HPMT is likely to experience a multi-year growth ahead due to (i) capacity expansion throughout FY19-FY21, (ii) healthy growth outlook in the cutting tools industry, (iii) wide range of end-user industries and (iv) HPMT’s total solutions and technical know-how. Despite the decline in FY18 core earnings amid the increase in staff costs, we see potential recovery in FY19 earnings to RM17.2m, followed by RM19.4m and RM22.4m in FY20 and FY21, respectively HPMT has a dividend policy with a payout of 30% which implies FY19, FY20 and FY21 yield of 2.3%, 3.2% and 3.6% respectively. We derive a fair value of RM0.67 based on mid-FY20 EPS pegged to P/E multiple of 12x.

Company background. HPMT Holdings, through its subsidiaries, is involved in the manufacturing and distribution of cutting tools, trading of third party cutting tools, supporting equipment and accessories for metalworking as well as provision of physical vapour deposition (PVD) coating service.

Global network of more than 30 countries. Currently, HPMT has established sales branch offices in Germany, Hong Kong and China to liaise with its customers and provide technical support. Besides, the global sales network (comprising of distributors in more than 30 countries) would open up to greater business opportunities in the particular region in an effective manner.

Decent global industry growth outlook. We understand from Protégé Associates’ market research that the global cutting tools industry is projected to grow at a 5-year CAGR of 3.9% from USD19.4bn in 2018 to USD23.5bn by 2023. In addition, the incorporation of automation for manufacturing industries will lead to a surge in machine tools usage, specifically for CNC machine tools, eventually fuelling healthy demand for cutting tools.

Broad range of end-user markets. Cutting tools are used widely by different end users coming from automotive, aerospace, medical, electrical & electronic, general machining and O&G industries, amongst others. The top 3 industries that we see high demand would be automotive, aerospace and medical sectors. With the diverse range of demand, the cutting tools industry should be able to benefit from the all the related industries, providing the opportunities for market expansion. HPMT manufactures a broad range of cutting tools that are suited for various applications which enables its tools to remain relevant across a wide range of industries. Generally, the average replacement cycle of the standard tools are 2-3 months, depending on usage.

Strong margins industrial consumable products. In regards to margins, HPMT has shown an impressive historical 4-year average GP and core PATAMI margin of 45.1% and 16.2%. These high margins are a reflection of (i) the highly specialised nature of HPMT’s products and (ii) its capability to provide total solutions and technical know how to their end-user in order to improve production efficiency.

Forecast. In FY18, HPMT’s core earnings declined -22.8% YoY to RM12.2m on back of higher staff cost in anticipation of their capacity expansion plans. However, we project this to increase by 41.0%, 13.2% and 15.3% to RM17.2m, RM19.4m and RM22.4m over FY19-21, respectively. This will be underpinned by its 43.5% capacity expansion over the next 3 years.

Fair value of RM0.67. While there is no listed direct comparable in Malaysia, we have obtained the historical 3-year mean PE of two listed foreign companies in Thailand (10.6x) and Japan (16.2x). Hence, for HPMT, we derive a fair value of RM0.67 based on mid-FY20 EPS pegged to PE of 12x. Based on management’s 30% dividend payout guidance, this implies FY19-21 dividend yield of 2.3-3.6%.

Source: Hong Leong Investment Bank Research - 21 May 2019