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2618 JP Morgan Research Report 20111027
2618 JP Morgan Research Report 20111027
27 October 2011
Overweight
2618.HK, 2618 HK Price: HK$4.09
Abs
YTD -56.4%
1m 8.4%
3m -51.4%
12m -48.9%
Company Data Shares O/S (mn) Market cap (HK$ mn) Market cap ($ mn) Price (HK$) Date Of Price Free float (%) 3mth Avg daily volume 3M - Avg daily Value (HK$ mn) 3M - Avg daily Value (USD) ($ mn) Index 1 Exchange Rate Fiscal Year End
1,112 4,550 585 4.09 27 Oct 11 40.6% 5,331,398.00 22.32 2.87 7.77 Dec
See page 11 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.morganmarkets.com
Company description
Founded in 1993, TCLC is a leading mobile handset manufacturer in China with two main brands, Alcatel and TCL. Headquartered in Shenzhen, the company has its production lines located in Huizhou and R&D centers in Shenzhen, Shanghai and Huizhou with more than 1,300 engineers. TCLC has over 90% of its shipment volume in overseas and officially launched the 3G smartphones in FY11.
Smartphones 13%
ODM 14%
Our price target (changed due to earnings revision) is based upon DCF methodology. The nature of the industry leads us to apply a terminal growth of 3%.
DCF assumptions
Risk free rate: Market risk premium: Beta: Cost of equity Terminal g:
Source: J.P. Morgan estimates
Our PT (Dec-12, DCF-derived) of HK$6.0 implies a fwd P/BV (FY13E) of 3.0x and a fwd P/E (FY13E) of 7.8x. The key risks to our PT include a slower pace of migration from 2G to 3G and an unexpected increase in brand recognitions of other domestic players in the low-end segment of the handset market.
Peer comparison
Companies TCLC (OW)* LENOVO (OW) HTC (N) CHINA WIRELESS (NR) ZTE (NR) Average Ticker 2618 HK 992 HK 2498 TT 2369 HK 763 HK Price, LC 4.09 (6) 5.53 (5.8) 691 (800) 1.42 22.25 MCAP US$MM 583.3 7,317 20,755 391 9,478 Vol US$MM 2.9 32.9 196.1 1.4 20.5 50.8 1W chg 33.2 10.8 1.5 22.4 14.0 16.4 3M chg (41.5) 7.4 (28.2) (18.4) (10.1) (18.2) 11E P/E (x) 5.3 16.5 8.0 10.9 18.2 11.8 12E P/E(x) 4.7 12.9 7.1 9.3 15.0 9.8 11E EV/ EBITDA 6.5 59.9 6.5 11.8 13.0 19.5 11E ROE (%) 34.4 24.3 69.0 19.6 13.5 32.2 11E P/B (x) 1.3 3.7 4.3 1.6 2.3 2.6 11E Yld (%) 7.2 2.5 5.1 2.0 1.4 3.6
Source: Company data, Bloomberg estimates for NR stocks, J.P. Morgan estimates for all others. Share prices are as of 27 Oct 2011.
TCLC reported a decent set of 3Q11 results with sales of HK$2,862mn (up 33 % Y/Y; 2% below our estimate) and net profit of HK$215mn (up 7% Y/Y, 8% below our estimate). 3Q11 GPM came in at 21% vs. 22% in 1H11. We had not anticipated a positive surprise in GPM given the predicted lack of economies of scale of 3G smartphone production in its first FY official sales. ASP rose to US$33.4 (3Q11) from US$30.3 (1H11), thanks to improving product mix and the continued success of the step-up strategy to high-end phones. As mentioned in our previous note 'Handset shipment growth intact; we await evidence of smartphone sales in 2H11, the swing factor published on 9 Aug, we expect that the ASP will improve further in 2H11 when more 3G smartphone models are unveiled; however, the magnitude of the ASP rise (up 10% Q/Q) came in as positive surprise, in our view.
Shipment volume
Source: Company (Jan-11 Sep-11); J.P. Morgan estimates (Oct-11- Dec-11)
Y/Y growth
Alcatel license fee: Short-term pain, long term gain. TCLC has made a payment of USD40mn in 3Q11 utilizing its internal operating cash. Background of the Alcatel-Lucent deal: On 23 Sep, TCLC announced that it will pay USD 40mn, or HKD 312mn, to Alcatel-Lucent for the use of the Alcatel brand name from Jul 2011 to Dec 2024. From 2004 to 2010, TCLC paid 1% of the sales of Alcatel One Touch handset series as loyalty fee to Alcatel-Lucent. As in 2010, approximately 90% of the sales, or HKD 7.8bn, came from overseas (i.e. using the Alcatel brand). JPM view: Assuming that overseas sales remain constant, TCLC will pay HKD 78mn/year or HKD1.05bn over 13.5 years, more than three times the license fee of HKD 312bn. As such, we believe the Alcatel-Lucent deal is positive to TCLC and liquidity risk will remain low as TCLC can fully fund the fee with its ample cash (which amounted to a total of HKD1.5bn as of 3Q11). Smartphone shipment volume to account <5% of total shipment in FY11 Sep smartphone shipment volume accounted 198k units, up 38% M/M, bringing the total shipment to 653k this year. If TCLC achieves 40% M/M smartphone shipment volume growth in each of the three months in the rest of this year, its smartphone shipment volume will reach 1.9mn, which would only account for 4.3% of the total shipment volume (that is estimated to be 44 units), falling short of 8-10% guidance given by management earlier this year. We have lowered our assumption from 6% to 4%.
