Venture @ 13.30 ( Contract manufacturing / Singapore ) 4 comments
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1.High 17X PE for a contract manufacturing firm with declining revenue and declining margins
2.May have to invest or acquire aggressively to build new capabilities
Venture has been one of the top, if not THE top, performers on the SGX over the 1990s when it grew from a S$200M-sales SESDAQ counter in 1995 to a S$3B multinational by 2004, with a similarly meteoric rise in share price over that period. Even during the three gloomy years of 2001-03 it was able to register at least 30% year-on-year growth in topline and bottomline, and it is currently among the top ten contract manufacturers in the world.
Yet that is exactly the problem. The strong earnings momentum is what has made Venture a fund managers' favourite (Aberdeen has been accummulating, while Templeton has also declared its substantial interest) and accorded high earnings multiples of about 20. That earnings momentum is about to stall for a second straight year in 2005, following its faltering performance (drop in profit) in FY04. Forget the stellar 10-year track record; do you want to buy into a company trading at 17 times PE (trailing and probably forward), stagnating revenue and declining profit margins, positioned in the technology manufacturing sector which is prone to over-investment and consequent margin pressure?
The stagnating revenue is less important, because Venture has stated for some time that it is their goal to focus on margins by going into R&D, providing value-added design and other services like supply chain management, producing high-mix low-volume products and exploring more lucrative segments like the networking and non-technology sectors like medical and automotive. Yet despite their efforts profit margins fell again for the fourth straight year in 2004; their venerable CEO Wong Ngit Liong acknowledged that there was "a shift in product mix towards high-volume
and relatively lower-margin business", exactly what Venture wanted to avoid. That does suggest execution problems and barriers to entry (such as lack of technological know-how and business connections compared to their North-American rivals, for example). A situation where revenue stagnates and margin softens is a recipe for prolonged earnings decline.
The performance in FY05 has seen continued decline in profit. There was a year-on-year 20% improvement in profit for 3Q05 over 3Q04; however one should note that 3Q04 was when Venture's profit first showed signs of softening, so favourable comparisons with a weak quarter does not say much. The company expects that market conditions continue to be "very competitive and challenging, with further pricing pressure expected over the next 12 months".
In terms of revenue, margins, outlook, industry positioning, the company looks to be entering a consolidation phase where its strong cash kitty of S$600M might help, through acquisitions and investment in organic growth. Either it settles into a comfort zone or it has to spend and invest aggressively in building new capabilities since it is clear that it may not be that easy to enter the high-margin sectors. Either way, I don't see it warranting a 17X PE valuation despite its global footprint; note that fellow contract manufacturing peers (in terms of scale of operations) Solectron, Sanmina-SCI, Celestica and Flextronics are all trading at about 12 times forward PE in the world's most liquid market --- the US.
(1) Forbes article Nov 05: Solectron Seen As Rebound Pick Among EMS Laggards