This article continues on where we left off in the previous article.

STRENGHTS AND OPPORTUNITIES

• Strong track record in terms of growth, profitability, and cash flow generation capability. For the past 10 years, the Group has only made a loss in FY2012 and a deficit in operating cash flow in 2 of the financial years i.e. FY2011 and 2012. Since FY2013, the Group has been recording consecutive years of revenue and profit growth, up to 2019.
  

• Experience management team with more than 40 years of industry experience. Operating from Penang, Malaysia also provides the Group easy access to raw materials, sub-contractors, engineering talents, logistics, etc.

• Established reputation and direct relationship with Tier-1 customers. The Group has been collaborating with its top customers for an average of >7 years. Most of the major customers are product brands owner who spearheads technological advancement across various sectors. Penta’s dealings with Tier-2 clients are usually referred to by the Tier-1 brand owners.

• Strong presence in the APAC region, with >90% of the Group’s revenue derived from China, Singapore, Taiwan, Korea, etc. Having a strong footing in APAC is key to Penta’s long-term growth as demand from this region is expected to outpace the rest of the World in the foreseeable future.

• Riding on the supercycle of electro-optical, semiconductor, and automotive industry. The Group is well-positioned to benefit from the supercycle across 5 key segments which are of their expertise i.e. Electro-Optical, Semiconductor, Automotive, Industrial 4.0, and Medical.

• Opportunities with venturing/expanding into new larger markets i.e. Germany and United States would be a catalyst to the Group’s growth in the medium term. The management is targeting Germany as their next key market for its EV solutions and the United States for its medical and FAS related solutions.

WEAKNESSES AND THREATS

• Rapid technological change and advancement require continuous commitment from the Group to invest in human capital training and research & developments. Failure to keep pace with change would lead the Group’s product/solutions to obsolete within a short period of time.

• Shortage of supply for critical semiconductor components is resulting in a slower production lead time. The change in clients’ ordering pattern (piecemeal basis at shorter notice) complicates the issue further.

• Travel restrictions are directly impacting the Group’s revenue as on-site installation of equipment must be delayed. Install and commissioning of equipment are the critical criteria for the Group’s revenue recognition.

• Extended lockdowns & limitations on workforce capacity may cause further delays to the Group’s production time.

• Concern with the longer trade receivables cycle as the Group venture into new segments. A potential risk if the Group actually relaxes its credit terms to secure new clients.

• Tax pioneer status expiring in 2026. Malaysia’s standard corporate tax rate is 24%, compared to the Group’s 5-year average effective tax rate of just 4.0%.

• Others i.e., cyclicality of the semiconductor and end-user industries, intellectual property infringement, scarcity of engineering talents, etc.

MAJOR SHAREHOLDERS AS AT 26 FEBRUARY 2021

Penta MY

As the founder of the Group, Mr. Chuah controls a total stake (direct & indirect) of 19.7% in Penta MY. Other notable institution shareholders include Kumpulan Wang Persaraan (Diperbadankan) (3.3%), AIA (3.0%), EPF (Nomura) (2.2%), Tabung Haji (2.0%), Kenanga (1.4%), Vanguard, Public Bank, and Eastspring, etc.

The top 488 shareholders hold a total stake of 91.7% in Penta MY.

Penta HK

Institution funds hold about 6.3% stake in Penta HK including Standard Life Aberdeen (1.8%), First Sentier Investors (Australia) (1.5%), Evli Fund Management (1.1%), Affin Hwang (1.0%), Deutsche, Mobius Capital, and State Street, etc.

Penta MY holds a 63.1% direct stake in Penta HK.

KEY DIFFERENCES BETWEEN PENTA MY VS PENTA HK

1) Group corporate structure



The first notable difference between Penta MY and Penta HK is the composition of the respective Group’s structure. Penta MY wholly owns two subsidiaries that do not fall under the structure of Penta HK. They are:

Pentamaster Smart Solution Sdn Bhd (“PSS”)
PSS owns the business division of smart control solutions systems (“SSS”). As brief in our earlier article, SSS’ contribution to the Group remains insignificant as Penta has not commercialized any product relating to SSS.

In fact, the management indicated that contribution from PSS will remain minimal, as their focus is on ATE and FAS. In FY2020, revenue contribution from PSS was only RM192k (Loss after taxation was RM2.3mil).

Origo Ventures (M) Sdn Bhd (“Origo”)
In 2015, Origo was awarded a project finance and management contract for the development of a mixed development project (GDV of RM164m) in Kelantan. The contract has since been completed. As of FY2020, Origo is inactive and does not have any material contract subsisting other than the above.

Origo makes no contribution to the group top/bottom-line.

