Excerpts from analysts' report

UOB Kay Hian analysts: Nicholas Leow & Andrew Chow, CFA

plant1.16Innovalues' plant in Johor. File photo.Innovalues enjoyed positive feedback during its recent marketing trip to Taiwan. Investors were attracted to the high entry barriers of the automobile business and the company’s strong cash flow.

In addition, we see M&As as a potential catalyst as companies in this sector have begun to attract suitors. Maintain BUY and DCF-based target price of 
S$1.06.


WHAT’S NEW
• Marketing trip in Taiwan. We hosted the management of Innovalues during various meetings with institutional investors in Taiwan recently. This report highlights the key takeaways and feedback.

STOCK IMPACT
• Positive feedback. Investors gave positive feedback on Innovalues, citing management quality and track record. The group’s automobile business looked interesting to investors, given the sector’s high barriers to entry in the form of pre-qualification requirements as well as long-standing client relationships which Innovalues has.

Drive to ensure productivity bears fruit. Investors were also impressed with management’s drive to improve productivity by investing in more machinery in the last few years, which has led to a more efficient production process, lower defect rate during production and less reliance on labor (a decline of slightly over 40% in headcount to 1,500 currently compared with 2,500 in 2010). As a result, its gross profit margin has been on an upward trend since 2011, with per unit direct labour costs declining over 2011-15. Innovalue’s gross margin has increased from 12.8% in 2011 to 30.7% in 2015. We expect gross margin to remain stable at 30% going forward.

• Strong free cash flow on low capex intensity. We estimate its 2016-17 FCF yield at 8.7% and 10.1% respectively due to a low capex intensity of only S$6m p.a.. Given the automotive plants’ average utilisation of 85% and the office automation segment’s average plant utilisation of only 30%, we view earnings growth over the next 2-3 years can be driven by higher utilization as well as total capex of S$6-7m which will add on to capacity for the automotive segment.

High barriers to entry and long-standing customer relationships.
"In 2014, Innovalues derived over 80% of total revenue from its automobile segment. The auto segment has high barriers to entry due to the time it takes to attain qualifications and automakers’ longstanding relationships with customers. Innovalues took about two years to achieve certification for the production of auto components." 

-- UOB Kay Hian

• Positive industry dynamics. The current environment of low gas prices and low interest rates has spurred demand for new cars. Auto sales in the US hit a record high of 17.47m units in 2015 and could see a strong 2016 as more young buyers enter the market. In late- Sep 15, the Chinese government cut the 10% purchase tax in half on cars with engine capacity of less than 1.6 litres.

• Opportunities in the sensor space. A typical household car could have 50-100 sensors onboard, while Innovalues produces about 30 different types. We see possible expansion in this segment given the company’s long-standing relationship with Sensata Technologies which supplies more than 50 sensors per car. Another opportunity lies within the industrial sensor space, which allows for some auto sensor parts relatedknowledge transfer. The size of the industrial sensor market was estimated to be worth about US$4.7b in 2014 according to research conducted by Reportlinker in May 15. Of this US$9.2b, the automotive sensor space made up about 21% and the industrial sensor space is close to double the size at 37%.

• Cleantech coming of age. In Dec 15, nearly 200 nations signed a legal agreement in Paris, setting ambitious goals to limit temperature increases and to hold governments accountable for reaching those targets. Innovalues produces a variety of energy-saving automotive products which are safe for the environment. We reckon the Parisian deal and the recent Volkswagen scandal will be much needed catalysts for a breakthrough in cleantech.

EARNINGS REVISION/RISK
• No change in estimates. We maintain our estimates, which forecast a three-year net profit CAGR of 11% over FY16-18F.

VALUATION/RECOMMENDATION
• Maintain BUY and DCF-based target price of S$1.06. Innovalues remains a top midcap pick given its earnings growth as well as strong financial position. We forecast its net cash balance to rise from 8.2 S cents per share in 2015 to 19.8 S cents by 2018 given its low capex requirements in the next 2-3 years. On our estimates, the stock offers a resilient dividend yield of 4.4% and 5.2% for 2016-17F respectively. Our cost of equity and terminal growth rate assumptions remain constant at 10% and 0% respectively. 

SHARE PRICE CATALYST 
• M&A excitement? In Dec 15 alone, we saw two precision engineering-related takeover deals in the region. IPE Group in Hong Kong was acquired at a trailing PE of 17.4x. This multiple would imply a fair value in excess of S$1.20 based on Innovalues trailing 12- month PE ratio. Innovalues’ 2015 favourable net cash position, free cash flow generating capabilities, strong management team and potential cost-cutting measures make it a prime leveraged buyout target.


Full report here.


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