SINGAPORE (June 10): Technology companies figured prominently in RHB Securities Singapore’s 20 Jewels 2019 Edition, with seven companies from this sector included in its list of small caps that are likely to do well.
RHB Securities had expected technology stocks to perform better this year after being hit badly in 2018. “Our house view is that the US and China will eventually come to a trade agreement, and since the trade war started, tech stocks, especially in the small-mid cap space, have been hammered down badly, more so in 2018,” says Jarick Seet, its head of small-mid caps.
“Even though the large-sized ones have come back, a lot of small-mid cap ones are still trading at low valuations as compared with their peers. They are also enjoying high growth of 20% to 30% for FY2019F and give attractive dividend yields for investors,” Seet told The Edge Singapore at the launch of 20 Jewels early last month, when there was talk of a possible resolution to the US-China trade dispute.
Technology counters on the Singapore bourse had rebounded in early March after an announcement that the US and China were on the brink of signing a trade deal to roll back tariffs imposed by both countries. It indicated a waning of tensions between the two superpowers. Technology services and solutions provider Venture Corp was the Straits Times Index’s biggest gainer on March 4 — the day the news broke — rallying 3.5%, or 64 cents, to close at $19.09. Following the news, the Singapore market took the cue from a weaker US market closing on that day, slipping 0.41%, or 13.2 points, to 3,231.88.
Other analysts The Edge Singapore spoke to concurred that this was the sector to watch. John Cheong, an analyst with UOB Kay Hian, said it would face some weakness until the trade tensions are resolved, but remains the best-performing sector among small caps.
Similarly, Maybank Kim Eng’s Singapore Market Monitor report called the sector “resilient amid a lacklustre outlook”. It added that there were concerns about end-market demand uncertainties within the industry because of “customer supply chain diversification, catalysed by the trade war”.
Weakening industry
In less than a month, however, the situation began escalating rapidly. US President Donald Trump took aim at perceived external foes in a tweet on May 13. “I say openly to President Xi [Jinping] and all of my friends in China, that China will be hurt very badly if you don’t make a deal because companies will be forced to leave China for other countries. Too expensive to buy in China. You have a great deal, almost completed and you back out!”
He also did not bother to hide his impatience or his inclination to meddle in the US economy. He called on the US Federal Reserve to cut rates. “China will be pumping money into their system and probably reducing interest rates as always, in order to make up for the business they are, and will be losing”, he tweeted on May 14. “If the Federal Reserve ever did a match, it would be game over, we win! In any event, China wants a deal.”
Trump believes his clash with Xi is boosting his popularity ahead of next year’s US election campaign. His use of the Fed is believed to be a tactic to help deflect the blame if the trade dispute wrecks the US economy. Markets the world over were deeply unsettled on May 13 after his tweet.
Asian markets were shaken once again on May 30, as Beijing ratcheted up its rhetoric against Washington, accusing it of “naked economic terrorism” and fanning investor anxiety over a potential global economic slowdown. This comes after China said it would impose tariffs on US$60 billion ($81.9 billion) of US goods from June 1. The move is in retaliation to the US raising tariffs from 10% to 25% on US$200 billion of Chinese imports a few days earlier.
The STI lost 0.8% while Hong Kong’s Hang Seng Index dropped 0.6% and the Nikkei fell 0.9% as a result of the move. Analysts have revised their forecasts, with Seet saying that technology and manufacturing stocks will only become attractive when “trade tensions subside or an agreement is reached”. Trump and Xi are set to meet to air their issues this month.
Chua Hak Bin, senior economist at Maybank Kim Eng, warns that the trade war is fast turning into a technology war. Along with the recent US ban on phones by Chinese company Huawei Technologies, Chua envisions that US export control measures may broaden to other technologies beyond 5G, making products obsolete and worsening the disruption to tech supply chains.
Such a scenario would have dire implications on companies in the technology sector, as they will see a fall in demand.
Frencken the next Venture?
