Here’s another post by our guest writer who has extensive experience with analyzing the fundamental side of things.
Elec & Eltek International Company will announce a buoyant set of earnings in next month. According to preliminary estimates, the company submitted a regulatory filing to SGX that earnings in the quarter will jump more than 170% compared with the same period last year.
As a background, Elec & Eltek manufactures Printed Circuit Board (PCB) that is used in personal mobile devices, cars, computers and a vast array of consumer electronics. Parent-company Kingboard Chemical took one of its subsidiaries private, fueling speculations that Elec & Eltek- as one of the subsidiaries- could be privatized as well.
We put forward a case of acquisition by its parent-company Kingboard. First, Elec & Eltek has decreased investment into its own business. Capex per revenue dollar dropped from 7.2% in FY10 to 4.7% last year, hitting a high of 11.9% in FY11.
Second, significant related party transaction. An undisclosed single customer, believed to be Kingboard, increased its invoice with the company between FY11 and FY16 at a compounded rate of 8.8% p.a. to USD95.4m. Meanwhile, dividend payout is aggressive into the pockets of parent company with little regard for future earnings growth. Even in loss-making FY15, shareholders received 3.8% dividend yield.
Third, directors and management have cross shareholdings in Kingboard. Furthermore, an independent Board of Director has resigned with no replacement to restore a rigorous corporate governance structure.
Lastly, there is cost synergy between the company and Kingboard, as they have similar business units. As one of the leading PCB manufacturers, Elec & Eltek could barely breathe. Hence, smaller-scale peers are expected to struggle in the current economic landscape. A wave of consolidation amongst PCB manufacturers should bring about firmer profitability for the wider group.
The PCB market is fiercely competitive. In FY16, Elec & Eltek recorded before-tax profit of USD 11.7m on USD 472m revenue, translating to a meagre 2.5% margin. The same metric was in the red a year ago, as compressed pricing in electronics weigh heavily on its profitability.
Last year, management decided to focus on higher-margin products, namely manufacturing PCB for the automotive industry. Sales and margins ticked higher, with a profitability boost that extends to the current quarter. Riding on the tailwind of Chinese manufacturing sector expansion that began since Oct 2016, earnings momentum is set to gain traction into the year.
Elec & Eltek is essentially a dividend play. Management has anchored the portfolio by leasing its factory space in Hong Kong, generating a sustainable USD 5.9m in passive rental earnings annually.
With stable rental income, the wildcard, ironically, will come from its core manufacturing business. Despite the return to profitability on higher-margin products, business volume remains critical to drive earnings.
Stronger profitability of Elec & Eltek lifts expectations of resumption in interim dividend come August 2017. It will be in line with earlier years when the PCB manufacturer was in the black.
Valuation of Elec & Eltek is undemanding, considering the price Kingboard Chemical Holdings paid for its supplier Kingboard Copper Foil (pending delisting on SGX). The transaction occurred at 12x EV/EBITDA for the core copper business. For a low-margin PCB manufacturing business, we apply the transacted multiple 6.8x EV/EBITDA between TTM Technologies and Viasystems. Thus, Elec & Eltek is easily worth USD 365m, or USD 1.95 per share.
On a P/E basis, the company trades at 24.5x, while peers trade at wide variance. Taiwanese PCB manufacturers are cheapest at an average of 18x P/E, while non-Taiwan-listed manufacturers are either loss-making or trade at close to 40x P/E.
We view Taiwanese manufacturers as value play with limited expansion scope into the mainland Chinese market. A conservative 35% earnings expansion would compress the FY17 forward P/E of Elec & Eltek, trading in line with the average of Taiwanese peers.
Profit-takers may put downward pressure on the share price that is just a whisker from its 52-week high. However, we are positioning for a bumper harvest with a potential dividend yield of 7% (USD 0.06 in May + summer special) on current share price.
This one could take a really long time to play out, so please do your own due dilligence!
Have a great Labour Day weekend folks!