Sinotronics (September 18, 2003)

Buy

Stock Code

1195.HK

Price(as at 17/9/03)

HK$1.51

Target Price

HK$1.96

 

 

 

Key Data

 

 

Shares Outstanding

402.6M

 

Market Capitalisation

HK$607.9M

 

52 week high/low

HK$1.56/ HK$0.81

 

ROA

7.0%

 

ROE

9.4%

 

Current ratio

3.17x

 

Gearing

0.27x

 

Major shareholder

 

 

Mr. Lin Wan Qaing

57.67%

Booming demand, rapid growth

High-mix strategy Sinotronics concentrates on relatively small orders, but with higher margins. It provides value-added services such that gross profit margin has been maintained at above 50% in FY01 and FY02.

Strong design capability The group・s strong research and development team works closely with its customers, which can enhance its design skills. The group also diversifies its business into power systems design by acquiring 49% stake in Floret Industries.

One-stop service provider The group provides integrated services, ranging from design to manufacturing that shortens product cycle. As China has joined WTO, competition in electronics industry will increase, resulting from imports influx. Total solutions services demand from domestic producers is expected to be robust.

Promising future growth Sinotronics can benefit from outsourcing trend and continued rapid industry growth. Industry output of electronic and information enterprises rose 21% in 2002. MII forecasts sales of China electronic products will increase 17% in 2003.

Attractive valuation The group is trading at 8.7x and 7.7x prospective PER for FY03 and FY04, respectively. Yield can reach 2.3% and 2.6%. Valuation is undemanding when compared with other high-tech industrial stocks. We believe its fair valuation should be at 10x FY04 PER.

As at 30 June (RMB M)

2001A

2002A

2003F

2004F

Turnover

189.1

204.1

234.7

269.9

Gross Profit

97.9

103.9

120.6

138.7

Net Profit

56.8

64.8

69.9

78.9

Basic EPS (HK$cents)

20

18

17.4

19.6

P/E (x)

7.6

8.4

8.7

7.7

Source: Sinotronics, Tung Tai estimates

Established in March 1996 in Fuqing City, Fujian Province in the PRC, Sinotronics has been developing from a single-sided, double-sided, and then multilayer printed circuit boards (PCB) manufacturer to an integrated electronic manufacturing services (EMS) provider. In May 1999, Sinotronics implemented an EMS business development strategy, providing full-range of services including presale engineering services, schematic capture and PCB layout design, quick-turn prototyping and pre-production services, volume production and PCB assembly and sub-system creation and testing.

PCB has wide applications. The group mainly provides services to telecommunication, computer, industrial, and consumer electronics industries. The group maintains long-term relationships with its customers that it has at least three years of relationship with each of its customers. The five largest customers accounted for 71% of turnover in FY02. The group・s major customers are China-based. In FY02, China accounted for 89.5% of turnover. The group also exports its products to Australia, USA and Germany.

Competitive Strengths

High-mix strategy and value-added services

Gross margin can be maintained above 50% with high mix strategy

Sinotronics adopts a high-mix strategy that concentrates on relatively small orders, but with higher margins. In contrast, most players in electronics industry adopt low-mix strategy to produce huge amounts, but with low margins. The industry in China is flooded by such manufacturers who provide little value-added services. Keen competition coupled with pricing pressure from customers, their profit margins are shrinking. Sinotronics has its niche market, as it provides high quality design and engineering services in addition to manufacturing service to ODM manufacturers. Gross margin for Sinotronics has been maintained at above 50%, which were 51.7% for FY01 and 50.9% for FY02.  

Strong design capability

The group forms strategic alliances with customers and hence design capability can be increased

The group has a strong research and development team, which consists of over 30 professional engineers, focusing on PCB engineering. It has design offices in Shanghai, Shenzhen. The group intends to form strategic alliances with its customers to establish closer relationships. It opened a joint development centre at the office of Newland in 1999 and assigns staff to work at the centre. Currently, Sinotronics・ staff also work with other major customers such as Start Network and Amoisonic on a regular basis. The group adopts an open attitude towards future cooperations with Start Network and Amoisonic that are similar to that with Newland. Through interacting with customers, the group・s design skills and market sense can be enhanced.