We are revising down our FY11E/ FY12E sales by 7%/ 22% to factor in 1) lower handset shipment volume assumptions (FY11E down from 47mn to 44mn; FY12E down from 63mn to 53mn); 2) weaker-than-expected sales growth in EMEA regions; and 3) lower proportion of 3G smartphone sales. We are lowering our FY11E/ FY12E NP by 8% and 14%, respectively, to factor in 1) the lack of economies of scale in the early stage of sales of 3G smartphone, which were only official launched this year; and 2) lower total sales. We assume that 4Q11 GPM will come in at 20.3%, lower than the 3Q/ 2Q/1Q11 GPMs of 20.9%/ 21.9%/ 22.3%, bringing our FY11 GPM assumption from 21.8% to 21.2%. We assumed that the FY11E GPMs for ODM/ low-tier feature phones/ midtier feature phone/ 3G smartphone are 16%/ 21%/ 22.8%/21.5%. We highlighted in our last note, 'Handset shipment growth intact; we await evidence of smartphone sales in 2H11, the swing factor published on 9 Aug, that 2H11 will represent a key testing time for TCLC and that investors shall stay focused on shipment volume and GPM of 3G smartphones. We believe higher 3G smartphone sales will couple with a continued margin squeeze in 4Q11 when seven new smartphone models are
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unveiled vs. 2/2/4 new models introduced in 1Q/2Q/3Q11. We will also review: 1) the pricing pressures from high-end smartphone producers and domestic players; 2) the sustainability of shipment growth in Latin America and EMEA amid recent development in Europe; and 3) the early receptions of 3G smartphones and Facebook feature phone models. Higher ASP and favourable product mix do not result in higher GPM. TCLC uses chipsets produced by MediaTek (for feature phones) and Qualcomm (for smartphones). TCLC faces a higher cost structure for smartphones due to: 1) lack of economies of scale for smartphone production; and 2) price competition from Apple (a potential low-cost iPhone)/ Nokia (WP7) in the low-mid end smartphone segment and from ZTE/Huawei in the feature phone segment. Share price correction overdone. The share price of TCLC was up 22% yesterday after declining sharply (down 52%) in the past three months. Currently, the stock is trading at 4.7x FY12E, 88% higher than the trough P/E of 2.5x in Mar-09 and 61% lower than the height of 12.1% in Apr-11. We maintain our Overweight rating and lower our Dec-12 PT from HK$7.5 to HK$6.0 (DCF-derived; g = 3%; beta = 1.5), representing a 47% upside from the current level, which is an attractive entry point, in our view.
P/E band chart (Oct 08- Oct 11)
12 10 8 6 4 2 0
10/26/2008 4/26/2009 10/26/2009
13x
10x 7x 4x 1x
4/26/2010
10/26/2010
4/26/2011
Price
Source: J.P. Morgan estimates. Bloomberg.
