TCL Communication Technology Holdings Limited
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HONG KONG TCL Communication 2618 HK Outperform Price 27 May 11 HK$5.61 Technology 12-month target HK$ 8.90 Upside/Downside % 58.6 Emerging market handset play Valuation HK$ 8.90 - PER Event GICS sector Technology Hardware & Equipment We initiate coverage on TCL with an Outperform rating. TCL produces Market cap HK$m 6,205 handsets under the TCL and Alcatel brands for the Chinese and overseas 30-day avg turnover US$m 3.0 markets, respectively. Our target price of HK$8.90/sh is based on our target Market cap US$m 797 multiple of 8x FY12E PER. We like TCL as an emerging market low-end 2G handset manufacturer improving its product mix as it progressively introduces Number shares on issue m 1,106 3G smartphones. Investment fundamentals Impact Year end 31 Dec 2010A 2011E 2012E 2013E Revenue m 8,701 12,756 17,145 20,614 Improving ASP. In contrast to the trends seen at other handset vendors, we EBIT m 530 857 1,184 1,657 EBIT growth % nmf 61.8 38.1 40.0 expect ASP to improve by 6% in FY11. We see two major drivers for this; Reported profit m 702 941 1,245 1,694 firstly, TCL is introducing 3G into its handset mix for the first time this year EPS rep HK$ 0.63 0.84 1.11 1.50 EPS rep growth % 3,127.9 32.2 32.3 36.0 with our expectations for 3G to make up 10% of shipment volumes and in the PER rep x 8.9 6.7 5.1 3.7 ODM segment, secondly, TCL is moving away from super low-end production. Total DPS HK$ 0.25 0.28 0.36 0.50 Total div yield % 4.4 4.9 6.5 8.8 Margin expansion. We factor in 7% unit cost inflation in FY11 as product mix ROA % 5.6 6.6 8.0 9.9 ROE % 42.4 36.2 36.1 37.1 moves toward higher spec 3G smartphones, seeing gross margins decline by Net debt/equity % 231.4 173.8 128.2 83.2 60bp. However, due to the 40% uplift in volumes, we expect TCL to realise P/BV x 2.8 2.1 1.6 1.2 scale economies, resulting in 60bp in operating margins. 2618 HK rel HSI performance Handsets stack up well in the mass market segment. Compared with other handsets, we find TCL’s smartphones compare reasonably well, with similar or slightly better specs on OS, CPU, camera and screen size. Capacity expansion. Production capacity is currently 65m units and TCL intends to increase this by 15% this year and to double capacity to 130m over three years. We see capacity utilisation increasing to 67% in FY11 from 56% in FY10. Earnings and target price revision Source: FactSet, Macquarie Research, May 2011 (all figures in HKD unless noted) Initiation of coverage. Price catalyst 12-month price target: HK$8.90 based on a PER methodology. Catalyst: continued growth in monthly shipment volumes Action and recommendation Outperform. Our target price of HK$8.90 is based on 8x FY12E PER, an undemanding multiple that represents a discount relative to other handset vendors. We believe TCL will trade at a discount to other handset names until Lisa Soh, CFA successful execution of its strategy to move into the smartphone segment is +852 3922 1401 [email protected] Jason Zhou reflected not only in volumes but also in ASP and margins. We believe +86 21 2412 9062 [email protected] continued strong monthly shipment volumes, improving ASP and margins will be positive catalysts for TCL, moving it toward our target price. 31 May 2011 Macquarie Capital Securities Limited Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/disclosures. Macquarie Research TCL Communication Technology Investment thesis We initiate coverage on TCL Communication (TCL) with an Outperform rating and target price of HK$8.90/sh. TCL is evolving from a legacy 2G low-end handset manufacturer to a 2G/3G smartphone manufacturer in the low to mid-end range. The vast majority of its volumes go overseas (over 90%), with only a small proportion remaining in China. TCL is increasing capacity, with current capacity of 65m units increasing to 75m by end 2011 (+15%) and plans underway for a new factory that will see this rise to 130m units. At MWC 2011, TCL introduced its new Alcatel One Touch brand that is designed for easy use with a variety of different features targeted at attractive pricing points. TCL markets this as “Alcatel One Touch makes access to