Turnaround Company With Growth Potential 
We are initiating coverage on IQ  with a  BUY  recommendation  and  MYR1.84  FV pegged to  FY15f  12.5x  P/E, which is  still within  the 10-15x P/Es range of consumer stocks under our consumer analyst’s coverage. We like the company for its: i) earnings turnaround, ii) new product launches  in  the  pipeline,  iii)  ability  to  ride  on  the  recovery  in  the  global  economy,  and  iv)  solid  balance  sheet  with  total  net  cash  of MYR12.1m as at end-Sept 2013. At our FV, it will be trading at 1.5x P/NTA, in line with its Taiwan-listed competitor, Everspring Industry Co. Ltd. Earnings growth is expected to remain strong over the next two years, underpinned by more new products launching. We are expecting a CAGR of 90.9% for FY12-15F. IQ is still trading below its NTA/share of MYR1.11 as at end-Sept 2013.

Penang-based motion sensor lighting producer. IQ is involved in the designing and manufacturing of a range of passive infrared sensors (PIR), motion sensor light controllers, door chimes and wireless video communication products. The company has two production facilities located in Penang, Malaysia, and Dongguan, China. Its products are mainly exported to Europe, the US, Japan and South-East Asia. Deteriorating performances  triggered  business restructuring and streamlining  activities.  IQ enjoyed two good years in FY06 and FY07 before being  impacted  by  several  years  of  deteriorating  performances.  The  company  was  in  the  red  for  three  financial  years  –  FY09-11  –  before returning to  the black in  FY12. During  the  troubled times,  IQ  faced  several headwinds,  including: i)  2008  global  financial  crisis,  and  ii)  rising manufacturing costs  in China.  To ensure efficiency and cost-savings, the company underwent a business restructuring and streamlining of its overall operations. In FY07, it  restructured its Dongguan  manufacturing facility.  Subsequently,  in FY08,  IQ  embarked on a centralised business coordination  process  to  allow  its  UK  customers  to  channel  their  sales  orders  directly  to  the  company’s  head  office  in  Malaysia.  The  entire restructuring and streamlining process was completed in FY11.

Earnings  turnaround  underway.  With  the  completion  of  the  restructuring  process,  IQ  is  now  able  to  focus  on  growing  its  business.  The company’s  FY12  results were  back in the black,  with  a  core  net profit of MYR1.8m. We further witnessed  a  significant improvement in  IQ’s 1HFY14 results, with NI surging 51-fold to MYR8.3m from 1HFY13’s MYR0.2m. Besides, the improvement is mainly due to stronger sales for the company’s new products and favourable foreign exchange rate.

New product launches to boost sales. IQ is planning to launch a series of new products in FY14. The company is also planning to unveil its own line  of  high-bay  lighting  solutions  –  which  are  equipped  with  motion  sensors  –  by  2QCY14.  This  product  range  will  be  able  to  detect movements  from  either  people  or  vehicles  within  a  certain  distance  and  is  suitable  for  industrial  facilities  and  warehouses,  allowing  their owners  to  achieve  higher  energy  savings  by  minimising  the  unnecessary  use  of  lighting.  In  addition,  IQ  recently  announced  that  it  has increased  its  stake  in jointly-controlled entity SILQ (Malaysia) SB to 51% (from 50%). Thus,  we should be able to see more synergies between IQ and its 51%-owned subsidiary, which will allow the latter to produce more light-emitting diode (LED)-related products in the future.

BUY, with MYR1.84  FV.  We like IQ for its: i) earnings turnaround, ii) new product launches in the pipeline, iii) ability to ride on the recovery  in the global economy, and iv) solid balance sheet with total net cash  of MYR12.1m as at end-Sept 2013. We expect earnings to rebound strongly in  FY14,  underpinned  by  stronger  sales  from  the  company’s  new  products,  and  expect  a  CAGR  of  90.9%  for  the  FY12-15F  period.  We recommend  a  BUY  on  IQ,  with  our  MYR1.84  FV  pegged  to  a  FY15f  P/E  of  12.5x  –  within  the  range  of  the  10-15x  P/Es  of  consumer  stocks (excluding consumer staples)  under our consumer analyst’s  coverage.  The company is still trading below its NTA/share of MYR1.11 as at end Sept 2013.

