Nanofilm Technologies looks set to be back on the growth track even as investors have yet to appreciate its full potential.
When Nanofilm Technologies International reported its first full-year earnings as a listed company for FY2021 ended December 2021, the company cited the Chinese proverb “everything is prepared except the East Wind” in its press announcement.
This proverb originates from the Chinese classic Romance of the Three Kingdoms in which it describes the pivotal Battle of Red Cliffs when the smaller states of Wu and Shu joined forces to fend off a massive naval invasion led by warlord Cao Cao.
Zhou Yu, commander of Wu, and Zhuge Liang, the strategist of Shu, put in place an elaborate, multi-step plan. Via an intermediary, they managed to trick Cao Cao into chaining his ships together to reduce the seasickness for his army of mainly northerners on the mighty Yangtze River. By doing so, Cao’s fleet became vulnerable to attacks using fire.
However, the elaborate plan required one critical element: a favourable easterly wind, without which the flames would cause a blowback and set themselves on fire. After a few tension-filled days, the wind eventually turned in their favour, an attack was launched and the smaller states won a resounding victory.
Nanofilm was using the proverb to describe how the company had all the right pieces in the right place and was only waiting for a proverbial “East Wind” to propel it upwards.
“Our investments in production capacity, infrastructure and R&D made in 2021 and previous years will position us well for future growth,” says group CEO Gary Ho in the press release accompanying the FY2021 results.
Source: Nanofilm FY2021 Results Presentation
Founded by Shi Xu, a former NTU associate professor, Nanofilm, which specialises in providing coating services to consumer electronics and vehicle parts using its proprietary technology, was initially seen by many as Singapore’s long-awaited “tech unicorn”.
However, following its disappointing 1HFY2021 financial results which saw an unexpected fall in earnings, will investors look past the letdown and buy into the company’s growth story?
The company said it had experienced operational challenges in the period under review. A combination of lower-than-expected volume by its customers who could not secure enough parts because of supply chain disruptions as well as higher-than-expected capacity at its Shanghai-based operations had weakened its bottom line.
The earnings miss caused a market selloff that saw the company’s share price plunge almost a third from its peak of $6.67 in just three days. Although Nanofilm’s share price has recovered from its all-time low of $2.32, as of May 4, the closing price of $2.71 is still nowhere near the peak. At this price, the company is valued at 28.93 times historical earnings and has a market cap of $1.8 billion.
Investors were also spooked by the resignations of the company’s former CEO Lee Liang Huang last June and former COO Ricky Tan Chong Hoon less than two months later. Shi, who holds the executive chairman title, had to take on the additional role of interim CEO, along with then-deputy CEOs Gian-Yi Hsien and Ho. On Oct 14, Ho was formally appointed CEO while Gian was named chief commercial and strategy officer.
In an interview with The Edge Singapore, Shi acknowledges that the resignations came “a little bit ahead of time” but claims that it is all part of succession planning. “It is a good opportunity for our younger generation to step up. So, we did that in a very good fashion and good manner. And now I’m very happy to see our senior management very much enhanced,” he says.
While Shi remains the executive chairman, he has made it clear he prefers to focus his time on R&D to come up with a pipeline of technologies and products that the company can commercialise in the next three to five years.
Expand and reorganise
As described by Ho in the same interview, Nanofilm has been preparing for the future by investing in R&D and infrastructure to achieve sustainable long-term growth. While acknowledging that supply chain disruptions had dampened the company’s growth momentum, the subsequent expansion of operations and management reorganisation has put it in a “strong position” today.
All this while, the company has maintained two “fundamental building blocks”. These are its asset base, which has grown to $290 million, and its R&D spending, which accounts for about 7.1% of revenue or $17 million as at end 2021.
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Source: Nanofilm FY2021 Results Presentation
The asset base allows the company to pursue “continuous growth” while the R&D spending allows the company to develop new products to drive the business. Ho points out that Nanofilm’s proprietary technology in coatings and nanofabrication allows it to venture into multiple products and industries simultaneously. “We are a key enabler for the applications we are in. For every application that we enter into, we are the sole supplier. With this really strong technology platform in place, I think that will be a very key catalyst for us to drive the business.”
Since late March, although the city of Shanghai has been under a severe lockdown to curb the spread of the Covid-19 pandemic, Shi says there is only a “limited impact” on Nanofilm as the company’s 1,500 staff in Shanghai sleep, eat and work in the factory, minimising contact with the outside world.
Although there have been “all kinds of difficulties”, Nanofilm’s management has kept production going and successfully applied for special permits to enable its products to be shipped out of the city. “[The] eventual impact will be limited and we are very sure it can be contained,” says Ho.
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Deep-tech destiny
With the benefit of hindsight, Shi thinks the reason for the selloff last year was a “mismatch” between Nanofilm’s vision and that of the market. “The market generally didn’t see what we saw [in Nanofilm],” he says.
Since the 1HFY2021 briefing, Nanofilm has also spent a lot more time engaging investors and shareholders to provide more timely updates and explain how its growth is getting back on track. Instead of sticking to half-yearly reporting as required, the company has been providing quarterly updates as well.