Given the bleak macroeconomic and stock market outlook, Seet says now is the time for investors to be equity-light. He recommends that they start to bargain hunt for cheap stocks, especially in the technology and manufacturing space, once the market has corrected.
Seet says the main issues facing technology and manufacturing companies are rising labour costs, a diversification away from manufacturing in China and mounting pressure to automate services. He notes that these arise from “intense cost pressures from customers”.
One of the technology companies on RHB’s recommended list is Frencken Group, a provider of high-tech capital and equipment services. The company’s former chairman was Larry Low Hock Peng, father of alleged 1MDB mastermind Low Taek Jho, or Jho Low. In August 2016, Larry Low left the company’s board, citing “health reasons”. He has since sold the bulk of his stake in the company.
According to a stock exchange filing on Aug 29, 2018, Larry Low’s interest in the company had dropped from 8.14% to 4.74%, or just under 20 million shares. This was the result of the disposal of his shares in Meng Tak Corp — a company named after his father — which is one of the entities he used to hold shares in Frencken.
With Larry Low out of the picture, Frencken is today led by Gooi Soon Chai, who took over from the former as chairman in August 2016. He had joined the board a year earlier. On May 31 this year, Gooi bought 200,000 shares at 59.5 cents each, bringing his direct stake in Frencken to 5.97 million shares. Coupled with his deemed stake of another 98.7 million shares, Gooi now controls 23.3% of the company.
Under Gooi, Frencken is tapping the growing trend of industrial automation, as more companies try to make their manufacturing operations more efficient. The company operates via two main business units. The first is the mechatronics division, which helps customers design and manufacture complex, high-precision parts used in capital equipment sold by renowned brands in the healthcare, life sciences, semiconductor and industrial automation markets such as Philips, Siemens and General Electric. The company does not compete on mass-volume products, focusing instead on low to mid-volume products with relatively long product life cycles of between seven and 10 years. The bulk of its mechatronics business comes from the analytical and industrial automation markets.
The second key operating unit, the integrated manufacturing services division, offers design and manufacturing services for automotive, office automation, consumer and industrial products. Within this division, the automotive industry is the largest revenue source. Frencken makes products such as micro-moulds and mechanical switches.
Between these two operating units, the mechatronics business is larger as well as more profitable. Mechatronics generated around 80% of the company’s total revenue in FY2018, and commanded an earnings before interest and taxes (Ebit) margin of more than 8%. The integrated manufacturing services division, on the other hand, generated the remaining 20% of Frencken’s total revenue in the same period. Its Ebit margin was just around 1%.
On May 9, the company reported that revenue for 1QFY2019 ended March 31 increased 14.7% y-o-y to $159.1 million, thanks to higher orders from Europe-based customers. In the same period, higher net margins lifted its earnings 27.2% higher y-o-y to $8.6 million.
The gains helped offset a marginal sales decline at its integrated manufacturing services division, where revenue contribution by the consumer and industrial electronics and tooling segments fell.
Frencken shares seems to have weathered the volatility in the markets. Year to date, they have gained 42.9% to close at 60 cents on June 6. At this level, the shares are trading at a historical price-to-earnings ratio of 7.93 times, giving the company a valuation of $254 million.
While the company expects the macroeconomic backdrop to remain challenging with trade-related uncertainties and a cyclical downturn in the semiconductor industry, it says it will continue to operate in a broad array of business segments, end-user markets and geographical regions, as it believes this business diversity will provide greater resilience and stability to the group.
Besides RHB, three other brokerages — KGI Securities, DBS Bank and CIMB — maintain active coverage on Frencken’s stock. After the release of its 1QFY2019 results, the analysts are maintaining “buy” or “add” calls on the stock, with price targets ranging between 67 and 90 cents.
Seet believes the company is significantly undervalued compared with its peers and is “a potential Venture [Corp] in the making, with its technology also making rapid advancements in recent years, [enabling it] to provide more solutions to its customers”.
