Brief TMT & Internet: GMO Internet Reports Solid FY12/18 Despite Heavy Losses Incurred in Crypto Mining Business and more

In this briefing:

1. GMO Internet Reports Solid FY12/18 Despite Heavy Losses Incurred in Crypto Mining Business
2. U.S. Equity Strategy: Upgrading Manufacturing Sector
3. NTT Corp: The Rising Dividend Story Is Playing Out.
4. Valuetronics (VALUE SP): Trade War Uncertainty Continues, Downside Supported by Large Cash Position
5. Apple Shipments to China Fall as Local Phone Makers Eat Up Market Share

1. GMO Internet Reports Solid FY12/18 Despite Heavy Losses Incurred in Crypto Mining Business

GMO Internet, Inc. (9449 JP) announced its consolidated financial results for its full-year FY12/18 yesterday (12^th February). Despite heavy losses incurred in the cryptocurrency mining business in FY12/18, GMO managed to achieve a solid year with 20% YoY growth in top-line alongside a 23.5% YoY growth in operating profits. Excluding the crypto losses, the operating profit increased 35.7% YoY, with an OPM of 13.2% compared to 11.4% reported a year ago. For the full-year, the company has reported a net loss of JPY20.7bn as opposed to a net profit of JPY8bn in FY12/17, blaming the crypto losses for the decline. For FY12/18, the management has proposed a dividend of JPY29.5 per share (compared to JPY23 paid in FY12/17) in spite of reporting net losses for the fiscal year. Further, the company has also allocated JPY1.36bn (equivalent to 0.7% of outstanding shares at the current price) for share repurchases in FY2019.

GMO is currently trading at JPY1,741 per share which we believe is undervalued compared to its combined equity stake in 8 listed subsidiaries. The company share price has lost more than 40% since it peaked in June last year due to the negativity surrounding its cryptocurrency and mining segment. However, we believe further downside is limited as the company has closed down a majority of its mining related business which weighs very little on the consolidated performance of the company. Further, the company’s key businesses, Internet Infrastructure, Online Advertising & Media and Internet Finance generate solid recurring revenues, which should help the company achieve strong growth. Following its earnings announcement, the share price gained 5.6% from the previous days close.

2. U.S. Equity Strategy: Upgrading Manufacturing Sector

The S&P 500 continues to hover below critical resistance at its 200-day moving average while market participants remain in a wait-and-see mode for new developments on U.S.-China trade and details on the latest border security proposal. At the same time, breadth improvements have extended to our Manufacturing Sector – a welcomed sight given its cyclical nature.  We are Upgrading Manufacturing to market weight from underweight. Our cap-weighted Manufacturing Sector has steadily improved in our RSR ranks due in large part to strength in Aerospace & Defense Groups. In today’s report we highlight attractive Groups within Manufacturing and Technology..

3. NTT Corp: The Rising Dividend Story Is Playing Out.

As we wrote about in Preference for NTT Retained on Its Commitment to a Substantial Long Term Profit Increase, we like the long term story at NTT (Nippon Telegraph & Telephone) (9432 JP) given its relatively low payout ration, long term opportunities for cost reductions as their workforce shrinks through retirements. While government action and the announced price cuts announced by NTT Docomo Inc (9437 JP) hurt sentiment to the sector in 2H18, Chris Hoare remains positive. The recent 3Q results were decent with the key positives being a rising dividend and strong cash flow growth which is in line with our long term positive thesis on the stock. We remain Buyers with a target price of ¥7,150.

4. Valuetronics (VALUE SP): Trade War Uncertainty Continues, Downside Supported by Large Cash Position

Valuetronics reported its 3Q19 figures this week which showed a 7.5% decline in revenues but a small (+2.6%) increase in bottom line profits. Stronger margins in its ICE segment offset weakness in its CE segment.

Valuetronics Holdings (VALUE SP) remains a solid company run by a good management team with interesting clients in consumer electronics and automotive. The valuation of the company is cheap (5x ex-cash 2019 P/E) and the balance sheet is rock solid.

All these positives are currently being overshadowed by the US-China trade war as the company has 100% of its production in China and does 45.7% of its sales in North-America. While many companies try to downplay the impact of the trade-war Valuetronics cannot hide and the alternatives it is working on to offset the tariff impact will surely cause short-term disruption and increased costs.

YTD the share price is +12% as the market is hoping for a positive resolution to the US-China trade war. Management is cautious on macro political improvements as trade war friction is unlikely to dissipate soon. Given the weak outlook for its CE segment and no significant new customer wins in its ICE segment risk/reward does not seem very attractive despite good dividend yield and cheap valuation.

5. Apple Shipments to China Fall as Local Phone Makers Eat Up Market Share

• The Chinese smartphone market, which commands approximately 30.0% of the global smartphone market, experienced declining sales in 4Q2018. The Chinese smartphone market fell by 9.7% YoY in 4QFY2018 .
• Meanwhile, the global smartphone market fell by 4.9% YoY in the same quarter as a result of conditions in China, longer replacement cycles and a lack of technological innovations in the industry.
• Apple continued to suffer with iPhone shipments to China falling by 20.3% YoY during the last quarter.
• 5G compatible phones are likely to turn around industry performance, however, the introduction of such devices will most likely occur in the latter half of 2019. Apple, in question is rumoured to release their 5G compatible iPhone in 2020, later than close competitor Samsung.
• Slow market conditions are likely to prevail until the next generation of communication technology becomes commercialised. Until such a time, companies such as Apple, and parts suppliers to smartphone vendors may continue to struggle with slowing performance similar to that of present. However, over the long term, companies stand to benefit once 5G is released in spite of the short term outlook not being too favourable.