Established in Malaysia since 1989, Formosa Prosonic Industries Berhad (“FPI”) is a manufacturer of conventional speaker systems, smart audio systems, and musical instrument components.

In 2014, Taiwan-listed engineering firm, Wistron Corporation (“Wistron”) had emerged as a strategic and major shareholder of FPI with a 28% stake acquisition. Wistron is a major original design manufacturer (“ODM”) spun-off from Acer Inc. in 2000.

In its latest financial year, Wistron Group recorded a turnover of more than USD 29b, employing over 80,000 people worldwide across the United States, Mexico, Czech, China, India, and Vietnam, etc.

This article will discuss FPI’s fundamentals, prospect, valuation, and provide our investment case for the Group. Do visit us at www.the1994investor.com :)

KEY SUMMARY

1. Impressive business track record in terms of revenue growth, profitability, and cash flow results since 2015. The business is seen to have benefited from the emergence of Wistron as its strategic investor.

2. The business is trading at a reasonable valuation of 11x PE (based on our normalized projection) and TEV/EBITDA of 6x. Investors can expect a consistent annual dividend yield of ~5% from the business. Its latest market capitalization is RM650m vs a net cash position of RM250m.

3. A stock we would recommend to conservative investors who are seeking consistent dividend-yielding businesses.

FPI is mainly involved in the provision of original equipment manufacturing (“OEM”), where they design and manufacture products for their customers who then sell under their respective brands. FPI also does joint design manufacturing (“JDM”) and contract manufacturing services, where FPI’s customers play a bigger role in product design.

Before FY2018, FPI was engaged in sales of high-quality speaker systems under the Acoustic Energy brand. The business was operated under separate management in the United Kingdom. In FY2017, the Group disposed of the UK subsidiary after consecutive years of poor performance.

Today, FPI is a one-stop OEM service provider offering a wide range of services from product design, material sourcing, woodworking, plastic injection, PCB assembly to finished-products assembly.

Over the past 20 years, the Group had served several multinational companies in the home entertainment, audio, and musical instrument industries. FPI’s long-standing customers include brands like Sony, Bose, Onkyo, and Sharp, etc.

Based on FPI’s FY2020 annual report, we understand that the top 3 largest customers contribute a total of 93% of the Group’s revenue (2019 was 91%). Customer A, B and C contributed 38%, 29% and 27% of the Group’s revenue respectively. We suspect Sony and Bose to be two amongst the Top 3. FPI’s business and clients are all based in Malaysia.

The Group is headquartered in Malaysia with two manufacturing facilities based in Port Klang and Sungai Petani. FPI also operates a design and engineering center in Taiwan.

MANAGEMENT TEAM

Shih Chao Yuan, aged 65, Taiwanese who established FPI in 1986 remains as the Group’s Managing Director, a position he had held since day one. Mr. Shih is assisted by Koh Ming Ching and Cheong Hong Yip who both are 53 years old and have been with the Group since 1993. Mr. Koh is the Director and Senior General Manager for the manufacturing operations in Sungai Petani, while Mr. Cheong heads the Port Klang operations.

Other senior management personnel includes:

Chew Boon Hua, aged 52 is currently the General Manager responsible for marketing and development of speaker system. He joined the Group in 1993.

Chong Lien Kieung, aged 51 is currently the General Manager responsible for the finance and accounts department. He joined the Group in 2003.

Lim Chun Hooi, aged 51 is the Senior Manager for internal controls and risk management. She joined the Group in 2005.

Kris Chang Shih Yang, aged 52 is the General Manager focused on sales development and products management. He joined the Group in 2009.

As seen, the Group is managed by a team of experienced and loyal management personnel, with all of them being with the Group for at least a decade.

RECENT KEY DEVELOPMENTS

1. Capacity expansion through investing in new machinery i.e. injection machines, CNC machines, fully and semi-automated machines.

2. Process improvements via the adoption of Just-In-Time (“JIT”) approach to reduce the usage of production floor area and storage space (minimize inventory holdings) and streamlining manufacturing processes.

3. Enhancement of tracking systems covering the materials store, production, and logistic areas to reduce downtime and defect issues.

PAST YEARS FINANCIAL RESULTS

For the past years, FPI’s revenue had grown at a 4-year CAGR of 22.5% from RM340m in FY2016 to RM766m in FY2020. The Group’s bottom line grew even stronger at a CAGR of 29.7% due to improved profitability margin since FY2016.

The Group’s gross and net margins improved from 7.5% and 5.3% in FY2016 to 11.8% and 6.6% in FY2020 respectively. This was despite the higher effective tax rate. The Group no longer enjoys any tax incentives as they are incurring the standard corporate tax rate of 24%.

In FY2020, the business showed its resilience for maintaining its business turnover at RM765m despite disruptions during the several lockdowns throughout the year.

