Singapore Equity: Broadway Industrial

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Quick update on the current portfolio:
Equity Portfolio

Portfolio Comments
1.  Ho Bee continues to see interest due to speculation over a privatisation exercise which is highly unlikely in my opinion. However, due to improved earnings from 2016 and still attractive valuations, Ho Bee remains in the portfolio.

2.  Overseas Education saw decent appreciation with sell-side reports highlighting the potential revenue upside from their new Pasir Ris campus which should achieve TOP at the end of this month.

 

Had a request to comment on Broadway Industrial which I used to follow a few years ago when I spent quite a bit of time covering the technology sector.

I would classify this stock as a special situation stock in the sense that it should eventually become an M&A target as there is likely to be a willing seller who is a controlling shareholder and valuations are sufficiently attractive on a Price/Book basis to entice buyers.

However, I would not include this stock into the portfolio due to the following reasons:

  1. Uncertainty over the timing of the potential M&A;
  2. Core business as a contract manufacturer for hard disks which is a sunset industry;
  3. Relatively weak balance sheet (net gearing of 43%) compared to other contract manufacturers (generally net cash or low gearing except for Amtek Engineering due to major M&A);
  4. Lack of dividends for the past 3 years due to very weak profits and;
  5. Valuation from a 1 year estimated forward P/E perspective is not attractive.

Company Name: Broadway Industrial
Share Price: SGD 0.189
Market Capitalisation: SGD 89m

Here is the 3 year price chart:Broadway Industrial 3 Year Chart

Background
Founded in 1969 and listed on the SGX Main Board in 1994, Broadway Industrial (Broadway), through its subsidiary Compart Asia, is one of the top three manufacturers of actuator arms and related assembled parts for the global hard disk drive (“HDD”) industry. Compart also supplies precision components to the semiconductor, automotive and other industries.

From what I can recall, Broadway was the main supplier for Hitachi’s enterprise hard disks. Since enterprise hard disks require higher quality components compared to consumer hard disks, the implication was that Broadway produced better quality products than competitors such as Eng Teknologi and JCY International (listed in Malaysia) which were more focused on consumer hard disks.

In addition, Broadway is also a leading-edge producer of eco-friendly foam plastics solutions for packaging, insulation, automotive, medical as other applications.

Investment Rationale
The main reason to buy Broadway is to hold out for an eventual sale by the controlling shareholder.
The late Mr Wong Sheung Sze, the founder and former Executive Chairman, holds 36.16% of the shares and unfortunately passed away on 10 March 2015.

Mr Wong has a daughter, Wong Yi Jia (age: 31). I cannot find information about Mr Wong’s other children if there are any to begin with; maybe readers who know can enlighten us?

Hence, assuming that Yi Jia is the sole beneficiary of Mr Wong’s shares in Broadway and she decides to sell out her entire stake to an acquirer, this will trigger a general offer for the remaining Broadway shares.

In the meantime, Broadway has seen an earnings turnaround (from losses) since 2Q 2014 and steadily improving profits over the past 2 quarters. Besides the hard disk sector which is forecasted to see a 1.7% decline in shipments in 2015, Broadway should see higher profitability in 2015 (I am assuming core net profit attributable to shareholders of SGD 12.1m (FY14: 9.0m) and this should help the share price reverse its downtrend.

Risks
The key risk is that Broadway remains a value trap if the anticipated sale by the controlling shareholder takes far longer than expected due to lack of interested buyers (I cannot recall any recent takeovers in the contract manufacturing space, only privatisation exercises for the likes of Armstrong Industrial and Eng Teknologi).

I still expect the sale to occur as it makes no sense for Yi Jia to hold a controlling stake when she is only a non-executive director who is not involved in the day to day management of the business and has relinquished her role as the legal counsel and joint secretary of the company.

The other significant risk is a deterioration in the profitability of the company due to weaker than expected demand for its products or higher than expected costs.

Valuation
Broadway is trading at cheap valuations with 1 year forward Price/Book and Price/Net Tangible Assets (NTA) at 0.36x and 0.47x.
The 5 and 10 year historical mean for Price/Book is 0.70x and 0.88x respectively.

In terms of EV/EBITDA (1 year forward), it is still attractive @ 2.9x vs 5 year and 10 year historical averages of 3.9x and 3.4x respectively.

P/E is not used due to volatile net profits over the past 4 years.

Assuming Yi Jia would want to sell at least at historical mean Price/Book or Price/NTA valuation; this implies that the sale price could range from at least SGD 28 cents to SGD 47 cents which implies upside of 48% to 148% from the current share price.