today’s mobile lifestyle simple by offering colorful, easy-to-use devices equipped with the technology people need most at prices they can afford”. The new product line up is grouped into five different ranges (Get Apps, Just Add Friends, Keep In Touch, Simply You, Speed It Up). This is a change from the company’s legacy product focus that was 2G based (and an ODM operation that was also largely low end). The focus going forward is on introducing 3G handsets into the product mix and in the ODM business, trying to change the products manufactured to slightly less low-end handsets. We believe that TCL’s mix will remain dominated by 2G but the introduction of 3G into the mix within the Alcatel/TCL business and better (higher value) product in the ODM business will help TCL temper the extent of ASP erosion. Can a move to a 3G product strategy be successful? Other handset vendors that have adopted similar strategies (ie. trying to upsell product range from low- to mid-end) have had limited success in improving ASP to date due to the general price deflation trends in the handset business. A notable example is ZTE’s (763 HK, HK$26.7, UP, TP HK$27.00) terminal business that has also increased its smartphone mix but has yet to see an improvement in ASP. We believe ZTE and Huawei (unlisted) are competitors to TCL in the emerging market handset segment, however we see TCL succeeding in increasing its ASP where ZTE has failed, as we believe that in order for ZTE and Huawei to secure volumes in these markets where it lacks brand presence, these companies will have to necessarily price their white label handsets more aggressively. Our forecasts for TCL factor in ASP increases of 6% but a decline of 4% in FY11 and FY12, respectively. We believe ASP increases are likely, driven by: ⇒ Change in sales mix from no 3G handsets in 2010 to 5m in FY11E that should help blended ASP, with our forecast for 3G ASP at HK$750 (approx US$96). Our forecasts see a 17% decline in 2G ASP in FY11E. The uplift from 3G volumes (10% of total volumes) and ASP should offset the price decline on the 2G side. ⇒ Moving to low/mid-end ODM (from super low-end). Our forecasts see an average ASP for ODM units in FY11E of HK$85 (US$11) vs HK$70 (US$9) in FY10. This should also help PRC ASP. 31 May 2011 2 Macquarie Research TCL Communication Technology Fig 1 ASP assumptions HK$ 2010 2011E 2012E PRC 230.8 281.6 292.9 Overseas 240.8 252.8 240.2 Blended 240.2 255.1 244.9 US$ equivalent 30.9 32.8 31.4 % change PRC 31% 22.0% 4.0% % change Overseas -17% 5.0% -5.0% % change Blended -11% 6.2% -4.0% % change US$ equivalent -11% 6.0% -4.1% ASP 3G na 750.0 625.0 ASP 2G 240.2 200.1 193.1 % change 3G na na -17% % change 2G -11% -17% -4% ASP Alcatel/TCL 300.3 311.8 297.6 ASP ODM 70.0 85.0 87.0 % change Alcatel/TCL 4% -5% % change ODM 21% 2% Source: Company data, Macquarie Research, May 2011 We show examples of TCL’s product range in Fig 2 and Fig 3, below. As can be seen, the overwhelming majority of handsets are 2G, with the OT-890 the company’s first 3G handset. Fig 2 Examples of TCL’s handset range OT -890 OT-808 OT-710 Range Get Apps Just Add Friends Keep in Touch Display 3.2” TFT resistive, 320x240 2.4” TFT, 320x240 2.8” TFT resistive, 320x240 OS Android 2.1 2G 2G CPU 420MHz None None Source: Company data, Macquarie Research, May 2011 Fig 3 Examples of TCL’s handset range OT-665 OT-880 OT-208 Range Simply You Display 1.8” TFT 128x160 2.4” TFT resistive, 320x240 1.45” CSTN, 128x128 OS 2G 2G 2G CPU None None None Together the OT-208, OT-808 and OT-880 accounted for 3.5m units in 2010 Source: Company data, Macquarie Research, May 2011 31 May 2011 3 Macquarie Research TCL Communication Technology Compared with other handsets, we find that TCL’s smartphone handsets stack up reasonably well (in the absence of more pricing detail). For the upcoming launch of the OT-990, this appears to be very much targeted at the low-cost smartphone segment. Looking across other vendors with similar offerings, we find these handsets all run on Android 2.2 with the same CPU speed (600MHz) and same camera resolution (with Samsung Galaxy Mini lower resolution at 3MP) but TCL has a slightly larger screen at 3.5” vs 3.1-3.2” from other vendors.