Sinotronics has diversified its business into power supply systems. It can leverage on the experience to its power supply and data transfer and storage systems design

The group has been actively diversifying its business that it acquired 49% stake of Floret Industries at RMB47M in August 2002. Floret Industries indirectly holds 83% equity interests in Fuzhou Tin Fong. Tin Fong is primarily engaged in R&D of computer hardware, software and systems of power supply systems. Its employees are engineers and university graduates. By cooperating with Tin Fong, the group has gained technical experience and it can transfer the know-how to motor PCB and power supply system PCB design. The associate contributed RMB1.5M profit in 2Q03 to the group. We expect full-year contribution can be over RMB4M.

One-stop service provider

Sinotronics provides one-stop service that shorten production cycle

The group provides design services that cater to customers・ demand. Since China has joined WTO, electronic imports will compete with domestic products. Domestic producers have to improve their designs in order to stay competitive. As a result, the group is positioning itself in the right direction to provide design services. In addition, Chinese companies tend to find close partners. As the group・s technicians are stationed at the offices of customers most of the time, the group can have customer・s feedback immediately. The group also introduces prototyping that shortens production time. Moreover, the group・s manufacturing capability can complement those of customers. Because product cycle is shrinking for high-tech products, prompt product launch is the key to success. If customers are successful, in turn, they will place more orders on the group.

Future growth prospects

Benefiting from global outsourcing trend

The group possesses skilled engineers and can benefit from the outsourcing trend

Unlike those leading multinationals in the electronics industry, setting up a technical department solely for product design is cost inefficient for most ODM manufacturers. Capital investment is large, but resources may not be fully utilized. Hence many ODM manufacturers scale down or even close their engineering departments and outsource the design work to third parties. Besides lower costs required, design houses possess skilled engineers who specialize on electronic products design. As engineers in the mainland remained competitive in wages and skills, the outsourcing trend to the mainland will continue.

Rapid industry growth continues

Information technology industry in China posted strong growth last year and it is expected to sustain

According to Ministry of Information Industry, the industry output of electronic and information enterprises reached RMB1.78 trillion in 2002, up 21% yoy. Sales volume rose by 17.8% to RMB1.4 trillion. Integrated circuit sales jumped 43% in 2002. Sales growth in PCs achieved 46.5% and notebook computer even rose by 92.3%. Mobile phone sales and mini-calculator sales grew 42.9% and 58.5%, respectively. The authority forecasts sales of China・s electronic products to grow 17% to US$198B in 2003. In fact, the growth may be higher than the forecast. In the first four months in 2003, 51.68M mobile phones were manufactured in China, representing a growth of 67.4%, while integrated circuits output was 4.3B units, up 45%. We expect electronics and high-tech industry in the mainland has enormous potential to grow.

Conclusion

Sinotronics is well positioned to tap growth potential in mainland electronics industry by providing one-stop EMS services. The group plans to increase it production capacity from the current 21,000 square metres per month to 27,000 square metres per month by 2004. The whole process mainly involves buying machines that requires about RMB70M. Approximately half of it was completed. In 2002, the group・s capex was RMB15M. In order to further strengthen its production ability, the group does not rule out possible mergers and acquisitions.

The group・s turnover in May achieved 10-20% growth y-o-y. In addition, it has half year・s orders in hand. To be conservative, we expect Sinotronics can have about 15% turnover growth in FY03. We expect earnings growth to be 8% due to $7.5M expense on changing listing status to main board. The expense was fully reflected in 1H03 results. We expect 15% turnover growth in FY04 to sustain, but earnings growth will be lower, at 12.9%. It is because the preferential tax treatment by mainland authority will be over by the end of 2003. From 2004 onwards, tax rate will be 15%.

The group has about RMB 100M cash in hand and no bank borrowings. Gearing is only 0.27x. Sinotronics is currently trading at 8.7x and 7.7x prospective PER for FY03 and FY04, respectively. Assuming a 20% dividend payout ratio, yield reaches 2.3% and 2.6% for FY03 and FY04 respectively. Valuation is undemanding when compared with other high-tech industrial stocks. We believe Sinotronics should be valued at 10x FY04 PER.

