Sun East Technology (November 3, 2003)

Buy

Stock Code

365.HK

Price(31/10/03)

HK$1.20

Target Price

HK$1.76

 

 

 

 

Key Data

 

 

Shares Outstanding

350M

 

Market Capitalisation

HK$420M

 

52 week high/low

HK$1.44/ HK$0.1

 

ROA

-13.25%

 

ROE

-22.6%

 

Current ratio

1.36x

 

Gearing

0.11x

 

Major shareholder

 

 

Mr. But Tin Hing & Asso

50.5%

Turning around

PCB assembly lines total solution provider Sun East designs and manufactures its own screen printing, soldering and cleaning machines. The group is now the largest global distributor of Samsung SMT machines for 7 years. It offers full range of services that few manufacturers offer.

Lead-free soldering machines Sun East is the largest soldering machine manufacturer in China. It is also the only manufacturer that possesses the necessary technology to produce lead-free soldering machines. Global trend in electronics production is going lead-free. Moreover, the group is competitive in price, thus lead-free soldering machines are expected to be one of the future growth drivers.

Rapid growth in electronics sector in China Industry output of electronic and information enterprises in China in 2002 grew 21%. MII forecasts 2003 growth to be 17%. Shift of production base into China by foreign firms will continue to contribute to the growth.

Undemanding valuation The group has disposed of the loss-making consumer products and sub-contracting services. We expect the group to return into black with a $32.5M net profit this year. Based on our estimation, it is trading at 12.9x and 7.5x PER for FY04 and FY05, respectively. Valuation is undemanding. We believe it should be valued at 11x FY05 PER, which is equivalent to $1.76. 

As at 31 March(HK$・000)

2002A

2003A

2004F

2005F

Turnover

494,466

502,072

478,507

622,059

Gross Profit

113,822

54,171

119,627

167,956

Net Profit(Loss)

27,052

(42,670)

32,493

56,088

Basic EPS (HK$cents)

8.67

(14.81)

10.41

17.98

Diluted EPS (HK$cents)

N/A

N/A

9.28

16.03

P/E (x)

13.8

N/A

12.9

7.5

Source: Sun East Technology, Tung Tai estimates

Company background

Established in 1984, Sun East Technology has been principally engaged in design, manufacture and sale of soldering machines and automatic production lines in Hong Kong and China. In 1997, Sun East began to involve in the distribution of SMT (Surface Mounting Technology) machines supplied by Samsung.  Together with its PCB printing, soldering and cleaning machines, Sun East offers a full range of PCB manufacturing equipment. With its reputation and track record, the group has recently secured distribution rights of Siemens SMT machines.

Sun East Technology has workshops both in Shenzhen and Shanghai, with total area of 76,300 sq.m.. It has strong design capability as it has over 300 engineers and technicians. It is the largest soldering machine manufacturer and the largest SMT service provider in the PRC. It has 21% market share in the China market for soldering machines. In FY03, production lines and brand name production equipment accounted for 57.5% and 14.7% of the group・s turnover, respectively. Consumer products and sub-contracting services accounted for 23.9% and 3.9% of turnover. However, because consumer products and sub-contracting services incurred losses, the group disposed of the subsidiary, Pro-Tech Industries Corp., in March 2003.

Competitive strengths

Strong customer base

Sun East has a well established customer base, with a lot of customers being renowned brand names

Sun East has 19 years of experience in manufacturing soldering machines and production lines. It has established a strong and diversified customer base with over 2500 customers. Most customers of the group are renowned brands such as Emerson, Philips, Sony, Skyworth and TCL. The group has maintained over 10 years・ relationship with some of its customers. The largest customer only accounts for approximately 3% of turnover. The five largest customers account for less than 10% of turnover. A broad customer base enables the group to have more stable income. Reliance on a small number of customers can be avoided.

PCB assembly lines total solution provider

Together with distributing SMT machines, Sun East provides full range PCB assembly lines

Sun East designs and manufactures its own soldering machines and cleaning machines. Together with Samsung・s SMT machines, Sun East is able to provide full range PCB assembly lines from printing, SMT, soldering to cleaning. It has been one of the major distributors of Samsung for seven years. Sun East has recently secured distribution rights of high-end SMT machines of Siemens. The group・s target is to achieve $200-300M sales. The group・s market share in SMT machines is expected to grow. Compared with its peers in the industry, the group offers better services. 

Future growth drivers

Lead-free soldering machines

Lead-free soldering machines of the group is price competitive

Having 30% market share, Sun East ranks no. 1 in soldering machine market in the PRC. At present, soldering machines account for 34% of total turnover. In 1999, Sun East started research on lead-free technology. In 2002, it introduced lead-free soldering system, reflow and other series products. Lead-free soldering machine costs about $180,000 per unit, 20% higher than soldering machine. However, it is still 30% lower than its Japanese competitor and profit margin can reach 35%. Since cost is a major concern for most component makers, Sun East is more competitive than its Japanese competitors. Current customers include Samsung, Pioneer, JVC and Sony. Annual capacity for lead-free soldering machines can reach 1500 units by next year. 

