SINGAPORE (June 11): CGS-CIMB Research analyst William Tng has initiated coverage on mainboard-listed precision metal part maker Innotek with an “add” call and target price of 57.9 cents, representing an upside of 52.5% for the stock.
Innotek, which currently serves the consumer electronics, office automation and automotive industries, has five manufacturing facilities in China and one in Thailand as at end December 2019. Its end-customers also include Sony Corp, Bosch and Canon Inc,
Despite the ongoing Covid-19 pandemic, Tng forecasts prospective dividend yields of 3.95% for the company over FY2020-22F, which will be backed by its “strong balance sheet.”
“[Innotek] has been in a net cash position for the past five years. From a $34.9 million net cash (including marketable securities) balance in FY2015, Innotek’s net cash (including marketable securities) balance has grown to $69.3 million as at end Dec-2019,” says Tng.
He adds that as a percentage of the company’s market capitalisation, its net cash accounted for some 80.6%.
“As a percentage of market cap, net cash (including marketable securities) as at end Dec-2019 accounted for 80.6% of its market cap.
Tng also notes that Innotek has been in a free cash flow positive position since FY2016. The company did not distribute dividends in FY2015 as it booked a loss of $16.3 million, and chose to remain prudent. However, the company has resumed its dividends in FY2016, rewarding shareholders with a payout of 0.5 cents.
“Dividend per share (DPS) was raised to 1.0 cent in FY2017, 1.5 cents for FY2018, and maintained at 1.5 cents for FY2019,” says Tng, adding that Innotek does not have a formal dividend policy.
While the long-term outlook remains positive, Tng cautions that Innotek could face some headwinds in the near-term. On a macroeconomic level, Innotek is set to be adversely impacted by slower economic growth and weaker global automotive demand. The demand for televisions and automation equipment are set to weaken for the year, too.
Apart from macroeconomic challenges, Innotek operates in a “highly competitive” environment with low margins, where 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,” says Tng, who observes that in FY2019, Innotek’s two major customers had accounted for 30% of its total revenue.
In addition, Tng says the group’s core assets and raw materials are primarily denominated in RMB, while manufacturing and related expenses take 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,” says Tng.
“The group also hedges its exchange rate exposure through short-term forward contracts,” he adds.
According to Innotek's FY2019 annual report, its key foreign exchange exposure is the USD/HKD exchange rate. And Tng forecasts that a 5% decline in the USD vs. HKD is estimated to lead to a $1.4 million decline in its pre-tax profit.
As far as FY2020 is concerned, Tng says Innotek’s revenue could fall by 15% year-on-year due to the impact of Covid-19, before recovering to a 2-3% growth in FY2021-22F. The company's gross profit margin in set to slide to 21% from 21.8% last year, and recover in tandem with its revenue in FY2021-22F.
The brokerage’s base case assumption for DPS in FY2020 is a 1.5 cent payout, similar to FY2018-19. “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,” says Tng.
As at 12.32pm, shares in Innotek are trading one cent higher, or 2.6% up, at 40 cents.