Consolidated Income Statement

For year ended 30 June (RMB in million)

2001A

2002A

2003F

2004F

Turnover

189.1

204.1

234.7

269.9

Cost of sales

(91.2)

(100.2)

(114.1)

(132.3)

Gross profit

97.9

103.9

120.6

138.7

@

 

 

 

 

Other revenue

0.6

2.3

2.3

2.3

Distribution costs

(5.2)

(6.5)

(7.5)

(13.5)

Administrative expenses

(8.3)

(13.5)

(23.9)

(22.9)

Other operating expenses

(8.6)

(3.4)

(3.1)

(3.1)

Profit from operations

76.4

82.8

88.4

101.5

@

 

 

 

 

Finance costs

(5.2)

(3.6)

(3.3)

(3.6)

Profit from ordinary activities before taxation

71.2

79.2

85.1

97.9

Taxation

(7.6)

(6.7)

(7.2)

(11)

Profit from ordinary activities after taxation

63.6

72.5

77.9

86.9

Minority interests

(6.7)

(7.8)

(8)

(8)

Profit attributable to shareholders

56.9

64.7

69.9

78.9

@

 

 

 

 

Proposed final dividend

-

12.8

14

15.8

Earnings per share - Basic (RMBcents)

20

18

17.4

19.6

Source: Sinotronics, Tung Tai estimates

Consolidated Cash flow statement

For the year ended 30 June (RMB in millions)

2001

2002

Operating activities

 

@

Profit from ordinary activities before taxation

71.2

79.3

Adjustments for:

 

@

Depreciation

6.5

7.9

Finance costs

5.2

3.6

Interest income

(0.2)

(0.08)

Provision for obsolete and slow-moving inventories (written-back)/made

1.5

(1)

Provision for bad and doubtful debts

5.4

1.9

Bad debts written off

-

2.2

Write-off of long outstanding creditors

-

(1.5)

Gain on disposal of fixed assets

-

(0.1)

Operating profit before changes in working capital

89.6

92.2

@

 

@

Decrease/(increase) in inventories

(3.6)

2.3

Increase in debtors, deposits and prepayments

(14.6)

(34.1)

Increase in creditors and accrued charges

11.7

1.5

Increase/(decrease) in other tax payables

(1.8)

0.4

Cash generated from operations

81.2

62.3

@

 

@

Tax paid

 

@

PRC enterprise income tax paid

(5.3)

(6.7)

@

 

@

Net cash from operating activities

75.9

55.6

@

 

@

Investing activities

 

@

(Increase)/decrease in deposits for purchase of machinery

1.5

(28.7)

Payment for purchase of fixed assets

(22.1)

(5)

Proceeds from sale of fixed assets

-

0.3

Increase in other receivables

(13.9)

-

Decrease in loan receivable

6

-

Increase in amount due from a minority shareholder

-

(1.3)

Decrease/(increase) in amounts due from directors

(0.1)

0.1

Interest received

0.2

0.08

Net cash used in investing activities

(28.5)

(34.5)

@

 

@

Financing activities

 

@

Proceeds from issuance of share capital

74.1

71.3

Payment for share issuance expenses

(22)

(4.3)

Proceeds from shares issued by a subsidiary

0.08

-

Proceeds from new short-term bank loans

41.2

33

Repayment of short-term bank loans

(67.8)

(35)

Repayment of long-term bank loans

(10)

(7)

Proceeds from advances from related companies

4.2

-

Repayment to related companies

(0.5)

(14.8)

Proceeds from advances from a director

2.4

0.3

Repayment to a director

(3.8)

-

Interest paid

(5.2)

(3.6)

Net cash from financing activities

12.6

39.9

@

 

@

Net increase in cash and cash equivalents

60

61

Cash and cash equivalents at 1 July

3.4

63.4

Cash and cash equivalents at 30 June

63.4

124.4

@

 

@

Analysis of the balances of cash and cash equivalents at 30 June

 

@

Cash at banks and in hand

63.4

124.4

Source: Sinotronics

Consolidated Balance sheet

As at 30 June (RMB in millions)

2001

2002

Non-current assets

 

@

Fixed assets

96.7

93.3

Deposits for purchase of machinery

1

29.7

@

97.7

123

Current assets

 

@

Inventories

8.7

7.4

Trade and other receivables

90.6

121.7

Cash at banks and in hand

63.4

124.4

@

162.7

253.5

Current liabilities

 

@

Trade and other payables

41.4

26.5

Short-term bank loans

35

33

Current portion of bank borrowings

7

-

Taxation

2.3

2.6

@

85.7

62.1

Net current assets

77

191.4

@

 

@

Total assets less current liabilities

174.7

314.4

@

 

@

Minority interests

12.6

20.5

Net assets

162.1

293.9

@

 

@

Capital and reserves

 

@

Share capital

36.8

42.7

Reserves

125.3

251.2

@

162.1

293.9

Source: Sinotronics




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