Is value emerging in battered tech manufacturing stocks?

Singapore

EVERYONE'S bracing for slower growth in 2019, and the beat-down valuations for Singapore's tech manufacturing services stocks reflects that.

Regional purchasing managers' indices are sending weaker signals and export numbers look set to follow them lower, so there's not much reason to expect higher output next year, CGS-CIMB analyst William Tng told The Business Times.

"I think most analysts will cite the second half or third quarter of 2019 as a better time to relook manufacturing stocks," he said.

The US-China trade war and the two giants' messy brawl for tech supremacy has also created a serious overhang, said John Cheong, an analyst at UOB Kay Hian.

"Now, it is very hard to forecast future prospects because things are changing very fast and there's a lot of uncertainty. Outcomes from the trade war are very binary, so it's hard to make a call," he said.

Sifting through the rubble, analysts polled by BT said they prefer companies with a strong cash balance and dividend-paying ability.

Indeed, free cash flow is king as pundits prepare to ride into the late stage of the business cycle.

Bank of America Merrill Lynch strategists wrote in a US equity report last month: "2019 boils down to buying sources of cash and selling users of cash. Free cash flow yield has been the way to value companies late in the cycle, as capex and inflation start to weigh on profitability.

"We would avoid companies with increasing capex (FANG), high labour intensity and leverage, all of which represent claims against cash. R&D is the only cash burn we like, as it has been a good signal of superior returns and long-term growth."

Stock pickers here are on the same page too.

Mr Cheong likes electronics manufacturing services (EMS) firm Valuetronics, which has zero debt and a cash pile that makes up about half its market cap.

"The only risk is that all their plants are in China. They said that 20 per cent of their revenues will be hit (by US tariffs), but they won't take the full hit because they deliver the goods to customers on a free on board basis, they only deliver to the port. However, clients may ask for a discount," he said.

Otherwise, Valuetronics is seeing growth in key segments, and is a key beneficiary of in-car connectivity, Mr Cheong said.

He also likes precision plastic components maker Fu Yu, which is debt-free with a cash balance that accounts for more than half its market cap.

"They started a turnaround initiative back in 2015. It's been bearing fruit but there's still a lot of fats to be trimmed. Their China operations are making a very low profit and two out of five factories in China are loss-making. So they are trying to bring in new local customers to turn around these operations," said Mr Cheong.

Fu Yu also has big plants in Singapore and Malaysia, which makes it a good acquisition target for manufacturing firms looking for new capacity outside of China, Mr Cheong said. There is room to spare - Fu Yu is currently operating at 50 per cent of full capacity, he said.

Contract manufacturer Hi-P International also came into play last month on privatisation talk.

The net cash company said its controlling shareholder was "considering a possible transaction involving the shares of the company", although whether a deal is struck remains to be seen.

RHB analyst Jarick Seet is lukewarm on the tech manufacturing services sector but likes global EMS firm Venture Corp because it is less exposed to the trade war.

Venture's third quarter results were a disappointment, but that was a "blip".

Said Mr Seet: "Management remains bullish on a V-shaped recovery in the fourth quarter and subsequent quarters. Management has also seen business pick up strongly across all segments."

He's expecting the net cash company to dish out higher dividends this year.

Punters are also keeping a close eye on Venture's presumed key customer Philip Morris and its IQOS product rollout to determine if Venture will be 2019's comeback kid.

The other darling of tech's earlier rally until it faded off at the end of the first half of 2018 was semiconductor capital equipment maker AEM Holdings.

AEM's shares have recovered slightly after being sold down in anticipation of slower demand for the test handlers it supplies to Intel.

CGS-CIMB's Mr Tng said: "My best guess is that the previous concerns of a 2019 slowdown which we highlighted have been priced in, and the current share price reflects investors who are buying for a recovery in 2020 or thereafter. Either that or investors are trying to price in positive financial guidance when AEM provides earnings guidance next."

AEM executive chairman Loke Wai San told BT: "The market can also see that our prior acquisitions have started to deliver with Huawei selecting AEM's cable-test solution for its 5G rollout for delivery in 2019.

"The initial win will be at the labs, and the larger opportunity will be when the test equipment gets deployed with the field installations and that may take a year to hit that stage. So the impact on 2019's financials is still too early to tell."

Meanwhile, fund managers are on the prowl for bargains.

Havard Chi, portfolio manager of Quarz Capital Management, which flagged precision plastic components maker Sunningdale Tech as an undervalued stock in a recent report, told BT: "I would say that post the strong rally in 2016-2017, share prices of the contract manufacturing sector have slumped badly in 2018 in part due to disappointing results.

"The correction has however resulted in a few interesting opportunities in the sector. We are aware of the risk that orders might still be soft for the next few quarters. However, we are assured that the trough valuation of these companies will limit potential downside risk while we wait for the turnaround in orders."

Mr Chi said he focuses on firms with a strong ability to generate cash flow: "Strong cash flow can also allow these companies to be consolidators in the industry."

He also screens for stocks with catalysts that can drive better earnings going forward, such as structural demand for their products, operating leverage, as well as potential beneficiaries if there is any diversion of supply chain from China.