Daily Equities Bottom-Up: Notes from the Silk Road: Smartgroup Corporation Ltd (SIQ.AX) and more

In this briefing:

1. Notes from the Silk Road: Smartgroup Corporation Ltd (SIQ.AX)
2. SK Hynix: Attractive at Current Level
3. Nidec (6594 JP): Recovery to Take Time, Valuations Still High
4. REIT Discover: Frasers Commercial Trust (FCOT SP) At Inflection Point
5. Korean Stubs Spotlight: A Pair Trade Between SK Telecom & SK Hynix

1. Notes from the Silk Road: Smartgroup Corporation Ltd (SIQ.AX)

• 2018 full results due on the 18^th February 2019: Since our initial report on 3rd September 2018, SIQ’s share price has declined some 21% versus the ASX All Ordinaries fall of circa 8%. With results due, we expect the market to refocus on Smartgroup and its good growth story. This is important as much of the focus for the group in the last two years has been on the acquisitions being made. To see management return focus to organic growth, post these acquisitions should help investor confidence in SIQ. Specifically concentrating on the cross-selling of its services whilst benefiting from Australia’s tight labour market and corporates chasing incremental cost savings can only be positives.
• Review and upgrade to forecasts: With the benefit of further time to review SIQ’s business progress and the composition of our forecasts, we have increased fiscal 2018 and 2019 EPS forecasts 10% and 12% respectively. Much of our thought process is at the SG&A line, whilst the view that the overall trajectory of earnings remains on track. 
• 2019 we expect to be a year of consolidation, with consistent growth: In the two years to the end of fiscal 2017, SIQ had made six acquisitions. These acquisitions were aimed at both industry consolidation, as well as complementary product build out. We expect 2019 to be a year where the benefits from these acquisitions are exhibited in both the bottom and top-line growth. We expect this even though 2019 may present macro challenges. 
• We reiterate our view that SIQ offers Growth at a Reasonable price: SIQ’s forward multiples are positive for a company which has posted a long term book value growth rate of circa 7%  (net of dividend) and is forecast to post a similar rate 2019 and in 2020. Based on our 2019 EPS forecasts SIQ should be able to deliver circa A$0.62/share, which implies 18% YoY growth and a 13 times P/E. 

2. SK Hynix: Attractive at Current Level

Multiple news article mentioned SK Hynix’ weak Q4 2018 numbers due to the slowdown in the smartphone markets but the fact remains that:

1. smartphone is the dominant communication tools
2. smartphone penetration still has room to grow
3. current model of smartphone is likely to remain the same for the next foreseeable future
4. lower end smartphones will likely be the next growth driver

In this report we will discuss the following:

1. Q4 2018 result

2. Price action in 2018

3. Margin comparison with the peers

4. Exposure to the growing affordable smartphone segment

3. Nidec (6594 JP): Recovery to Take Time, Valuations Still High

After dropping to a 52-week low of ¥11,405 on January 17 – the day after management announced a large downward revision to sales and profit guidance – Nidec rebounded to close at ¥13,055 on Friday, January 25. The latter price is 30% below the ¥18,525 peak reached a year earlier. Both the shock of the downward revision and the reflexive optimism of believers in the company now seem to have been discounted.

Consolidated sales and profits dropped abruptly in the three months to December and are expected to drop further in 4Q of FY Mar-19 due to weak demand in most regional markets, inventory write-downs and restructuring costs. Nidec is already reconfiguring its global supply chains, shipping products to the U.S. from Mexico and Europe instead of from China and planning to build factories to make motors for electric vehicles in Mexico and Poland in addition to China.

With most of the one-off expenses out of the way, profits should start to recover in FY Mar-20. Sales, on the other hand, seem likely to decline further due to weak unit demand and pricing for HDD spindle motors, falling auto production in China and elsewhere, and weakness in other industrial and commercial markets. Recovery will depend on U.S.-China trade relations and the state of the world economy, and new acquisitions that cannot be predicted. As things stand now, we expect sales to pick up going into FY Mar-21. In the long run, the company should continue to benefit from the electrification of the auto market and factory automation.

