Analysts are keeping a rather bearish stance on Hi-P International following its announcement of a 3.3% y-o-y drop in 1H20 earnings to $24.2 million from $25.0 million in 1H19.
The lower earnings came on the back of a 5.1% y-o-y drop in revenue to $543.8 million, which the company attributed to negative impact from Covid-19 disruptions in 1Q20, but the decrease was partially offset by higher revenue in 2Q20.
See: Hi-P posts 3.3% dip in 1H20 earnings to $24.2 mil
UOB Kay Hian has initiated coverage on Hi-P International with a “sell” recommendation and a target price of $1.11, saying prospects are overhyped for the contract manufacturer.
In a July 30 report, analyst Clement Ho says, “While Hi-P is ascending and widening its reach within the value chain, its lofty valuation does not take into account pricing pressure from clients, slow take-up of products, as well as risk in merger and acquisitions (M&A) synergies.”
He elaborated that this is due to downstream manufacturers for Apple facing pricing pressure. Apple’s reputation and stature as a leader in technology devices has allowed it to impose increasingly stricter terms on its suppliers, such as Hi-P.
This has caused Hi-P, as a downstream manufacturer, to be pressured into lowering prices or face the risk of a re-channelling of orders to competitors. The downstream manufacturers have also been pressured to make hefty investments in factory equipment to support future products - without being assured a minimum set amount of purchase orders.
“While this phenomenon is not new, the key difference now would be the ensuing demand for Apple’s upcoming new iPhone in 2020, to be launched amid the negative effects from the Covid-19 pandemic,” says Ho.
On the other hand, Hi-P has been successful in building up its revenue exposure from the consumer electronics industry in the past decade. Previously, over 90% of sales derived were from the technology sector.
Hi-P now has 35% of its revenue derived from consumer electronics. But, as orders from the consumer electronics industry are stickier and less cyclical, profitability relative to the technology industry is lower and will place further pressure on Hi-P’s net margins.
Furthermore, Ho expects the firm to have lower free cash flow (FCF) due to higher investment spending. Hi-P is aggressively gearing up towards automation and implementing artificial intelligence-aided system flows, which will effectively reduce reliance on labour and unnecessary admin overheads over the longer term.
In conjunction, capex spending over 2020-22 is expected to be “markedly higher” at $90 million each year, from an average of $54 million in 2017-19. This would significantly reduce free cash flow to the firm (FCFF) by more than half to just $50 million per year, compared to over $179 million on average in the past three years.
On the other hand, DBS Group Research analyst Ling Lee Keng has maintained a “hold” call on the stock but with a higher target price of $1.34 from 85 cents previously, as the analyst deems Hi-P’s recent 1H20 results as “decent”, despite the severe impact of Covid-19 on business. She believes that the worst is over now.
Ling noticed that the company’s operations have since normalised and demand remains strong. “We believe that given Hi-P’s track record and its strong relationship with its key customers, coupled with plans to target new customers, the group should continue to generate higher revenue.” she adds.
However, competition within the sector remains strong and could cause pressure on margins. Although the supply chain has generally recovered, the economic outlook still remains uncertain, causing the lack of commitment for advanced orders from customers. Eventually, this could lead to higher costs for Hi-P to fulfill orders given a shorter lead time.
Nonetheless, Ling expects Hi-P to generate decent volumes amid challenges in the market, and work towards enhancing operational efficiencies to improve margins.
As at 11.54am, shares of Hi-P were trading flat at $1.28, or 1.6 times FY20 book with a dividend yield of 1.5%, according to DBS’ estimates.
