Valuetronics Holdings

[GFG]

"On normalised market conditions, it is not worth paying for an OEM earnings growth."

OEM business is tough. Your customer squeeze you for margins while you are vulnerable to all kinds of cost pressure which means the math is always fighting against you. Historical net margin is also not relevant because labor cost (as a % of sales) is always increasing. It is hard to make a call on it. So you wouldn't want to pay for growth unless there is a huge margin of safety.

On Valuetronics, their historical mean has always been around 6x earnings for donkey years. You will need a strong conviction if you think fair is at 10x or 12x. Most OEM players trade at single digits P/E. So anything above it, you are somewhat paying for growth and I am not comfortable. The reason why it was attractive is because of the one-cost license disposal cost in FY2013. Strip that off, it was around 3x core earnings last year. IMO, it's only a one-year play and not meant for a long-term holding. 4Q14 will be critical and it may not be so easy because on a base comparison, 4Q13 already had recovered slightly.

And the sale from ED Hung Kai Wing is a strong signal. He oversees the entire manufacturing operations of the Group and he should know where the business is heading. If you strip out cash, valuations do look compelling but you also need to make a call on future cash burn rate. Don't forget, the recent cash build up was due to a huge spike in payables. It has to be paid up eventually. I don't think it is an improvement in credit terms.

Bottom line is do you not think the ED could also theoretically "strip" cash out and value the business? If it's so attractive, why did he sell? Yes, it could boil down to other non-fundamental reasons but this company doesn't have a good track record. We should remember back in 2012/13 that the directors also sold right at the peak.

My 2 cents opinion is I don't think this time is any different.

Yes, OEM business is tough, and most manufacturers have single PERs, and in fact, usually even closer to PE 5.
The main prob is OEMs are like commodities. They produce based on the requirements of their clients.
Which is why when I first invested, I wrote to their IR to clarify certain points:
The biggest 5 customers of valuetronics have been with them for > 7 yrs
They have, to a certain degree, some retaining power and some pricing power. A large part of which, I believe, is because they do ODM as well
They work with clients to design the products.
And they include the delivery as well
ODMs are more protected as it involves a working relationship
It is not easy to just pack up and work with another manufacturer if your current one has substantial input into your product designs
In addition, they would incur relocation costs as valuetronics customises their factory space for their clients
Let's see how the 4Q results go
I believe the sale by the ED doesn't mean the results are not satisfactory