10
13
10/26/2011
5
2008 4,538 40 141 (83) 138 (111) 86 0% 13.2% 5,878 731 (4) 0 6,605 1,097 6.0
2013E 13,358 1,268 1,192 (300) 350 (153) 1,088 3.0% 4.2% 6.0% 1.5 6.2% 3.0
Assumptions Terminal growth Risk-free rate Market risk Beta Cost of debt Implied exit P/E multiple (x)
Table 2: Sensitivity analysis based on WACC and perpetual terminal growth rate
5.0 11.7% 12.2% 12.7% 13.2% 13.7% 14.2% 14.7% 1.5% 6.2 6.0 5.8 5.7 5.5 5.4 5.2 2.0% 6.4 6.1 6.0 5.8 5.6 5.5 5.3 2.5% 6.5 6.3 6.1 5.9 5.7 5.6 5.4 Terminal growth rate 3.0% 3.5% 6.7 6.9 6.4 6.6 6.2 6.4 6.0 6.2 5.8 6.0 5.7 5.8 5.5 5.6 4.0% 7.1 6.8 6.6 6.3 6.1 5.9 5.7 4.5% 7.4 7.1 6.8 6.5 6.3 6.0 5.8
WACC
-8.4% 949 16.9% 21.8% (954) -8.7% 170 165 302 6.9% (137) -1.1% 165 3.8% (39) (26) (1) 0 34 -6.0% (11) 32.5% 0 23 -19.3% 0.6%
97.9% 1,948 105.4% 22.4% (1,413) 48.2% 278 813 984 11.3% (170) 24.7% 813 9.3% (63) (5) (0) 0 745 2086% (43) 5.8% (0) 702 2950% 8.1%
28.2% 2,324 19.3% 21.2% (1,834) 29.8% 518 1,008 1,249 11.4% (241) 41.4% 1,008 9.2% (67) (17) (0) 0 924 24.0% (55) 6.0% (0) 868 23.7% 7.9%
12.6% 2,609 12.3% 21.1% (2,064) 12.6% 592 1,137 1,442 11.7% (305) 26.5% 1,137 9.2% (69) (9) (0) 0 1,059 14.7% (63) 6.0% (0) 996 14.7% 8.1%
7.8% 2,843 9.0% 21.3% (2,230) 8.1% 655 1,268 1,617 12.1% (350) 14.6% 1,268 9.5% (70) (10) (0) 0 1,188 12.1% (71) 6.0% (0) 1,117 12.1% 8.4%
1H09 1,327 197 -13 -104 -104 -0.114 30.4% 14.9% -1.0% -7.9% -43.3% -55.0% -137.9% -193%
2H09 3,033 751 178 138 127 2.624 69.6% 24.8% 5.9% 4.2% 38.0% 101.1% 2693% -253%
1H10 3,452 724 303 279 250 0.225 39.7% 21.0% 8.8% 7.2% 160.0% 267.1% -2454% -339%
2H10 5,249 1,224 511 466 451 0.406 60.3% 23.3% 9.7% 8.6% 73.0% 62.9% 187.1% 254%
1H11 4,600 1,014 460 422 396 0.349 41.9% 22.0% 10.0% 8.6% 33.3% 40.0% 52.1% 58.5%
2H11E 6,381 1,310 548 502 472 0.416 58.1% 20.5% 8.6% 7.4% 21.6% 7.0% 7.2% 4.5%
FY09 2,357 448 1,304 3,356 6,278 55 220 66 488 6,766 1,074 0 0 1,461 5,310 0 361 361 5,671 715 369 1,095 0 1,095 6,766
FY10 7,545 780 2,535 6,959 11,619 106 309 72 635 12,254 1,843 0 0 6,488 10,014 0 0 0 10,031 1,098 946 2,218 4 2,222 12,254
FY11E 8,172 984 3,200 7,071 13,227 134 562 91 787 15,703 2,327 0 0 7,786 12,873 0 0 0 12,873 1,098 1,554 2,826 4 2,830 15,703
FY12E 9,163 1,108 3,601 7,139 14,811 151 719 103 972 18,326 2,619 0 0 8,763 14,799 0 0 0 14,799 1,098 2,251 3,523 4 3,527 18,326
FY13E 10,068 1,197 3,893 7,188 16,146 163 844 111 1,118 20,304 2,830 0 0 9,471 15,995 0 0 0 15,995 1,098 3,032 4,305 4 4,309 20,304
FY09 165 137 (97) 1 206 (26) 3 (39) (62) 141 38 358 (606) 1,741 351 495 684 (10) 1,170
FY10 813 170 (179) (11) 794 (139) (216) (63) (419) 591 272 0 (361) 0 (211) 164 1,170 11 1,345
FY11E 1,008 241 (603) (43) 603 (350) (19) (67) (437) 186 260 0 200 0 460 627 1,345 0 1,972
FY12E 1,137 305 64 (55) 1,451 (300) (12) (69) (380) 1,082 (280) 0 200 0 (80) 991 1,972 0 2,963
FY13E 1,268 350 (153) (63) 1,330 (300) (9) (70) (317) 1,030 (317) 0 200 0 (117) 905 2,963 0 3,868
(8.7%) (3.9%) -47.6% 309.5% -13.8% -19.3% (20.5%) (19.3%) 67.50 40.3% 111.0% 1.02 2.7% FY08 28.5 267 -111 40 -83 -62 -43 -59 808 -12 0 -76 709 684 -35.1% -81.9% 0.77 2.1% FY09 23.0 290 -97 166 -26 -23 141 358 -606 1,741 38 351 684 1,170
-12.1% -3.7% -3.3% -47.7% -13.7% -11.4% 0.91 0.79 0.73 42.4% 34.4% 31.4% FY10 FY11E FY12E 701.7 868.2 995.6 398 529 629 -179 -603 64 731 536 1,382 -139 -350 -300 -356 -369 -312 591 186 1,082 -361 200 200 272 260 -280 -211 460 -80 1,170 1,345 1,345 1,972 1,972 2,963
JPM Q-Profile
TCL Communication Technology Holdings Ltd. (HONG KONG / Information Technology)
As Of: 21-Oct-2011 Quant_Strategy@jpmorgan.com
Current:
3.07
Current:
0.89
Sep/08
Sep/09
Sep/10
Sep/11
