An undervalued stock in a moribund market presents a buying opportunity
Hong Kong-listed Sunny Optical Technology Group Co is a leading global integrated optical components and products manufacturer. The company’s principal business involves the R&D, manufacture and sales of optical and optical-related products.
The company reports three operating segments. These are optical components, optoelectronic products and optical instruments. Sunny Optical focuses on optoelectronic-related products, which combine optics, electronics, algorithms and mechanical technology for use in vehicles, VR, augmented reality, robots and handsets. The company trades at HK$48.25 ($8.29), giving it a market cap of HK$53 billion.
We have chosen to retain Sunny Optical from our 2023 portfolio as we believe that the company is deeply undervalued, given that the growth in the value of its business is significantly higher than the growth in its share price historically. Chart 1 illustrates the company’s price growth against weighted value growth over the one-, three-, fiveand 10-year periods. The weighted value comprises revenue growth, net profits, operating cash flow, and free cash flow in order of increasing weights. The chart shows a clear divergence between the price growth and the weighted value growth, suggesting the company is strongly undervalued.
Sunny Optical has taken a hit along with the broader stock market’s underperformance in China and Hong Kong. Higher investor risks have erased much of the share price gains over the years, including companies such as Sunny Optical that have financially performed well and possess strong business fundamentals. This backdrop presents a buying opportunity for these undervalued stocks, although investors should be careful when investing in these markets.
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If the market remains weak and the company’s business prospects are hurt by negative news about the broader economy, its share price will continue languishing. Conversely, investors may be rewarded with substantial gains if an individual stock performs well despite market risks. Although market risk is relatively high in China and Hong Kong, we think companies such as Sunny Optical should be able to outperform expectations, given its consistent performance in terms of cash flow generation.
Despite its recent profit warning, we forecast Sunny Optical’s cash flow generation capacity will stay strong. Tailwinds such as the forecast of a rebound in sales and profit over the next annual period led by higher demand in smartphone camera upgrades and autonomous vehicles are expected to more than offset the short-term profit warning. Furthermore, given the company’s increasing share in the manufacture of smartphone lenses for key market players and a substantial forecast increase in the global automotive-lens market, Sunny Optical is expected to have stronger earnings visibility that should be able to turn its share price around. Sunny’s business relationships with popular brand names along the value chain such as Apple and Meta are also a supporting factor for better earnings quality as it is likely to benefit from having stable and less risky key clients.
Sunny Optical’s financials have been excellent over the past five years, especially its operating cash flow and free cash flow, as shown in Chart 2. In terms of financial safety, Sunny Optical has good liquidity with a current ratio of 1.6 times, and solvency should not be an issue as the company has net cash with an interest coverage ratio of 9.8 times. Sunny Optical trades cheaply at 7%, 29% and 34% discounts for its forward P/E, forward EV/Ebitda, and forward P/B ratios, respectively, compared to global peers, versus 29%, 38% and 39% discounts respectively compared to regional peers, which indicates that the stock is attractive as illustrated in Chart 3.
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The company has 32 “buy” calls, nine “hold” calls, and only one “sell” call, with an average target price of more than 50% above its current trading price. Based on our in-house valuations, we believe that the company’s intrinsic value is around 60% above its current trading price. Sunny Optical, through potentially strong business tailwinds and solid fundamentals, is a clear buy for investors seeking deep-value companies willing to bear market risk.
Disclaimer: This is a virtual portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy or sell stocks, including the stocks mentioned herein. This portfolio does not take into account the investor’s financial situation, investment objectives, investment horizon, risk profile, risk tolerance and preferences. Any personal investments should be done at the investor’s own discretion and/ or after consulting licensed investment professionals, at their own risk.