Background

Founded by Mr Kent Chen  in 1989,  IQ  is involved  in  the designing and manufacturing  of a range of PIRs,  motion sensor light controllers, door chimes and wireless video communication products, which are mainly distributed in the US. In the 1990s, the company managed to expand its distribution  network  to  Europe,  Japan  and  South-East  Asia.  IQ  is  engaged  in  both  the  original  design  manufacturer  (ODM)  and  original equipment manufacturer (OEM) business models. Its main customers include ELPA Co Ltd (Japan), OSRAM Ltd (Europe), OPTEX Co Ltd (Japan), Friedland  Ltd  (UK),  Byron  (Europe)  and  Hager  (Europe).  The  company  has  two  production  facilities,  located  in  Penang,  Malaysia,  and Dongguan, China.  Both plants  have  a total production floor space of  19,493 sq ft.  IQ emphasises on research and development (R&D),  with8,156 sq ft, or about 49% of its 16,760 sq ft production floor space in Malaysia, allocated for R&D purposes.

IQ  has  a  simple  corporate  structure,  with  two  wholly-owned  subsidiaries  that  focus  on  manufacturing  in  Malaysia  and  China,  and  three subsidiaries to distribute its products  in  Japan, Europe and  South-East Asia.  In addition,  the company  owns  a 51% stake in a jointly-controlled SILQ (Malaysia) SB, which is involved in the  design, manufacture, and distribution of LED luminaires  and the manufacturing of light engines for luminaires.

Investment Case
Deteriorating  performances  after FY07.  After listing in 2005,  IQ  enjoyed two good years in FY06 and FY07 before  feeling the brunt of several years of deteriorating  performances.  The company was in  the  red for  three  financial years  (FY09-11)  before  returning to  the black in FY12. During  this troubled time, IQ  faced  several headwinds,  including  fading macroeconomic  conditions  during  the global  financial  crisis  and the Eurozone meltdown thereafter as well as rising manufacturing costs in China.

Underwent  internal  restructuring  since  2007.  In  late  2006,  IQ  appointed  Mr  Daniel  John  Beasley  as  its  managing  director.  Under  his leadership, the company underwent a restructuring of its business and the streamlining of its operations to ensure efficiency and cost-savings. IQ  also  embarked  on  a  restructuring  of  its  Dongguan  manufacturing  facility  in  2007  and,  subsequently,  completed  a  centralised  business coordination process  that  streamlined  its operations  in  the  UK  into a direct supply model. The latter allows IQ’s  customers  to  channel  their sales orders directly to the company’s head office in Malaysia.

Restructuring and streamlining activities are bearing fruit.  With its China manufacturing division having been consolidated into a single plant, as well as its leaner business model after  restructuring, IQ is able to focus on growing its business. The company’s  FY12  results were also back in  the black, as it posted a  core  net profit of MYR1.8m. IQ did  experience a dip in the latter  in FY13 to MYR0.6m, mainly due to  unfavourable foreign exchange rates.  It posted a  foreign exchange loss of MYR1.6m in FY13 compared to  a foreign exchange gain of MYR1.3m in FY12. With the recovery of the  global economy  underway, we believe that  a  stronger USD,  EUR  and  JPY will prove to be in IQ’s  favour  in the next two years.  We  have  further  witnessed  a  significant  improvement  in  its  1HFY14  results,  with  NI  surging  51-fold  to  MYR8.3m  from  1HFY13’s MYR0.2m.  The  improvement  was  mainly  due  to  stronger  sales  for  its  new  products  and  a  favourable  foreign  exchange  rate.  IQ  has  also launched a few new products in 2Q and its customers are loading up its volume.

New products launching to boost sales. IQ is planning to launch a series of new products in FY14. It is also planning to launch its own high-bay lighting  solutions  that  are equipped with  motion sensors  by 2QCY14.  This  product is  able to detect  movement by people or vehicles  within a certain  distance.  This  makes  them  suitable  for  industrial  facilities  and  warehouses,  as  it  allows  the  operators  of  such  structures  to  achieve higher energy savings  by minimising the use of lighting.  As LED  lighting products  are  getting popular, we see greater opportunities for IQ to source more LED components from its SILQ (Malaysia) SB subsidiary for new products. The company recently announced that it had subscribed for  0.5m SILQ  shares  for RM0.5m, representing 1% of the entire issued and paid-up capital of SILQ  (Malaysia) SB.  This takes its stake in the latter to 51% and we  believe that  IQ  will take the lead in developing more LED components  going forward, which will  eventually benefit its future products development.