0.00 Sep/96 Sep/97 Sep/98 Sep/99 Sep/00 Sep/01 Sep/02 Sep/03 Sep/04 Sep/05 Sep/06 Sep/07 Sep/08 Sep/09 Sep/10 Sep/10 Sep/10 Sep/10 Sep/11
Current:
29%
Current:
-353.89%
Sep/08
Sep/09
Sep/10
Sep/11
-4.00 Sep/96 Sep/97 Sep/98 Sep/99 Sep/00 Sep/01 Sep/02 Sep/03 Sep/04 Sep/05 Sep/06 Sep/07 Sep/08 Sep/09 Sep/11
PE (1Yr Forward)
18.0x 16.0x 14.0x 12.0x 10.0x 8.0x 6.0x 4.0x 2.0x 0.0x Sep/96 Sep/97 Sep/98 Sep/99 Sep/00 Sep/01 Sep/02 Sep/03 Sep/04 Sep/05 Sep/06 Sep/07
Current:
3.4x
Price/Book Value
25.0x 20.0x 15.0x 10.0x 5.0x 0.0x -5.0x Sep/96 Sep/97 Sep/98 Sep/99 Sep/00 Sep/01 Sep/02 Sep/03 Sep/04 Sep/05 Sep/06 Sep/07
PBV hist PBV Forward
Current:
1.4x
Sep/08
Sep/09
Sep/10
Sep/11
Sep/08
Sep/09
ROE (Trailing)
150.00 100.00 50.00 0.00 -50.00 -100.00 -150.00 -200.00 -250.00 Sep/96 Sep/97 Sep/98 Sep/99 Sep/00 Sep/01 Sep/02 Sep/03 Sep/04 Sep/05 Sep/06 Sep/07
Current:
39.78
Current:
9.39
Sep/08
Sep/09
Sep/08
Sep/09
Sep/10
Summary
TCL Communication Technology Holdings Ltd. 437.68 HONG KONG 2.964592 SEDOL B02Y690 Information Technology Communications Equipment Latest Min Max 12mth Forward PE 3.41 15.67 3.45x P/BV (Trailing) 0.33 21.75 1.36x Dividend Yield (Trailing) 0.00 9.39 9.39 ROE (Trailing) -200.71 119.77 39.78 Implied Value of Growth -3.54 0.09 -353.9% Source: Bloomberg, Reuters Global Fundamentals, IBES CONSENSUS, J.P. Morgan Calcs As Of: Local Price: EPS: % to Max % to Med 355% 155% 1501% 46% 0% -100% 201% -71% 102% 85% 21-Oct-11 3.07 0.89 % to Avg 150% 79% -92% -86% 75%
Sep/11
* Implied Value Of Growth = (1 - EY/Cost of equity) where cost of equity =Bond Yield + 5.0% (ERP)
10
Sep/11
Sep/11
Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Important Disclosures
Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: TCL Communication Technology Holdings Ltd..
TCL Communication Technology Holdings Ltd. (2618.HK) Price Chart
18
Date 14-Jun-11
10-Aug-11
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends. Initiated coverage Jun 14, 2011.
The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings: OW = Overweight, N= Neutral, UW = Underweight Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] In our Asia (ex-Australia) and UK small- and mid-cap equity research, each stocks expected total return is compared to the expected total return of a benchmark country market index, not to those analysts coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analysts coverage universe can be found on J.P. Morgans research website, www.morganmarkets.com. Coverage Universe: Hsu, Andrew Tak Jun: TCL Communication Technology Holdings Ltd. (2618.HK), TCL Multimedia (1070.HK)
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J.P. Morgan Global Equity Research Coverage IB clients* JPMS Equity Research Coverage IB clients*
*Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.
Equity Valuation and Risks: For valuation methodology and risks associated with covered companies or price targets for covered companies, please see the most recent company-specific research report at http://www.morganmarkets.com , contact the primary analyst or your J.P. Morgan representative, or email research.disclosure.inquiries@jpmorgan.com . Equity Analysts' Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking. Registration of non-US Analysts: Unless otherwise noted, the non-US analysts listed on the front of this report are employees of non-US affiliates of JPMS, are not registered/qualified as research analysts under NASD/NYSE rules, may not be associated persons of JPMS, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.
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