Shi also believes that Nanofilm has a wide business moat as a “deep-tech company”, an advantage few investors may appreciate as more engineering and manufacturing companies make the same claim.
Shi says a typical engineering company buys technology and components, assembles them into a product, and then tests and sells them. However, there is a downside. “They can solve the market problems today but they may not be able to solve the problems tomorrow because the technology might change and market demand might change. This means they won’t be able to adapt quickly because they rely on other people’s technology,” explains Shi.
On the other hand, Nanofilm is “in control of its own destiny” due to the proprietary technology it possesses and invests in. By having control over its technology, the company is better positioned to create its own market while adapting to the existing needs of various markets and industries. This makes the company “very resilient, extremely robust, and safe” as the company is not affected by any one particular industry, he adds.
By extension, Shi is confident about the investment case for Nanofilm. He says the depressed share price does not worry him and emphasises that Nanofilm is not a stock for speculation. Its ability to “control its destiny” makes Nanofilm a “very safe company to invest in”.
“Our company can guarantee good growth,” says Shi, “Why do I say that? It is because we have multiple pillars. We are diverse in terms of industries but based on the same technology. So it’s very much focused. We do what we are good at, and we do many different areas that are independent of each other.”
Shi believes it is only a matter of time before the market recognises Nanofilm’s potential. “After the initial period, the market sees our growth every half year and every year. I think the market will gradually be convinced this is a good stock to invest in and it will bring them good returns.”
Normal services resumed?
The good news is Nanofilm seems to be getting back on the growth track. Compared to 1HFY2021, the 2HFY2021 earnings were a significant improvement, with revenue for the six months up 55% over the corresponding period a year ago while earnings grew at an even larger 145% to $44.1 million. In addition, net margins came in at 30% versus 19% a year ago.
Year on year, 2HFY2021 revenue and earnings were up 6.8% and 12.4% respectively. For the whole of FY2021, revenue increased 13% over FY2020 to $247 million while earnings grew 8% to $63 million from FY2020 with a net margin of 25%.
The company also managed to maintain its growth momentum in the current year. As indicated in its business update for 1QFY2022 ended March, revenue increased by 27% y-o-y, with growth seen across all its business units.
Source: Nanofilm 1QFY2022 Business Update
Analysts have taken note of Nanofilm’s improvement, saying there are fewer problems with the supply chain now. However, they warn of possible challenges including a slowdown in the wider global economy.
DBS Group Research’s Ling Lee Keng has maintained her “buy” call and target price of $4.12, saying in an April 20 note that Nanofilm has seen a “good start to the year” with all units registering growth. She expects the company’s growth momentum to remain strong, supported by the robust pipeline of projects and easing supply chain disruptions.
Demand will also be well supported by new capacity from the company’s Shanghai Plant 2, which is double the size of Plant 1. “There is still a lot of room for expansion in Plant 2, which is not running at optimal capacity yet,” she says.
With the worst of the supply chain disruptions likely behind them, Nanofilm can expect strong earnings growth of 29% in FY2022, followed by another 17% in FY2023, says Ling.
In her view, share price upsides for Nanofilm can come from stronger momentum for the so-called 3C (consumer electronics, communication and computers) segment, higher contribution from the nanofabrication business unit (NFBU), and successful entry into new segments. Furthermore, growth for Nanofilm is supported by its strong balance sheet, holding a net cash position of $146 million as at end December 2021.
Citibank’s Jame Osman has kept his “buy” call and $3.92 target price. “Despite investor concern that supply chain and production disruptions could persist due to the recent Russia-Ukraine conflict and the impact from lockdowns, revenue trends disclosed by the company appear healthy and broadly within our expectations,” writes Osman in his April 20 note.
Meanwhile, CGS-CIMB’s William Tng has similarly maintained his “buy” call and $3.50 target price. Tng notes that while the company is optimistic about its FY2022 outlook, he sees possible earnings risks from disruptions caused by the pandemic and a possible dampening of customer demand, as the appetite of end-buyers is eroded by inflation.
“Nanofilm’s production has not been disrupted thus far and while logistics are challenging, it is still flowing. However, should the situation be prolonged, its operations could be affected,” he warns.
In contrast, Jefferies’ Krishna Guha has a more conservative “hold” call. He has also slightly trimmed his target price from $3 to $2.90 as he changes his growth mix forecast to reflect slower growth from the higher-margin businesses which might lead to a 3.5% drop in earnings.
Nevertheless, Guha notes that top-line growth for the period, the easing of supply chain bottlenecks and minimal impact of Shanghai operations to date are “comforting”. There is also an “interesting” lens project by the nanofabrication business unit.
However, he points out that as the growth seen in 1QFY2022 is enjoyed from a 4QFY2021 demand spillover, “it is difficult for us to ascertain new demand outlook.” According to Guha, Nanofilm’s management confirmed that demand from prior periods has normalised towards the end of the reporting quarter and that new machine installations will be minimal.
“[As such], notwithstanding operational improvements, we think rising input costs will impact margins. Furthermore, end-customers may shift away from premium products,” Guha says.
Will Shi and Ho win their Battle of Red Cliffs? Will an “East Wind” blow in Nanofilm’s favour? Stay tuned.