Global  economy  poised  for  recovery.  Our  economists  are  expecting  a  more  synchronised  global  recovery  in  2014.  The  global  backdrop  is turning more positive, with: i)  sustained economic recovery in the US and Japan, ii) a stabilising  Europe,  and  iii) the  bottoming out  of China’s slowdown.  Global manufacturing activities strengthened for the fifth straight month in Oct  2013, while global services activities rebounded to their  highest reading in more than two years (See Figure  4).  Although the US economy is still facing several  headwinds, ie  quantitative easing (QE)  tapering  to  begin  in  January  and  the  yet-to-be-resolved  debt  ceiling  issues,  recent  economic  data  suggests  that  the  US  economy  is  in better shape to weather any unforeseen obstacles.  The country  reported a stronger 3Q13 GDP of 4.1%, up from 2.5% in 2Q13 and 1.1% in 1Q13.  The stronger than expected GDP growth  in  the  US is supported by rising exports, businesses restocking shelves and a pickup in home construction. The improvement in the US manufacturing and services sectors suggests  that the US economy is still on track to chart a stronger growth in 2014.

The Eurozone economy is on track for a gradual recovery, albeit slowly and unevenly. Its economy has returned to a positive growth of 0.3% qo-q in 2Q13  and austerity measures are becoming less restrictive. The  European Central Bank (ECB) has cut its key policy rate to a record low of  0.25%  in  Oct  2013  and  policymakers  are  now  looking  into  ways  to  boost  economic  growth.  The  Eurozone  composite  PMI  has  resumed growth  for  five  consecutive  months  up  to  Nov  2013  (See  Figure  6).  This  improving  growth  outlook  in  advanced  economies  augurs  well  for Malaysia, which will likely experience a cyclical economic recovery in 2014. Being an exporter, the global economy recovery also bodes well for IQ. In FY13, about 55% and 17% of its revenue are generated from the European and US markets.

Net  cash  of  MYR12.1m,  minimal  capex.  IQ  is  in  net  cash  position,  with  total  net  cash  of  MYR12.1m  as  at  end  of  Sept  2013.  The  business requires minimum borrowings and  does not involve high capex. Normally, the company  invests about MYR4-5m per year on capex, with the exception of FY08, where it invested about MYR8m for its China plant restructuring.

No dividend  since FY08, but expecting  to resume dividend payout by FY15.  IQ paid  a  net dividend of 9 sen  per share for FY06 and FY07. It halted  its  dividend  payout  since  FY08  to  facilitate  its  business  restructuring  and  streamlining  activities.  We  believe  that  the  company  w ill resume its dividend payout policy when its business is on track for recovery and stabilises in the mid-term.

Peer comparison & valuation
Attractive valuation. IQ’s closest peer  is Taiwan-based Everspring Industry Co Ltd (Everspring), which has a manufacturing plant in China. Both IQ  and  Everspring  have  similar  product  ranges  and  comparable  country  exposure,  and  both  export  to  Europe,  the  US  and  the  Asia-Pacific region. Europe is Everspring’s largest  exporting market, accounting for 83% of its total sales in FY12, vs.  IQ’s 55% of  FY13 total sales. As for IQ, it is  enjoying  a  bigger market share in  the Asia-Pacific  region, particularly in Japan,  which  accounts  for about 28% of its total sales in FY13.

While Everspring’s market capitalisation is much larger than IQ’s, the latter is cheaply trading at a low P/NTA of 0.8x compared to Everspring’s 1.5x. We like IQ  for  its:  i)  earnings turnaround,  ii)  more product launches in the pipeline, iii)  ability to ride on  the  recovery  in the  global economy, and  iv)  solid  balance  sheet  with  total  net  cash  of  MYR12.1m  as  at  end-Sept  2013.  We  expect  earnings  to  rebound  strongly  in  FY14, underpinned by stronger sales from new products.  Earnings growth is expected to remain  strong over the next two years, underpinned by more new products launching.    We recommend a BUY on IQ, with a MYR1.84 FV  pegged to a FY15f  P/E of 12.5x, which is within the range of the 10-15x P/Es of consumer stocks (excluding consumer staples) under our consumer analyst’s  coverage.  The company is still trading below its NTA/share of MYR1.11, as at end-Sept 2013.

Source: RHB