1QFY2021 results (Jan – Mar ‘21)

FPI’s 1Q2021 revenue dipped by 18% as compared to 4Q2020. The poorer 1Q performance was consistent with the industry cycle where orders usually peak during the 2nd half of the year. The shorter operating days (more public holidays) also contributed to the lower 1Q output.

Despite the dip in revenue, FPI’s recorded a stronger profit with its gross and net margin achieving a 6-year high of 13.1% and 10.0% respectively.

Consistently since FY2016, the business generates positive operating cash flow. For the past 5 years, FPI’s average CFO & FCF to net income ratio were impressively above 1.0x.

With such strong cash flow, shareholders can expect consistent dividend payouts from the business and minimal risk of the Group seeking to raise additional capital (risk of diluting shareholders’ holdings).

The Group’s balance sheet position strengthened over the years to a net cash position of RM270m as of 31 December 2020. FPI maintains relatively short operating cash cycle days of <30 days. In recent years, the implementation of JIT may have resulted in a lower inventory holding period.

Commendable business economics.

STRENGTHS AND OPPORTUNITIES

1. Strong and consistent growth in revenue and profitability ever since Wistron emerged as a strategic investor in FPI. Since 2014, FPI’s revenue had grown at a commendable 6-year CAGR of 20.3%. Net margin improved from about 3.0% in FY2014 to about 7% in FY2020.

The decline in revenue throughout FY2012 – FY2014 was due to economic slowdowns in major economies which dampen the demand for the Group’s products. The Group was also facing pressure for price reduction from its major customers during the period (A potential risk that may arise at the next economic downturn).

2. Superb balance sheet position with net cash of >RM250m (market capitalization of RM650m) and a low operating cash cycle of fewer than 30 days.

3. Ability to secure and retain Tier-1 customers proves FPI’s capability to produce and deliver high-quality products and services.

4. Wistron leverage provides FPI with the network and access to top-tier suppliers/clients. Sourcing of technology, technical know-how, and raw materials has been more convenient given the bargaining power and establishment of the Wistron Group. During FY2020, FPI made RM87m worth of purchases from Wistron (2019: RM90m).

WEAKNESSES AND THREATS

1. Customer concentration risk. FPI’s top 3 customers contribute up to 90% of the Group’s FY2020 revenue.

2. Average economic moat. FPI’s main competitive advantage would be its experience and consistency in delivering high-quality products and services. However, in our view, that does not create a deep moat for the business e.g. high switching cost or barrier of entry. The downturn in 2012 – 2014 showed the extent of how the business can be impacted as their clients seem to have strong bargaining power in terms of product pricing.

3. Changing economics of manufacturing. The rapid advances in technology, including robotics and material science, have led to further advancement in the manufacturing sector. The availability of less expensive manufacturing tools, quicker access to sophisticated design and tooling capabilities have lowered the barrier of entry to the industry.

4. Evolving nature of consumers’ expectations towards personalization, lifestyle, and customization are resulting in a demand shift towards more sophisticated and smarter products. The Group is required to constantly upgrade its technology and engineering capabilities to be ahead of the curve.

5. Related party transaction. In FY2020, FPI sold RM212m worth of speakers to Wistron (2019: RM189m), making up ~28% of its full-year revenue. There may be a potential transfer pricing risk.

MAJOR SHAREHOLDERS AS AT 3 MAY 2021

Wistron is the largest shareholder of FPI with a 28% stake. The founder cum Group MD, Mr. Shih holds only 2.4% of the Group. This was following the 2014 share acquisition by Wistron from several substantial shareholders of the Group including Mr. Shih.

Institutional investors in FPI include Manulife Investments (3.3%), Gibralter fund (0.6%), Affin Hwang (0.6%), Philip Capital (0.5%), Civetta Nanjia Fund (0.4%), etc

The notable individual investor, Fong Siling owns 3m shares (1.2%) in the Group.

PEERS COMPARISON

Based on the above, FPI seems to be performing largely in line with its peers in terms of profitability and return to equity. However, we note that the Group’s valuation is trading at a slight discount.

Based on our assessment, we would value the Group at a PE range of 8x – 12x. The chart below illustrates the Group’s PE range for the past decade for reference.

The unusual surge in FY2015 was likely due to market euphoria towards the company’s prospect following a turnaround in business performance after 2 years of consecutive decline in revenue and profitability.

For the other years, FPI was trading rather consistently within the range of 7x – 13x.

VALUATION

Based on its historical PE multiples of 7x – 13x, we opine that FPI’s current valuation of RM2.64 is fully valued. On a discounted cash flow model, we are projecting a valuation range of RM3.28 – RM3.72.

As a value/bargain investor, we would only invest in the business if it trades at a deep discount.

Having said the above, we do not deny its attractiveness for the 4% – 5% annual dividend yield, coupled with a 4-year revenue CAGR of 22.5%. Furthermore, FPI is currently trading at a Total Enterprise Value/EBITDA (“TEV/EBITDA”) multiple of 6x only.