Value Investing with Valuetronics

While I have invested more in the China and Hong Kong markets recently (Ping An Insurance, Link REIT and Fortune REIT), I have not forgotten the Singapore market.  I still have a plan that I set up during the earlier part of the year to accumulate more Singapore dividend stocks.  This plan I call my FORVER portfolio:

Recently, I added Valuetronics to my FOREVER portfolio.  After accumulating Valuetronics, I still have 5 counters that I have not been able to buy because their prices have gone up considerably since the March market meltdown:

Ascendas

Ascendas India

Keppel DC

MapleT Logistics

Vicom (should I replace it with SBS or Comfort Delgro?  Still undecided)

I’m perfectly okay if the ideal prices of these 5 stocks continue to elude me and I don’t get to have them in my portfolio.  No plan should ever be set in stone.  When it comes to investing, as with everything else in life, being flexible helps one to remain stable and balanced.  Buy when the price is right; move on when the price is less appealing.

I really should have bought Valuetronics at S$0.46 in March, but I didn’t.  I fired several bullets at a few REIT counters in March and April, and didn’t spend sufficient attention on small/mid-cap stocks until recently.  Valuetronics’s share price recovered in May, shooting to as high as S$0.69 (but not to its 52-week high of S$0.86).  After a short rally, the price collapsed again to the 50 cents region.  I viewed this 50 cents range as a good price to enter a position on Valuetronics. 

Introduction

Valuetronics Holdings Limited, which was founded in 1992 and is headquartered in Shatin, Hong Kong, provides integrated electronics manufacturing services (EMS) in the United States and internationally. 

There are two primary segments to Valuetronics’s operations: Consumer Electronics (CE), and Industrial and Commercial Electronics (ICE).  Valuetronics provides EMS to CE and ICE products that include such things as smart lighting products, temperature sensing devices, communication products, automotive products and medical equipment.  

Valuetronics also offers design, engineering, manufacturing, and supply chain support services for electronic and electro-mechanical products, and original equipment design and manufacturing services.   Valuetronics serves several multinational and mid-size companies in the telecommunications, industrial, commercial, and consumer fields. 

Highlights

1. Market Cap: HKD1209 million (as at 3 June 2020).

2. Revenue for FY2020 came mainly from the USA (41.3%), and China and Asia-Pacifc regions (43.7%).

3. For FY2020, the CE segment contributed 38.9% while the ICE segment contributed 61.1%

Results and Ratios

Valuetronics reported the following in its latest financial report (2020):

1. Total Revenue DROPPED 16.8% from HKD2828.8 million (2019) to HKD2354.4 million (2020).

2. Gross Profit DECREASED 15.7% from HKD430.3 million (2019) to HKD362.8 million (2020).

3. Net Profit FELL 10.3% from HKD199.5 million (2019) to HKD178.9 million (2020).

4. Net Asset Value GREW steadily from HKD857.3 million (2016) to HKD1231.6 million (2020).

5. EPS Growth has not always been consistent since 2008.  Compared to 10 years ago, the EPS of HKD41.20 in 2020 is more than double the EPS of HKD15.20 in 2010.  However, the EPS dropped from a height of HKD48.10 (2018) to HKD41.20 (2020).

6. Dividend Payout Ratio for FY 2020 was 49%, well covered by earnings.  I like Valuetronics’s medium payout ratio as it strikes a good balance between paying dividends and keeping enough cash to grow its business.  A moderate payout ratio also suggests that Valuetronics’s future dividends should be sustainable, for as long as its revenue does not drop precipitously.  For the past 7 years, dividend payouts remain pretty consistent at HKD0.20 (except HKD0.27 and HKD0.25 for FY 2018 and 2019 respectively) 

7. Cash Balance: Valuetronics INCREASED its cash balance (cash and bank deposits) by 13.2% from HKD930.4 million in 2019 to HKD1053.1 million in 2020.  Compared to 5 years ago, the cash balance grew by about 53% (from HKD689.3 million in 2016).  Valuetronics has built a steady track record of increasing its cash flows.  Over 92% of Valuetronics’s cash and bank deposits were placed in reputable financial institutions in Hong Kong, UK and Singapore. The remaining balance of the cash and bank deposits, mainly in China and Vietnam, were placed in reputable financial institutions. 

8. ROE DROPPED to 14.5% from 17.2% (2019).  I would have preferred the ROE to be 15% and above.  So Valuetronics is just barely meeting this criteria of mine.

9. ROA DROPPED to 8.9% from 9.9% (2019)(my criteria: above 5%)

10. Current Ratio: 2.2 (my criteria: more than 2)

11. Fair Value: Estimated to be between SGD0.60-0.65.  Thus, I was comfortable buying Valuetronics at SGD0.56.

12. Dividend Yield: 7.69%, slightly more than its 10-year average of 7.3% per annum.

Why did I buy Valuetronics?

Judging from Valuetronics’s growth in revenue, net profit, cash balance and EPS while maintaining a low to no debt position over the years since 2015, it is an excellent company to invest in. However, the growth projection of Valuetronics became unclear as it was besieged by double jeopardy: the global Covid-19 pandemic and the escalating US-China trade dispute.  Valuetronics is confronted with the toughest business environment since its IPO days. 

My decision to buy Valuetronics was contingent on its ability to mitigate these twin challenges that it currently faces.

The US-China Trade Tensions:  As a result of Washington’s attempt to curtail the technological advancement of China and induce US companies to move their operations and supply chains out of China, all shipments due for US shores were subjected to tariffs ranging from 7.5% to 25%.  The tariffs were imposed after the first phase of the US-China trade deal was signed in January 2020.

