Securities Analysis (Equity) TCL Communication (218 HK) Painful transition period 1H12 profit warning. TCL Com announced profit warning on 15 Jul and expected to record a significant drop in 2Q12 net profit on yoy basis. However, net profit in 2Q12 is expected to be higher than that in 1Q12. The substantial fall in profitability is due to 1) featured phone ASP and gross margin declined on weakened consumer confidence around the globe; 2) slow uplift in Smartphone gross margin on longer than expected ramp-period; and 3) R&D and SG&A costs surged for penetration into the Smartphone market. Buy (Maintain) Target Price HK$2.33 Up/downside +28.5% Current price HK$1.81 Michael Cheung, CFA (852) 3900 085 michaelcheung@cmbi.com.hk Jun shipment growth backed on track, but Smartphone shipment growth faced bottleneck. TCL Com reported a strong June shipment growth. Total handset shipment reached.33mn, increased by 1.3% yoy; turned around from 1.5% yoy shipment shrunk in May. Overseas market was the key contributor to the shipment turnaround, thanks to new CDMA phones launching and enhanced cooperation with overseas operators. However, we see a slowdown in shipment growth in Smartphone segment. Smartphone shipment growth faced bottleneck due to 1) a slower than expected new Smartphone model launching by TCL Com; and 2) new-entrants to the entry-level Smartphone market intensified competition. 3Q12 to be the key for Smartphone ramp-up. As featured phone market keep being squeezed by entry-level Smartphone, we believe TCL Com s step-up strategy is necessary. 3Q12 will be the key for TCL Com s Smartphone ramp-up, the Company will launch series of new Smartphone models, including W989 and S500 which have been selected by China Unicom (73 HK). TCL Com expands its sales network in China by 1) cooperating with all three operators; 2) open market sales through partnering with retailers like Suning (00202 CH); and 3),000 point of sales (10,000 by the end of 2012). We revise down our FY12 and FY13 revenue forecast by 7.7% and 7.2% respectively. We also lower our FY12 and FY13 earnings estimate by 50.% and 31.2% to HK$2mn and HK$5mn respectively. TCL Com is undergoing a painful but necessary transition, temporary rise in R&D and marketing cost pave road for success in Smartphone market. The Company faced similar hardship in 2009 and successfully turned around in 2010 by capturing the emerging market feature phone boom. June shipment figures backed on growth trend also indicate the Company s R&D and marketing effort started to take effect. We lower our target price to HK$2.33 from HK$.9 on.0x FY12 PE, implying 28.5% upside potential. Given the bright future of China Smartphone market, and current undemanding valuation, we believe it s a good entry point for long term investors. Maintain BUY. Technology Mkt. Cap. (HK$mn) 2,0 Avg. 3mths t/o (HK$mn) 5.2 52W High/Low (HK$) 7.31 /1.72 Total Issued Shares (mn) 1,11 Shareholdings Structure TCL Holding 7.83% TOE Yeung Wong 7.75% Dong Sheng Li 3.13% Free float 0.5% Share performance Absolute Relative 1-mth -37.% -37.3% 3-mth -5.8% -1.1% -mth -9.1% -8.2% 1 year price performance HK$ 10 8 2 0 Jul 11 Sep 11 Nov 11 Jan 12 Mar 12 May 12 Earnings summary (YE Dec 31) FY10A FY11A FY12E FY13E FY1E Turnover (HK$ mn) 8,701 10,53 11,801 13,1 15,530 Net Income (HK$ mn) 702 800 2 5 87 EPS (HK$) 0.5 0.73 0.39 0.59 0.77 EPS CHG (%) 27.5 12. -.8 51. 31.3 PE (x) 2.8 2.5.7 3.1 2.3 PB (x) 0.9 0.7 0.7 0. 0.5 Yield (%) 13.8 1.1.3.5 17.0 ROE (%) 31. 29.9 15.3 19.3 20.9 Net gearing (%) Net cash Net cash 11.5.7 2., CMBIS Auditor: Ernst & Young Web-site: www.tclcom.tcl.com