Global trend in electronics production is going to be lead-free. At present, Sun East is the only lead-free soldering machines producer in China

Soldering is widely used in electrical appliance manufacturing. However, soldering material with lead in content is hazardous to health. It was banned to be used in Japan in 2003 and will also be completely banned in Europe in January 2004. In China, soldering with lead may be banned by 2006. By that time, old soldering machines may have to be replaced. Moreover, if brands want to maintain their market share in Europe and Japan, they must have lead-free parts. EMS companies in China have to be more involved in lead-free manufacturing. Demand for lead-free soldering machines may surge. At present, Sun East is the only company that manufactures lead-free soldering machines in China. Though there will be competition from foreign manufacturers, Sun East is well established in China market and has the first mover advantage.

China continues to be the world factory

Outsourcing to China will continue. Fast growth in electronics sector in China is expected to sustain

Low labour costs in China remain to be attractive to foreign capital. According to industry sources, international brand names such as Nokia and Motorola have 60% and 70% of their handsets made in China. Electronics is one of the sectors that undergoes fast growth. According to Ministry of Information Industry, the industry output of electronic and information enterprises reached RMB1.78 trillion in 2002, up 21% yoy. The authority forecasts sales of China・s electronic products to grow 17% to US$198B in 2003. In 1996, China produced just 2.61% of electronic goods in global market. By 2002, the percentage surged to 15.1%. Export value of electronics products in 2002 reached US$92.04B, accounting for 28.3% of China・s total exports. For semiconductor, the market in China is expected to reach US$28B this year, up 23.4% yoy. It is expected to grow at a 18.6% CAGR from US$23B in 2002 to $54B in 2007. The trend of shifting production base to China will continue, as multinationals are increasingly cost conscious. As a result, there will be sustainable demand for Sun East・s products.

Fabrication business

Orders on fabrication are expected to have stable growth

Sun East has been doing sheet metal fabrication business, which has wide application including telecommunication, electronic power, computer, commercial stereo appliances, etc. Emerson, an existing production lines customer of the group, has recently acquired Huawei, which is engaged in power supply. The group received orders from Emerson and is expected to grow continuously in the next three years. Moreover, the group formed a JV, Sun East Sanki, in which it has 50% interest with Sanki Trading Co Ltd. With a factory located in Shenzhen, the JV will be principally engaged in automobile production line and automobile production facilities business, mainly serves Japanese automobile manufacturer.

Conclusion

In FY02, turnover dropped from $509M in FY01 to $494M due to 911 Incident. Most electronic enterprises were investing little or unwilling to invest and thus affecting the sales of the group. The group suffered a loss in FY03 due to $25.5M operating loss from consumer products and sub-contracting services. In addition, the group invested $46M in product development for lead-free soldering, logistics, fabrication and bonding machines. Some of the costs are one-off. The group expects there will be $15M R&D costs each year, mainly on developing bonding machines, soldering machines with Rehm and logistics system software. The group made a $14M bad debt provision during SARS period. Sun East acquired Eastern Century Speed, which is engaged in the research and development of micro electronic precision wire solder interconnection technology at $28M.

The group did a 38M-share placement at $0.61 per share in October 2003. Net proceeds raised was about $22.5M in which $10M would be used for expanding capacity and the remaining balance as working capital. As at 31 March 2003, gearing (long term debt over equity) of the group was 11%. We expect gearing after share placement to drop slightly to 9.8%. Cash on hand is about $70M.

The group・s sales orders were affected by SARS, but were able to rebound afterwards. According to management, orders in 1H03 rose 20% yoy. We expect full-year turnover to be $478M, represents a drop from $502M in FY03, but striping out the discontinued operations, it is expected to be up 32%. The group is expected to return into black, with net profit of $32.5M. The stock is trading at 12.9x and 7.5x PER for FY04 and FY05, respectively. Valuation is undemanding given its growth potential. It should be valued at 11x FY05 PER, which is equivalent to $1.76.

Consolidated Profit and Loss Account

For year ended 31 March (HK$'000)

2002A

2003A

2004F

2005F

Turnover

 

 

 

@

Continuing operations

303,729

362,505

478,507

@622,059

Discontinued operations

190,737

139,567

-

@-

@

494,466

502,072

478,507

@622,059

Cost of sales

(380,644)

(447,901)

(358,880)

(454,103)

Gross profit

113,822

54,171

119,627

167,956@

@

 

 

 

@

Other revenue

3,480

2,066

2,043

2,043@

Selling and distribution expenses

(21,940)

(31,017)

(14,355)

(18,662)@

General and administrative expenses

(41,319)

(53,536)

(35,170)

(46,654)@

Other operating expenses

(18,687)

(14,733)

(29,355)

(32,291)@

Gain on disposal of discontinued operations

-

379

-

-@

Profit/(Loss) from operating activities

35,356

(42,670)

42,790

72,392@

@

 

 

 

@

Finance costs

(1,586)

(1,976)

(2,174)

(2,282)@

Profit/(Loss) before taxation

 

 

 

@

Continuing operations

33,092

(18,449)