Tariffs are an impediment to free trade, and Valuetronics is unfortunately caught in this situation as it operates out of its factory in Guangdong Province, China.  

With the tariffs in place, the products of Valuetronics has become more expensive in the USA.  US Importers often pass the costs of tariffs on to manufacturers and customers in the USA by raising their prices.  

An orange-haired clown, who is well-known for his belligerent and xenophobic behaviour and who has the extraordinary ability to inspire revulsion, has wrongly said that China pays the tariffs worth hundreds of billions of dollars on Chinese exports to the USA. 

Valuetronics’s products being now more expensive, its customers in the USA are therefore sourcing for alternatives.  They are accelerating their procurement sources and strategies outside China.  This is quite a blow to Valuetronics as it derives about 40% of its revenue from the USA (43.1%, 45% and 41.3% in FY2018, FY2019 and FY2020 respectively).

To attenuate the effect of US-imposed trade tariffs, Valuetronics has shifted part of its operations to Vietnam.  

Why Vietnam and not anywhere else like Thailand or Taiwan?  

Very likely for these reasons: (1) young, hardworking, skilled and cheap labour, (2) fairly good infrastructure such as port facilities along a long sea coast facing the busy South China Sea, (3) geographical proximity to China, (4) cultural and political comparability with China and its communist system, (5) far lesser bureaucratic torpidity in Vietnam’s autocratic governance as compared to other democratic countries with their cumbersome labour laws and often cantankerous trade unions.  

Valuetronics will find operating in Vietnam to be very similar to operating in China in terms of the type of workers it employs and the general cost of running a factory. 

Several Valuetronics’s customers have started diversifying their productions between Valuetronics’s China factory and Vietnam plant.  In spite of Valuetronics’s effort to migrate part of its operations to Vietnam to avoid the tariff problem, it looks set to lose some US customers (auto industry and CE segment) who have decided to switch to other suppliers within the USA for their own US market.  Nevertheless, Valuetronics has expanded its US business development team to source for new and additional customers.

Valuetronics’s first Vietnam leased manufacturing facility started production last year while the second leased facility has successfully launched a trial production in May 2020. Valuetronics’s plan to commence mass production at its own factory/campus will come to fruition come the last quarter of FY2022 (ending 31 March 2022).  

With the existing leased facilities and the new campus in Vietnam, Valuetronics is well positioned to meet the changing supply chain needs of its customers who are avoiding to pay hefty tariffs imposed under the US-China trade deal. 

Covid-19 pandemic: As a manufacturing entity, Valuetronics suffered much when the Covid-19 pandemic led the Chinese government to shut factories across the country.  

In Guangdong province where Valuetronics’s campus is located, the provincial government imposed strict measures such as the screening of travel histories, limited transportation facilities and quarantine requirements for returning non-Guangdong employees.  This caused a constrain in the supply of manpower even when factories reopened across the province.  Like other beleaguered plants in China, Valuetronics faced a slower than normal recovery of production capacity after Chinese New Year.  

It didn’t help that Valuetronics’s customers in Europe and the USA also had to shut down their operations in response to anti-Covid-19 measures implemented by their respective governments in a bid to control the spread of the virus.  With reduced demand came reduced orders, and Valuetronics’s products had no where to go.  The Covid-19 pandemic has indeed weakened global economic activity and outlook.

When exactly this pandemic will end nobody knows for sure.  Everyone is hoping for sooner rather than later.  It will hopefully end when there is global access to Covid-19 treatment and vaccines.

There is a lot of talk about vaccines and a whole lot more questions on that.  For example: (1) at what level of efficacy will the vaccine stop the pandemic? (2) how affordable is this vaccine? (3) how quickly can this vaccine be manufactured and deployed globally? (4) does this vaccine provide long-term immune protection? If not, how many booster shots are needed after the initial shot? (5) what might some side-effects of this vaccine be?  

Even should the Covid-19 pandemic last beyond 2020, Valuetronics is in a good position to ride it out.  It is sitting on a mountain of cash to help it survive this health crisis and meet the challenges that come from any disruption to its manufacturing operations.  Its cash reserves of HKD1053.1 million is equivalent to 52.3% of its total assets (HKD2013.46) and 87.1% of its market capitalisation (HKD1209).  What a beacon in the night!

With the Covid-19 pandemic and unresolved US-China trade tensions, Valuetronics is facing an unprecedented crisis and a lacklustre FY2021 financial results (one that is very likely lower compared to FY 2020) is to be expected.  Nevertheless, I have no doubt Valuetronics will turn the corner and things will look up for its business eventually.  Companies with liquidity issues will not survive this prolonged pandemic period, but Valuetronics, by virtue of its huge cash reserves and consistent track record of positive free cash flow generation, will pull through this health crisis.  Let’s not forget to mention its strong balance sheet, strategic plans to diversify out of China and other precautionary measures taken to reduce operating costs.

The management has been efficient and prudent in running Valuetronics’s operations and both Tse Chong Hing, Chairman and Managing Director, and Chow Kok Kit, Founder and Executive Director, have skin in the game.  Together, both gentlemen hold close to 25% of the company’s shares.  Both gentlemen are influential and aligned owners of Valuetronics’s business.  This makes me feel more secure owning Valuetronics’s shares as their interest is aligned with mine.

Will my investment in Valuetronics turn out to be a profitable one?  Again, time will tell.  I do take a long view on all my stock investments.  The market has rebounded although not quite back to its pre-pandemic level.  So, until a viable vaccine is available, everything will move on and forward in the “new normal”.  Life goes on and so does investing.  Really, its TINA … there is no alternative. 

Hence, instead of burying my money in a hole, perhaps it was better to invest it in the stock market.  And Valuetronics was one of a few choice picks for the month of June.

Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.