1H12 pre-announcement profit warning TCL Com announced profit warning on 15 Jul and expected to record a significant drop in 2Q12 net profit on yoy basis. However 2Q12 net profit is expected to be higher than that in 1Q12. The substantial fall in profitability is due to 1) featured phone ASP and gross margin declined on weakened consumer confidence around the globe; 2) slow uplift in Smartphone gross margin on longer than expected ramp-period; and 3) R&D and SG&A costs surged for penetration into the Smartphone market. Jun shipment growth backed on track Despite the challenging environment TCL Com is facing, the Company reported a strong June shipment growth thanks to sales pick up in overseas market. Total handset shipment reached.33mn, increased by 1.3% yoy; turned around from 1.5% yoy shipment shrunk in May. Overseas market was the key contributor to the shipment turnaround, thanks to new CDMA phones launching and enhanced cooperation with overseas operators. Overseas shipment showed positive yoy growth for the first time in 2012, overseas shipment grew 1.1% yoy in June against 8.3% decline in May. Figure 1: Monthly shipment volume Figure 2: Overseas shipment volume 5.0.5.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 3 2 1-1 -2-3 -.5.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2 1-1 -2-3 - Shipment volume (mn units, LHS) yoy change (RHS) Overseas shipment volume (mn units, LHS) yoy change (RHS) but Smartphone shipment growth faced bottleneck Year-over-year shipment growth in the PRC market weakened from 58. in May to 15.8% in June due to higher comparison basis and slower than expected Smartphone ramp. Majority handset shipments in China are Smartphone models. We see a correspondingly slowdown in shipment growth in Smartphone segment. Smartphone sales accounted for 13.5% of total shipment in June, down from 1.% in May. Smartphone shipment growth faced bottleneck due to 1) a slower than expected new Smartphone model launching by TCL Com; and 2) new-entrants to the entry-level Smartphone market intensified competition. Figure 3: PRC shipment volume 1. 1.2 1.0 0.8 0. 0. 0.2 0.0 100 80 0 0 20-20 Figure : Shipment break down 10. 5.2% 5. 5.2%.1% 7. 11.% 9.7% 12.% 1.% 13.5% 8 2 PRC shipment volume (mn units, LHS) yoy change (RHS) Non Smartphone shipment Smartphone shipment
3Q12 to be the key for Smartphone ramp-up As featured phone market keep being squeezed by entry-level Smartphone, we believe TCL Com s step-up strategy is necessary. 3Q12 will be the key for TCL Com s Smartphone rampup, the Company will launch series of new Smartphone models, including W989 and S500 which have been selected by China Unicom (73 HK). TCL Com expands its sales network in China by 1) cooperating with all three operators; 2) open market sales through partnering with retailers like Suning (00202 CH); and 3),000 point of sales (10,000 by the end of 2012). Revenue and earnings revised down We revise down our FY12 and FY13 revenue forecast by 7.7% and 7.2% respectively on lower ASP expectation due to slower product mix improvement. We also lower our FY12 and FY13 earnings estimate by 50.% and 31.2% to HK$2mn and HK$5mn respectively due to higher than expected operating cost rise and prolonged gross margin erosion. Undemanding valuation, maintain BUY rating TCL Com is trading at.7x and 3.1x our FY12 and FY13 earnings forecast respectively, which are at the low end of the stock s forward P/E range. Current 0.7x FY12 P/B is also at the low end of last three years forward P/B range of 0.5x to.0x. TCL Com is undergoing a painful but necessary transition, temporary rise in R&D and marketing cost pave road for success in Smartphone market. The Company faced similar hardship in 2009 and successfully turned around in 2010 by capturing the emerging market feature phone boom. June shipment figures backed on growth trend also indicate the Company s R&D and marketing effort started to take effect. We lower our target price to HK$2.33 from HK$.9 on.0x FY12 EPS estimate, implying 28.5% upside potential. Given the bright future of China Smartphone market, and current undemanding valuation, we believe it s a good entry point for long term investors and maintain our BUY rating. Figure 5: Forward P/E band HK$ 10 9 8 7 5 3 2 1 0 12x 10x 8x x x Figure : Forward P/B band HK$ 10 9 8 7 5 3 2 1 0 3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x, CMBIS, CMBIS Figure 7: Peers comparison Company Code Share Price Market cap EV/EBITDA (x) ROE (%) PE (x) P/B (x) EPS (local currency) (local currency) (US$mn) FY11 FY12F FY13F FY11 FY12F FY13F FY11 FY12F FY13F FY11 FY12F FY13F FY11 FY12F FY13F TCL Com 218 HK 1.81 22 3.9 1.3.2 29.9 15.3 19.3 2.5.7 3.1 0.7 0.7 0. 