A Complete Analysis of PNE Industries Ltd: Is This The Net-net Stock You Are Looking For?

PNE Industries Ltd (SGX:BDA) is engaged in manufacturing and distribution of transformers, electronic controllers, emergency lighting equipment and electronic ballasts.

The group operates in two segments:

1- Contract manufacturing segment: manufacturing of electronic controllers and other electrical and electronic products. The designs of the transformers and electronic controllers are customised for clients.

2- Trading segment: manufacturing and trading of emergency lighting equipment and related products. The emergency lighting equipment and electronic ballasts are mass-market products which are not customised.

The manufacturing segment contributes 85% to revenue and 70% to profits while the trading segment contributes the remaining 15% to revenue and 30% to profits.

Electronics Contract Manufacturing Services

The Group manufactures electronic controllers combined with intelligent features made possible by the use of microprocessors or by the connection to the Internet. These are products like smart home-lighting devices with IoT features for a leading European lighting company which allows users to control their lights over the Internet.

The Group also manufactures personal handheld medical scanning devices as well as energy management systems with IoT features.

The group’s Johor manufacturing facility is located at Tebrau Industrial Estate Johor Bahru is producing high-mixed low volume EMS products. While the manufacturing plant in China is producing the high volume EMS products.

Emergency lighting

PNE Industries also manufactures and distributes a wide range of emergency lighting equipments, including those for indoor use or outdoor use under its own PNE brand.

Emergency lighting equipment is a type of lighting equipment that turns on or remains on when a power failure occurs. One such type of emergency lighting equipment is the “Exit sign” that we typically see within a building. Exit signs are self-lit signage installed in buildings to show occupants the direction and location of emergency escape routes and/or exits.

Segment Historical Revenue and Profits

The group’s revenue and profits from 2014-2017 has been stable with marginal growth from both segments. However, 2018 financial performance has been poor as its profit margins declined.

In FY18, the contract manufacturing segment recorded a 13% drop in revenue to $69.27m from the previous year of $79.4m, this is due to a general decline in customer orders. At the same time, the trading segment marginally grew 2% to $10.6m due to larger sales volume in Malaysia.

The Group’s profit shrank by half in FY18 from $8.8m to $4.05m. The drastic decline in profits was largely attributed to differences in product mix, as the Group sold more products with higher

material cost content in FY18. This was aggravated by strong market competition which led to lower selling prices for existing products, while delays in the launch of new products also meant that the Group did not get to benefit from the higher margins that newer products usually enjoy.

Source: PNE Industries Annual Report

Key Geographical Markets

The majority of its customers are based in Europe, accounting for 39% of FY18 revenue – this excludes customers based in Poland and Hungary. Customers based in Poland are the second largest contributor of revenue, accounting for 21% of FY18 revenue. While, China contributes 12% of FY18 revenue.

In the last 4 years, revenue from its European customers have grown 4 times since 2015. However, markets like Poland and China have seen a gradual decline in orders. Despite the decline from Poland, the country is still an important market for PNE. China on the other hand, is likely to be a challenging market in the coming years due to trade tensions and rising labour cost. The Malaysian market remains steady despite the overall decline in revenue for FY18. While other markets like Indonesia and Singapore collectively contributed an average of 15-20% of revenue in the last 4 years.  

Source: PNE Industries Annual Report

Sales from the contract manufacturing segment are driven by 3 major customers which make up more than 70% of EMS segment revenue. Collectively, these 3 major customers accounted for more than 60% of overall revenue in FY18. 

Business Outlook

PNE industries operates in a competitive market where profit margins are squeezed as competition drives down the selling price of its products. Its contract manufacturing segment is cyclical as production of consumer electronics plateau in recent years. The unpredictability of orders from customers adds on to its challenge for long-term planning.

In the operational side, cost pressures continue to rise in Singapore, Malaysia and China, where the group’s main manufacturing facilities are located. China is no longer a low-cost manufacturing hub as minimum wage continues to rise. Due to this, the group’s operating cost, especially its labour cost will be impacted.

Source: tradingeconomics.com

Its declining margins over the past few years clearly reflects the challenges that the group faces now. In FY18, its operating margin dips below 10%, shrinking more than half since 2014.

Source: PNE Industries Annual Report

With the ongoing uncertainty on Brexit, sales from Europe might be affected –  a key region where most of its customers are based. In addition, the group is also exposed to the trade tensions between the US and China as it has manufacturing facilities based in China and where Chinese customers make up the group’s 3rd largest customer base.