At ¥13,055, the shares are selling at 34x management’s EPS guidance for FY Mar-19, 32x our estimate for FY Mar-20 and 30x our EPS estimate for FY Mar-21. Projected EV/EBITDA multiples for the same three years are 18x, 17x and 15x. Price/book value as of the end of December is 3.9x. The dividend yield is less than 1%. Over the past few years, the P/E has found support at 20x, EV/EBITDA at 10x and the PBR at 2.5x. The January 17 low put the shares on 30x management’s new EPS guidance for this fiscal year.

4. REIT Discover: Frasers Commercial Trust (FCOT SP) At Inflection Point

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to uncover hidden gems and gems in-the-making. In this insight, we give a lowdown on Frasers Commercial Trust (FCOT SP), which appears to be at an inflection point after seven consecutive quarters of falling net property income stemming from a downward trending occupancy rates.

At the centre of its conundrum is a key property, Alexandra Technopark (ATP), whose committed occupancy as at 31 December 2018 was a dismal 68.6%. 

In the meantime, there are three things happening that could help to spruce up FCOT’s operational metrics.

1. S$45mn asset enhancement initiative (AEI) at ATP to create a new contemporary business campus is nearing full completion. The AEI is aimed at creating a business campus environment to enhance property’s profile.
2. S$38mn AEI to rejuvenate the retail podium at China Square Central (CSC) which will increase its NLA from the current 64,000 sf to 78,000 sf upon completion by mid-2019. The concurrent launch of 304-room Capri by Fraser Hotel abut CSC will bring increased activity to CSC and benefit retail tenants.
3. Current gearing of 28.4% is one of the lowest among S-REITs, giving FCOT additional debt headroom estimated at about S$418mn to pursue growth initiatives. 

Following the recent run-up in the prices of S-REITs, FCOT trades at 0.9x P/NAV (ex-DPU). At current price, annualized FY19 DPU yield of 6.7% represents a differential of about 200 basis points above that of sector leaders like Capitaland Commercial Trust and Keppel REIT, a reflection of the Grade B profile of FCOT’s commercial properties. 

Interestingly, FCOT’s distributable income was growing in spite of the downtrend in gross revenue. This was likely the result of the new contribution from its UK asset acquired in January 2018. As such, FCOT was able to maintain DPU at a stable 2.40 cts for the past seven quarters. In the medium term, earnings upside will come from the organic growth of its revamped Singapore property portfolio and potential acquisitions in its sponsor’s key markets, Australia and Europe (likely UK). Any developments relating to the Brexit process will therefore have an impact on FCOT. In the near term, the built-in step-up rents mechanism in 47% of its leases in FY19 and FY20 should provide support to gross revenue. All things considered, FCOT’s future is worth a bet. 

5. Korean Stubs Spotlight: A Pair Trade Between SK Telecom & SK Hynix

In this report, we provide an analysis of our pair trade idea between SK Telecom (017670 KS) and SK Hynix Inc (000660 KS). Our strategy will be to long SK Telecom (017670 KS) and short SK Hynix Inc (000660 KS). Our base case strategy is to achieve gains of 8-10% on this pair trade. Our risk control is to close the trade if it generates 4-5% in combined losses. Cost of commissions are not included in the calculations and closing prices as of January 25th are used in our pair trade. [Long SK Telecom – $0.5 million; Short SK Hynix – $0.5 million for total of $1.0 million].

The following are the major catalysts that could boost SK Telecom shares higher than SK Hynix shares within the next six to twelve months: 

• Finally, a Higher DPS for SK Telecom is Likely, but Market Has Not Fully Factored In
• SK Hynix’s Plan for a 40% Lower Capex in 2019 Implies an Excess Inventory Condition
• 5G Service Ready to Start in March; Higher ARPU Typically Results in Higher Share Price
• SK Telecom’s Establishment of an Intermediate Holding Company Will Take Place in 2019