40,616

70,110@

Discontinued operations

678

(26,197)

40,616

70,110@

@

33,770

(44,646)

-

-@

Tax

 

 

 

@

Continuing operations

(6,718)

(890)

(8,123)

(14,022)@

Discontinued operations

-

(680)

-

-@

@

(6,718)

(1,570)

(8,123)

(14,022)@

Net profit/(loss) from ordinary activities

 

 

 

@

attributable to shareholders

27,052

(46,216)

32,493

56,088@

@

 

 

 

@

Earnings/(loss) per share (HK$cents)

 

 

 

@

Basic

8.67

(14.81)

10.41

17.98@

Diluted

N/A

N/A

@9.28

16.03@

Source: Sun East Technology, Tung Tai estimates

Consolidated Cash Flow Statement

For the year ended 31 March (HK$'000)

2002

2003

Cash flows from operating activities

 

@

Profit/(loss) before tax

33,770

(44,646)

Adjustments for:

 

@

Depreciation

16,780

25,562

Loss/(gain) on disposal of fixed assets

(28)

83

Gain on disposal of discontinued operations

-

(379)

Amortisation of technical know-how

-

5,134

Deficit on revaluation of investment property

250

130

Loss on write off of fixed assets

2,750

-

Provision for doubtful debts

4,129

14,486

Deficit on revaluation of leasehold land and buildings

5

34

Provision for slow-moving inventories

1,198

1,893

Interest income

(2,297)

(622)

Finance costs

1,586

1,976

@

 

@

Operating profit before working capital changes

58,143

3,651

Decrease/(increase) in inventories

(9,366)

4,228

Increase in accounts receivable

(6,401)

(3,839)

Increase in prepayments, deposits and other receivables

(493)

(1,199)

Increase in accounts and bills payable

30,152

2,404

Increase in accruals and other payables

9,823

2,180

@

 

@

Cash generated from operations

81,858

7,425

Interest received

2,297

622

Interest paid

(1,398)

(1,694)

Interest element on finance lease rental payments

(188)

(282)

Dividend paid

(12,480)

-

Hong Kong profits tax paid

(3,023)

(1,203)

@

 

@

Net cash inflow/(outflow) from operating activities

 

@

Continuing operations

50,930

(5,142)

Discontinued operations

16,136

10,010

Total

67,066

4,868

@

 

@

Cash flows from investing activities

 

@

Purchases of fixed assets

(106,343)

(21,890)

Proceeds from disposal of fixed assets

33

-

Acquisition of a subsidiary

-

(28,000)

Disposal of a subsidiary

-

9,076

Increase/(decrease) in amounts due to directors

(956)

41

Decrease in pledged bank deposits

5,000

-

 

 

 

Net cash outflow from investing activities

 

@

Continuing operations

(72,236)

(36,573)

Discontinued operations

(30,030)

(4,200)

@

 

@

Total

(102,266)

(40,773)

@

 

@

Cash flows from financing activities

 

@

New bank loans

14,950

28,390

Repayment of bank loans

(4,673)

(5,194)

Capital element of finance lease rental payments

(4,008)

(4,996)

Net cash inflow/(outflow) from financing activities

 

@

Continuing operations

(7,028)

25,970

Discontinued operations

13,297

(7,770)

Total

6,269

18,200

Decrease in cash and cash equivalents

(28,931)

(17,705)

@

 

@

Cash and cash equivalents at beginning of year

92,427

63,352

Effect on foreign exchange rate changes

(144)

(109)

Cash and cash equivalents at end of year

63,352

45,538

@

 

@

Analysis of balances of cash and cash equivalents

 

@

Cash and bank balances

35,224

24,572

Time deposits with original maturity of less than three months when acquired

33,105

20,966

Bank overdrafts

(4,977)

-

@

63,352

45,538

Source: Sun East Technology

Consolidated Balance Sheet

As at 31 March (HK$'000)

2002

2003

Non-current assets

 

@

Fixed assets

200,842

154,818

Intangible assets

-

22,364

Other deposits and receivables

3,568

9,531

@

204,410

186,713

Current assets

 

@

Inventories

57,837

48,591

Accounts receivable

80,580

56,505

Prepayments, deposits and other receivables

3,544

11,347

Cash and cash equivalents

68,329

45,538

@

210,290

161,981

Current liabilities

 

@

Accounts and bills payable

68,101

56,281

Accruals and other payables

37,624

27,998

Interest-bearing bank borrowings

19,927

6,204

Finance lease payables

5,311

2,026

Tax payables

24,686

23,376

Amounts due to directors

1,226

3,216

@

156,875

119,101

@

 

@

Net current assets

53,415

42,880

Total assets less current liabilities

257,825

229,593

Non-current liabilities

 

@

Interest-bearing bank borrowings

-

22,186

Finance lease payables

4,919

1,046

Deferred tax

3,098

1,900

@

8,017

25,132

@

249,808

204,461

Capital and reserves

 

@

Issued capital

31,200

31,200

Reserves

218,608

173,261

Shareholders' equity

249,808

204,461

Source: Sun East Technology




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