FY19 Half-Year Results

FY19 looks to be a better year PNE Industries as its mid-year results showed signs of recovery. For the quarter ending June 2019, the group recorded revenue and profit of $25.7m and $2.9m respectively as revenue improved by 70.4% vs 3Q18. For the 9 months ended June 2019, the group recorded revenue and profit of $73.9m and $5.7m respectively. Revenue rose by 37.3% vs 9M18, the gains in revenue is largely due to higher customer orders from the group’s contract manufacturing customers during this period. The group’s full year revenue and profit for FY19 is expected to exceed that of FY18.

That said, PNE’s profit margin is still under pressure because of differences in product mix as the group sold more products that have higher material cost content.

Strong Balance Sheet

Despite the gloomy business outlook, PNE Industries is financially strong. The group has been very conservative over the past few years with no outstanding long-term debt and has always maintained a healthy cash reserve on its balance sheet. This puts the company in a strong position to weather headwinds as competition and operational cost continues to be a challenge. The chart below shows the Cash per share (in blue) and Net Cash per share (in red) of the company over the past 5 years.

Source: PNE Industries Annual Report

Track Record of Positive Cash Flows

Despite its declining margins, the group continues to generate free cash flow in FY18. PNE has a good track record for maintaining positive cash flow from operations in the past 5 years and does not require large CAPEX to maintain or grow revenue, on average CAPEX represents only 1% of revenue.

Source: PNE Industries Annual Report

PNE’s ability to generate cash flow despite its challenges is a positive note for investors. This means that the company can continue to pay dividends and would not have to use its cash reserves for dividend payments. Over the past few years, the group has consistently paid out dividends averaging around $0.06-0.07, in some years, dividends paid were as high as $0.12.

Insider Ownership

The group is largely controlled by the Tan brothers (Tan Koon Chwee and Tan Kong Heng), both holding key positions in the group, Executive Managing Director and Non-Executive Chairman respectively. All directors of the company, excluding the independent directors, are siblings.

Historical Valuation

On the valuation side, PNE’s current P/E ratio may seem rich given its historical range between 4-8x price to earnings. Its low P/E trend reflects the lack of revenue growth in the past few years. Although the business is not in a terminal decline, investors seem to lack interest in the company given that it operates in a competitive and dull industry. Expansion in the P/E ratio since 2018 is mainly due to the decline in earnings in FY18. 

Source: PNE Industries Annual Report

Presently, PNE’s price to book value is marginally under the 3 period moving average. In FY15, its P/B was as low as 0.6 and by 2017, investors recognised that the company was undervalued thus, its share price doubled from $0.5 to as high as $1.1 in June 2017. Its Net Current Asset Value (NCAV) remains steady at $0.83 per share or approx $70mil in market value. With its current market capitalisation at $65mil, theoretically, an investor could buy its entire business, fixed assets and $70mill worth of liquid assets, for just $65mil.

A Case For Conservative Valuation

Given the uncertainty surrounding its revenue growth, PNE is an asset play where the case for valuation is based on assets the company owns. To arrive at a conservative asset valuation for the business, we consider its liquid and marketable balance sheet items such as Current Assets, Leasehold and Freehold land, Building as well as its ownership of shares in PNE PCB Berhad. The sum of these assets is subtracted against the company’s total liabilities, and then divided by its outstanding shares. This liquidation method gives us a value of $0.91 per share and in comparison to its share price today, this translates to a discount 15% from its liquidation value.

Key Risk

Europe and China are key markets that may continue to drive revenue growth. That said, the macroeconomic headwinds concerning these regions may also pose a risk for the company. Although, revenue from European customers has been increasing despite the uncertainty surrounding Brexit, the issue is still unsettled. In China, trade tensions continue to affect global trade sentiments. Although the on-going trade tensions have not had a significant impact on the Group for the 9 months to Jun 2019, the continuation or escalation of the tensions in future may worsen economic sentiments, which may in turn affect demand for PNE’s products.

VIA’s Verdict

Despite the challenges and uncertainty of revenue growth, PNE industries presents a unique opportunity as the company is financially strong with no long-term debt. The business is still cash flow generative as it does not require large CAPEX to maintain or grow revenue. The group has maintained a perfect dividend track record over the last few years despite the challenges it faces. On a valuation standpoint, the stock is relatively cheap as it currently trades below our conservative valuation of $0.91 per share. As a net-net stock, PNE fits perfectly in portfolio of deep value stocks. In a deep value portfolio, the focus is on the net-returns of the portfolio thus, the key is to diversify adequately and restrict a position limit to each stock so that if one stock fails, it doesn’t drag the entire portfolio down.

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