Investment Highlights

• We initiate coverage on Chin Well Holdings Bhd with a BUY recommendation and a target price of RM1.95. Chin Well’s key growth drivers will be premised on the resilient demand for bulk fasteners amid the global economic recovery and expectations of several domestic big-ticket infrastructure projects, as well as higher chicken wire mesh orders from a U.S.-based customer.

• Chin Well’s established global position, particularly in Europe via its strong distribution channels (Appendix 1), will continue to support export sales growth. The group is also in the midst of discussions with its DIY retailers to increase its distribution network which will augur well for the export sales growth. In the local scene, higher wire mesh orders will spur FY18 revenue growth, following progressive expansion in its production capacity to meet rising demand.

• FY19 net profit and revenue is expected to hit record highs of RM64.7 mln and RM677.9 mln at a five-year CAGR of 21.8% and 11.8% respectively. Bottomline margins, however, will fall marginally from 10.3% to 9.5% in FY19, weighed down by escalating costs. The group also adopts a 40.0% dividend policy, paid bi-annually which translates to a dividend yield of 3.0% - 5.0%.

• We arrive at our target price by ascribing a target PER of 9.0x to its forecast FY19 EPS of 21.6 sen. The assigned PER is slightly higher than its closest peer, Tong Herr Resources, which we think is justified due to Chin Well’s higher margins and the positive growth outlook in Europe’s fasteners industry. At the target price of RM1.95, Chin Well is trading at a prospective PER of 7.7x, which is below its three-year average PER of around 10.0x, implying an attractive 16.5% upside from the current share price.

Recommendation

We like Chin Well for its established position as one of the world’s largest carbon steel fastener manufacturer. With a strong distribution network that spans across the globe (i.e.: Germany, U.K., Italy, Australia and Singapore), the group’s international footprint has helped Chin Well to secure significant overseas customers, particularly from the European countries. Revenue from its European customers contributed to the bulk of the total group revenue at about 51.5% (or RM261.9 mln) in FY16. We think that export sales will continue to bolster revenue, underpinned by the recovery in the global economy and decent demand growth in the DIY home improvement market in Europe, as well as in the global industrial fasteners market.

Technavio (a leading global market research firm based in U.K.) expects the DIY home improvement market in Europe to grow at CAGR close to 2.0% from 2017-2021, while global industrial fasteners market expected to grow around 5.4% between 2012-2018 to US$94.65 bln by 2018 – according to Transparency Market Research, a U.S.-based market intelligence firm.

Chin Well is considered a family-owned business held by the Tsai family. Mr. Tsai Yung Chuan – the group’s Managing Director holds about 54.2% of the total shareholding of the group as at 2nd October 2017. Together with the production facilities in Taiwan and China (owned by the Tsai’s China-affiliated company) on top of Chin Well’s own manufacturing plants in Malaysia and Vietnam, the enlarged group supplies approximately 5.0% of the global fasteners market. Consequently, we think that the Tsai family’s substantial buying power as a whole has given the group the upper-hand in obtaining better pricing for its raw materials (i.e.: steel), which will sustain its higher margins. (Appendix 2)

Having accumulated strong net cash positions over the last few years, Chin Well’s robust balance sheet with a net cash of RM66.0 mln as at 30th September 2017 also gives the group adequate flexibility to fund potential expansion plans and sufficient liquidity buffer to weather any unexpected cash flow setbacks. We note that Chin Well’s net cash fell slightly by 9.4% Y.o.Y to RM65.8 mln as at FY17, as the group took advantage of lower steel prices to restock its inventory.

Historically, Chin Well has declared dividends bi-annually which translates to a decent dividend yield of about 3.0%- 5.0%. The group also distributes at least 40.0% of its earnings to shareholders as dividends every year.

Investment Risk

Risks to our recommendation include the volatility in the global wire rod prices, which could potentially increase production costs and crimp margins. Meanwhile, safeguard measures imposed by the government on steel will also increase costs of raw materials, although downside risk is partially offset by locking-in the selling price to match the raw materials costs.

Labour issues like shortages could also impact production and in turn, impair the group’s ability to fulfil its orders on time and incur additional costs/penalties due to delays. Meanwhile, further increases in minimum wage could also strain margins, although we note that Chin Well is already paying above the mandated minimum wage, thus reducing near-term impact to the group’s bottomline. The group also expects a new batch of foreign workers to alleviate manpower issues by 1HFY18. Downside risks also include the implementation of Employment Insurance Scheme, which will shift the foreign worker levy burden to employers. Meanwhile, potential increases in gas prices as well as electricity tariffs will also set to weigh on margins, albeit slightly cushioned by some cost-pass through mechanism.

Chin Well is exposed to the cyclical ups and downs of the housing market in Europe, which generally affect the demand for Do-It-Yourself (DIY) products. As the majority of its sales are derived from the European market, the overall economic health of the European countries will inevitably impact consumer sentiments, which in turn affect Chin Well’s sales to the region.

The group is also exposed to foreign exchange fluctuation risk, given that its sales and raw material costs are denominated in the U.S. Dollar and Euro, any fluctuations in aforementioned currencies will have an impact on the group’s earnings. Again, we expect the management to pass-through the additional costs to its customers, thus reducing the risk.

Lastly, tight competition from Chin Well’s Chinese counterparts also remains a constant hurdle, crimping selling prices due to China’s lower cost of manufacturing. However, we concur that rising costs of doing business are chipping away the latter’s low-cost edge, which is levelling the playing field.

Source: Mplus Research - 7 Mar 2018