0.73 0.39 0.59 Nokia Oyj NOK1V FH 1.0, NA NA 2.2 NA NA NA.8 NA 0.0 0.5 0. 0. 0.29-0.23 0.0 Ericsson ERICB SS 58.90 27,983.3 5.0. 8.5 10.8 11.0 12.9 12.8 10.3 1.3 1.3 1.2.55.59 5.9 Samsung Electronics 005930 KS 1,171,000 151,305 8.1 3.8 3.3 11.8 20.9 19.7 13.1 8.0.9 1. 1.5 1.3 89,073 1,909 19,391 LG Electronics 0570 KS 58,00 8,12 NA 5.2. NA.9 8.9 NA 10.7 7.8 0.9 0.7 0.7-2,78 5, 7,525 Apple Inc AAPL US 0.9 57,527 8. 7..2 1.7 2.2 3. 21.9 12.9 11.1 5.5.8 3. 28 7.09 5.7 Motorola MSI US 5. 13,33 8.8..0 1. 18.3 21.0 17.5 15.0 13.1 3.3 2.9 3.0 2.1 3.0 3.9 Research In Motion RIMM US.92 3,27 0.7.2 2.1 12.2 NA NA 1. NA NA 0. 0. 0..20-1.2-0.7 HTC Corp 298 TT 298.00 8,82 3.3.. 70. 32.0 29..1 7. 7.5 2. 2. 2.2 73.32 39.09 39.9 China Wireless 239 HK 1.33 30 1.5 12. 10. 15.1 13.3 1.1 10.7 9.7 8.2 1.3 1.2 1.1 0.12 0.1 0.1 Average.9.2.9 2.9 20. 20.1 10.8 11.0 13.1 1.9 1.8 1., CMBIS 3
Financial Summary Income statement YE Dec 31 (HK$ mn) FY10A FY11A FY12E FY13E FY1E Revenue 8,701 10,53 11,801 13,1 15,530 Cost of sales (,752) (8,325) (9,17) (10,25) (12,237) Gross profit 1,98 2,328 2,38 2,791 3,292 Research & development (357) (59) (23) (8) (75) Selling and distribution costs (20) (8) (1,030) (1,157) (1,32) Administrative expenses (3) (558) (29) (71) (77) Other operating costs (5) (28) (3) (0) (2) EBIT 530 17 39 238 38 EBITDA 58 503 12 30 529 Interest income 83 19 221 218 23 Finance costs (3) (10) (15) (11) (170) Other non-operating income/ cost 195 311 35 392 5 Pre-tax profit 75 783 0 87 902 Profits tax (3) 17 (13) (1) (5) Minority interests 0 (1) (1) (1) (1) Net profit 702 800 2 5 87 data and CMBIS estimates Key ratios YE Dec 31 FY10A FY11A FY12E FY13E FY1E Profit & loss ratios (%) Gross margin 22. 21.9 20.2 20.8 21.2 EBITDA margin.7.7 1.2 2.7 3. Operating margin.1 3.9 0.3 1.8 2.5 Net margin 8.1 7.5 3..8 5.5 Effective tax rate 5.8 (2.2) 3.0.0.0 Growth (%) Revenue growth 100 22 11 1 1 Gross profit growth 105 19 2 17 18 EBIT growth N.A. (21) (91) 512 1 Net income growth 2,951 1 (7) 51 31 Balance sheet ratios Current ratio (x) 1.2 1.1 1.1 1.1 1.1 Quick ratio (x) 1.1 1.0 1.0 1.0 1.0 Receivable turnover days 108 89 92 90 89 Inventory turnover days 2 3 5 3 2 Payable turnover days 100 8 87 85 85 Cash cycle 50 50 8 Total debt / equity ratio (%) 292 270 279 250 21 Net debt / equity ratio (%) (8) (2) 12 7 2 Returns (%) ROE 31. 29.9 15.3 19.3 20.9 ROA 5.7 5.7 2.8 3.8.5 Per share data (HK$) EPS 0.5 0.73 0.39 0.59 0.77 BPS 2.05 2.3 2.53 3.0 3.9 DPS 0.25 0.29 0.08 0.12 0.31 data and CMBIS estimates
Balance sheet YE Dec 31 (HK$ mn) FY10A FY11A FY12E FY13E FY1E Non-current assets 35 1,773 2,058 2,39 2,918 Property, plant and equipment 309 97 832 1,058 Other non-current assets 325 1,27 1,13 1,07 1,80 Current assets 11,19 12,25 13,130 1,50 15,835 Cash & cash equivalent 1,35 1,187 809 905 1,031 Pledged deposits,201,092,2 7,211 7,55 Inventory 780 981 1,11 1,252 1,08 Account receivables 2,57 2,585 2,97 3,308 3,787 Other 719 1,09 1,50 1,77 2,053 Current liabilities 10,01 11,315 12,370 13,512 1,57 Borrowings,88 7,222 7,75 8,31 8,8 Trade and other payables 1,83 1,952 2,25 2,7 2,850 Other 1,83 2,11 2,371 2,9 3,121 Non-current liabilities 18 39 39 39 39 Borrowings 0 0 0 0 0 Other 18 39 39 39 39 Minority interest 0 5 Total net assets 2,222 2,9 2,77 3,333,051 Shareholders' equity 2,222 2,9 2,77 3,333,051 data and CMBIS estimates Cash flow summary YE Dec 31 (HK$ mn) FY10A FY11A FY12E FY13E FY1E Net Income 702 800 2 5 87 Depreciation and amortization 57 8 103 122 15 Change in working capital (75) (335) (198) (83) (11) Others 8 (29) (221) (218) (23) Net cash from operating activities 731 122 111 3 Capex (15) (27) (251) (310) (371) Other (210) (92) 83 2 (19) Net cash from investing activities (35) (9) (18) (285) (390) Change in share capital 5 0 0 0 Net change in debt 5,030 735 532 587 35 Other (5,297) (13) (852) (71) (73) Net cash from financing activities (211) 37 (320) (8) (128) Net change in cash 1 (207) (377) 9 125 Cash at the beginning of the year 1,170 1,35 1,187 809 905 Exchange difference 11 9 0 0 0 Cash at the end of the year 1,35 1,187 809 905 1,031 data and CMBIS estimates 5
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