"Waterflow" contributed this article to NextInsight. Three months ago, he contributed 


InnoTek: Turnaround under Mr Lou and Mr Kuang


InnoTek released its results on 12 August 2017 which were below expectations (
results link). However, the share price has since corrected 25% and is at S$0.30 (as of 30 August 2017).

2Q'17

2Q'16

Change

Profit Before Tax

 $ 789

 $2,493

-68.4%

Non-Operational Activities

Gain/(loss) on disposal of held
for trading investments

-$4

 $108

Net fair value (loss) /gain on held
for trading investments

-$104

 $42

Foreign currency gain -
realised forward contract

 $115

 $139

(Loss)/gain on derivative (unrealised)

-$121

-$242

Foreign currency (loss) /gain - others

-$420

 $ 414

(Allowance)/write-back of allowance
for doubtful debts - net

-$136

 $180

(Loss) /gain on disposal of PPE

-$1

 $117

Net Effect

-$671

 $758

Profit before Tax (adjusted)

 $1,460

 $ 1,735

-15.9%


In summary, the 2Q’16 results were boosted by non-operational activities while the 2Q’17 results were dragged down by non-operational activities. The reported pre-tax profit for 2Q'17 was a terrible 68.4% drop but, if we focus on the core operations, it is only a 15.9% drop.

Let’s run through the negatives:

• The major office automation customers pulled out from China and moved to lower-cost countries in Southeast Asia. This is a problem fully understood by the management and are doing their best to diversify away from OA customers.

• They have secured new automotive programmes. Revenues will start next year.

• The TV segment remains competitive because a major customer changed the design of its TV bezel, replacing the bottom portion with plastic instead of a full aluminium TV bezel to reduce costs. 

“We continue to focus on strengthening the business. Internal efficiencies, new customer acquisitions and new product innovations will be the main initiatives for our next phase of restructuring. With the orders coming through for our heat-sink product, we hope to build on this momentum as we strengthen our portfolio. 

“FY2017 will likely be a crucial transitional phase as we work on both our restructuring efforts as well as our Thailand investments. We will focus on setting up the Thailand plant while also striving to continuously expand our customer base.”


Lou Yiliang,
CEO, InnoTek

(Source: Press release 12 Aug 2017)

The positives:

• The management is expanding its product portfolio to include children’s car seats (automotive) and a heat-sink (TV business) product. As indicated, the revenues will kick-start by end of the year.

• The management is focusing on securing new customers.

• The Thailand expansion is proceeding as planned and first down-payment (S$0.2m) for land in the Amata City (Rayong) Industrial Estate is done. It will be completed in the first half of FY2018 and production will start in the second half of 2018. Meanwhile, operational activities will be supported from Dongguan until the completion of Mansfield Thailand. 


I tend to focus on risks much more than positives. When we invest, we are risking our capital and it is important for us to understand the risks. Where does InnoTek lie? I believe it is slowly regaining its capabilities under the joint leadership of Mr Kuang Yu Bin and Mr Lou Yi Ling.  

The business risks are:

  • Rise of steel prices (it is one of their input costs)
  • Unable to build a strong middle layer of operations managers and department heads
  • The pace of office automation clients pulling out versus the pace where they can grow new customer base. 

Another metric which I follow closely is their current production utilization level. InnoTek’s IR shared some data, which shows that Magix and Feng Chuan are performing well. 

Plant

Utilisation Rate

Sun Mansfield (Dongguan)

51%

Feng Chuan Tooling (Dongguan)

80%

Magix Mechantronics

71%

Mansfield (Suzhou)

69%

Mansfield (Wuhan)

46%


On several key metrics (see table), InnoTek is very attractive compared to its peers. Does the 2Q'17 results warrant such a steep discount? I feel that investors are afraid of a failed turnaround and are pricing that in somewhat.

Company

Net Debt / Equity

GPM (%) (TTM)

EBIT Margin (%) (TTM)

ROE % (TTM)

EV/EBIT (TTM)

P/E (TTM)

P/BV (TTM)

InnoTek

-0.38

19.60

5.70

10.3%

1.67

5.26

0.54

CDW 

-0.52

24.90

3.85

1.5%

2.76

46.80

0.69

Spindex

-0.38

22.70

12.30

14.4%

5.30

9.21

1.32

Memtech

-0.23

18.10

6.02

11.7%

7.12

7.28

0.85

Sunningdale Tech

-0.01

14.60

7.19

13.6%

7.40

8.24

1.10

Valuetronics

-0.77

14.80

7.41

17.5%

7.59

12.60

2.19

Fu Yu

-0.54

16.00

4.65

4.7%

7.72

16.80

0.89

Fischer Tech

-0.25

22.20

8.86

11.9%

8.74

12.60

1.51

UMS

-0.21

45.90

27.20

17.9%

9.08

11.30

2.01

Frencken Group

0.02

16.20

4.53

13.5%

9.51

6.44

0.88

Micro-Mechanics

-0.43

57.40

32.30

26.9%

11.20

15.40

4.00

Jadason Enterprises

-0.20

23.70

4.87

7.6%

23.10

21.30

1.61

 

Your downside is protected:


Earnings Perspective

At a market cap of $67.2mil, it has almost $47m in “cash and held-for-trading financial assets,” meaning the business value is $20.3mil. In the last twelve months, it earned $12.86mil net profit after tax. This means the company is effectively trading at P/E ex. net cash of 1.58x.

Asset-backed Perspective

At $0.30, investors are assigning nearly zero value to InnoTek’s business. Just by taking its held-for-trading financial assets ($0.209 per share) and investment property ($0.086 per share), an investor would’ve gotten $0.295 per share in total.

Applying Graham’s net-net approach (cnav), current assets ($131.024m) minus total liabilities ($66.074m), you will get $64.95m. It is very close to its current market cap of $67.2m. Don’t forget you’ll get its investment property worth $19.2m for free. Even if you mark down its latest twelve-month earnings by 30%, the business (that comes free!) is still going to generate at least $9m for you.  


I read a Business Times article “KKR on the prowl at SGX, says its S-E Asia head”, which said: 


“BUYOUT giant KKR is looking at a couple of companies listed on the Singapore Exchange (SGX), said Ashish Shastry, the private equity firm's head of South-east Asia.

These could be mid-cap companies in the manufacturing or industrials sector, valued from a few hundreds of millions to S$1.5 billion, he said.

"There's value in stocks in Singapore, I think you can pay premiums to take some of these companies private," said Mr Shastry.

KKR, also known as Kohlberg Kravis Roberts, is flush with dry powder after raising a US$9.3 billion fund in June for private equity investments across the Asia-Pacific.”


I will not be surprised if private equity firms see some value in InnoTek’s business.

I also read a post by "Kelvesy" on Valuebuddies.com forum. He said InnoTek could turn its investment portfolio as a warchest to buy back its shares. See: https://valuebuddies.com/thread-2107-post-142118.html#pid142118


It is a quite smart idea. Using $0.30 to buy back your shares that has a NAV of 55.7cts.

Should the management embark on an aggressive buy-back? Once the company’s operations turn up, its treasury shares are going to be worth a lot. I believe much can be done in the area of capital allocation management.

For me, I am going to hold on to my shares and let the turnaround story pan out.


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