Based on the structure, Penta HK is at a disadvantage if:
– PSS and Origo business expand and flourish down the road; or
– In the event, the controlling shareholder (Penta MY) expands and/or venture into new businesses that may compete (directly or indirectly) with Penta HK.

Nonetheless, we view the chances of both risks occurring as remote. We opine that the structural difference should not be a factor impacting one’s valuation. In fact, Penta MY’s net profit attributable to shareholders must consider the 36.9% (100% – 63.1%) minority stake portion. Effectively, earnings reported by Penta MY are lower than Penta HK.

2) Management independence



Penta MY and Penta HK are managed by the same management team, led by the co-founder, Mr. Chuah. Disregard the concern of Mr. Chuah, Ms. Gan, and Mr. Leng holding the same positions in both entities, we remain comfortable on the Group as we view the partial overlap in roles as a risk of less concern.

Independent Board of Directors for both entities are comprised of a different set of non-executive Directors.

3) Variances in SOPL & SOFP



Minimal difference in terms of the statement of profit or loss (“SOPL”). However, to note that Penta MY’s PAT has yet to exclude the 36.9% (100% – 63.1%) minority stake portion.

Variances in the statement of financial position (“SOFP”) were mainly due to the higher cash and bank balances in Penta MY’s book of RM137mil.

As a percentage of Penta MY’s total shares in circulation (712mil shares), the additional RM137mil cash is equivalent to about RM0.20/share only.

4) Sector classification

Penta MY is classified under the ‘Technology’ sector in Bursa Malaysia, along with its peers i.e. ViTrox, UWC, Aemulus, and the rest.

On the other end, Penta HK is classified under the ‘System applications & IT consulting’ sector in HKex. Under the current classification, we realize Penta HK does not fit as well when compared to the others. Several examples of the company under this sector are:
– SUNeVision Holdings Ltd. (data center provider);
– Edvance Technology Hong Kong (cybersecurity solutions distributor);
– Edensoft Holdings Limited (integrated information technology and cloud service provider); and
– Chinasoft International Ltd (end-to-end software design, consulting, operation, and maintenance services).

In our view, a classification under the ‘semiconductors’ sector would better reflect Penta HK’s profile. Several examples of the company under this sector are:
– AV Concept Holdings Limited (Distributor and developer of electronic components);
– Contel Technology Co Ltd (Sale of IC products and related value-added services);
– Shanghai Fudan Microelectronics Group (Design and market IC products, including tester of ICs);
– Solomon Systech (International) Limited (Design and develop IC products and system solutions. Product range from wearables, consumer electronics to industrial appliances); and
– ASM (Manufacturer of semiconductor backend equipment).

The misclassification of Penta HK could be a reason for the stock’s cheap valuation all this while.

The lower PE range ascribed to companies under the System applications & IT consulting sector can be attributable to the poor profitability track record of the sector over the years. Many of the companies are either loss-making or with an inconsistent record of profitability.

As for the semiconductors sector, companies are generally more consistent in making profits. PE valuation also hovers at a higher range in comparison.  

5) Price gap between Penta MY and Penta HK since 2018



From the graph above, we take note of the significant variance in price movements between Penta MY and Penta HK since 2018.

From the day Penta HK was listed in 2018, the stock has only increased by 68% over 3 years when Penta MY increased by more than 3x in the same period. For the past 3 years, Penta’s revenue and profit performance are as follows:



Potential reasons to explain the market inefficiency could be:
– The misclassification of Penta HK in HKex poorly reflects its profile as a semiconductor player;
– HK investors are unfamiliar with Malaysian company given the abundance of investment options available on HKex;
– The fact that technology counters in Malaysia are generally overpriced compared to the region.

PEERS COMPARISON

The table below compares Penta MY to its closest peers on Bursa.

The table below compares Penta HK to several of its peers (of similar business operations) across the region.

From the comparisons above, we take note of several key findings as follows:

• Technology stocks listed on Bursa seem to be selling at a higher valuation as compared to its regional peers;
• Comparing Penta HK to its peers (though not directly comparable), Penta HK’s profitability seems to be better and comparable to the bigger boys;
• Penta HK and AEM Holdings are both selling at a lower valuation when compared to others; and
• Penta HK is selling at a bargain as compared to Penta MY.

Considering the above and the fundamentals of Penta, we would assign the Group with a PE valuation range of 15x – 30x. We deem the range as conservative yet sufficient to account for our optimism with the Group and industry. Ignoring the euphoric sentiment on technology-related counters in 2013, 2014, 2020, and 2021, we realized that Penta MY would usually trade at a rather consistent PE range of 15x – 30x.

The chart below illustrates Penta MY’s PE valuation range for the past 10 years.

 

---

VALUATION ESTIMATE - REFER TO OUR OFFICIAL SITE FOR MORE DETAILS :)