Excerpts from analyst's report
Fubon Securities (HK) analyst: Zhao Chen
Recent series of PRC food safety scandals is a wake-up call for global analytical instrument players to compete in this new frontier, and we consider Techcomp a strong contender, thanks to its strategic acquisition of specialty technologies in Europe and U.S. that takes decades to build.
Despite that these investments bear near-term costs to its earnings, they would drive a long-term production expansion in its China base. We initiate BUY rating with a target price of HK$3.0.
Richard Lo, CEO of Techcomp, with analysts. NextInsight file photo
A Food safety campaign
: The setup of China Food and Drug Administration (CFDA) is the central government's structural response to a series of widespread food safety scandals.
The government-led investment in food testing capacity should support the analytical instrument market to expand at 7-8% annual pace.
Techcomp is set to gain higher market share in China due to its technology lead.
Strategic acquisitions to push its manufacturing:
A series of pin-point acquisition in U.S and Europe should markedly bridge its technology gap with global players in specific fields that Techcomp chooses to specialize. Professor S. D. Smith, the founder of Edinburgh Instruments, now is Techcomp’s Chief Scientific Officer. Photo: Company
We expect a long term shift to its manufacturing on the back of technology advantage to lift its profitability and gradually reduce its reliance on distribution.
Geo-political and currency risks to remain
: An unstable or deteriorating Sino-Japan relationship has hurt Techcomp in the past given its distribution of Japanese products remains significant.
Techcomp also shows high earning sensitivity to wild fluctuation of Japanese Yen and other Asian currencies. A higher manufacturing contribution will reduce both risks but this takes time.
BUY initiated: We initiate our coverage on Techcomp with a BUY rating.
Our DCF values Techcomp at HK$3.0 per share and we include in our valuation the currency and margin risks already.
Earnings to bottom out in 2014 and margins to recover in 2015
» GP margin sensitive to yen fluctuation
Looking at the historical data, we can see that Techcomp’s GP margin is highly sensitive to yen fluctuation, all the more notable in light of the sudden yen depreciation and appreciation that occurred at the beginning of the year. For example, Japan saw significant yen depreciation after Prime Minister Abe released his plan for unlimited QE at the beginning of 2013, leading to a 33.5% increase in Techcomp’s GP margin in 1H13 (or 7.8ppt HoH).
The Bank of Japan issued an unprecedented QE policy at the end of November 2014, aiming to weaken the yen so as to boost Japanese exports and in turn help stimulate the stagnant Japanese economy. It may take time for Japan to see a significant improvement in its macro economy. As such, the yen will continue to depreciate or remain at low levels for the next couple of years, which in turn will benefit Techcomp.
» Rapid manufacturing expansion could lift GP margin
Techcomp will continue to strengthen its core technology in manufacturing after it acquired two valuable assets from Edinburgh and Bruker. As a result, the revenue from the manufacturing segment will see a higher growth rate than that of the distribution segment. The higher GP margin in manufacturing and the higher revenue proportion from manufacturing will help Techcomp lift its overall GP margin.
» Acquisitions result in short-term financial burden
Techcomp kept its SG&A to revenue ratio at about 24% to 25% before 2012, reflecting its efforts at cost control. The acquisition of Edinburgh in 2013 drove Techcomp’s administrative cost higher to 28%. For the same reason, Techcomp’s SG&A cost will continue to increase this year after its acquisition of Bruker’s GC assets.
The near-term financial costs resulting from the acquisition will weigh on Techcomp’s net profit.However, in the long run, as the company smoothes internal cost control, it will become less of a problem and net margin should gradually recover.
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