break even)

Things don’t work out.

These are business risks in this line.

What is the value proposition here

So with all these somewhat bad points here why are we still looking at it?

Click to see larger table

A better near term future prospect

The termination of the licensing business may signal a realignment back to the traditional way of securing sales and customer working relationship.

This business segment have burnt near 28-30 mil HKD for the past 2 years.

To put that into perspective, 30 mil will pay for that 6% dividends alone.

Not having this one time write off would mean a return to 2012 profit figures, which is a rather good profit figure.

Profitable since IPO

Valuetronics on the whole was profitable since IPO. This despite the difficult great financial crisis, and 2 writedowns in 2009 and 2013.

This somewhat shows the resilience in its relationship with key customers such that production orders can be preserved.

Net Cash with Very good cash conversion cycle

Although the attractiveness of such  company is its net cash status (Valuetronics trade at 21 cents, of which 10 cents are in cash), the caveat is that cash can be burnt through easily if products do not sell well, inventories build up and when they cannot collect receivables.

Valuetronics through the years have a very good cash conversion cycle. If I am harsh, I would say that its conversion cycle have worsen in the past 3 years perhaps due to the licensing business.

Still, even maintaining a less than 20 day cash conversion cycle is pretty good.

I do expect the cash conversion cycle to improve in the near term.

Low EV/EBIT

The Price Earnings ratio indicates much and the electronics industry typically have low price earnings. This indicates  cheap but also the riskiness in the future earnings in comparison to a traditional  high PE for healthcare establishment, which have more resilient and predictable cash flow.

Net of cash, the EV of Valuetronics is around 475-221 = 254 mil HKD (I am using the full year 2013 cash as the recent quarter the cash is bumped up by a rather large payable)

Sans the write down, EBIT should return to 2012 level of 134 mil HKD.

The EV/EBIT comes to 1.89 times.

This means that should Valuetronics keep their key customers and margins for the next 2 years, they should  earn back the value of the company in these 2  years.

This looks extremely cheap.

Summary

Questions you should ask is that whether Valuetronics can continue to do well for the next 3-4 years.

There are much caveats as the two right downs was due to reinvestment failure and flood in one of their production location.

Both I feel have to do with management decisions and risk management.

Purchasing it at this level is an educated bet with your eyes wide open that you get paid reasonably  with the prospect of a return to previous dividend levels.

I would urge caution in not over allocating here thinking it’s a sturdy business. Our past experience have shown otherwise (unless you have an edge figuring out some special relationships or advantage that redefines their long term profitability)

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