Description
Here’s another HK-listed niche manufacturer that looks incredibly cheap.
DBA Telecom (3335 HK) is the leading supplier of phone booths and smart card vending machines in mainland China. The company has a ten-year operating history with several product introductions and steady growth in sales and earnings. We like management’s strategy of focused growth and that management owns nearly half of the company.
The valuation is very compelling, with the company steadily profitable yet trading below its net cash level (as of June 2008) of 0.51 HK cents and well below its expected net cash level of 0.80 HK cents at end of 2009 (60% implied upside over next twelve months if stock rises in-line with expected growth in net cash balance). Furthermore, management is considering doubling its dividend from 15% of net income to 30% or higher. With the stock at 0.48 HK, the current 15% dividend on 0.31 EPS for 2008E (1H08 EPS was 0.15) gives a 10% dividend yield. With the stock at 0.48 HK, the current 15% dividend on 0.39 EPS for 2009E gives a 12% dividend yield. So, a doubling of the dividend yield to 30% could give a 20% and 24% dividend yield for 2008 and 2009, respectively. Unlike many HK-listed manufacturing companies, DBA has not excessively diluted its stock, driving impressive growth in diluted EPS (see below). Ignoring the significant net cash balance, the stock trades at 2.4x 2007 EPS, 1.6x 2008E EPS and 1.3x 2009E EPS.
Some metrics (2008 and 2009 estimates are from our recent conversations with CFO):
Price: 0.48 HKD
Market cap: 498 m
Net cash: 533 m
EV: -35 m HKD
Sales:
2003 265 m RMB
2004 385 m
2005 558 m
2006 670 m
2007 1,198 m
2008E 2,016 m
2009E 3,439 m RMB
Operating profit:
2003 83 m RMB
2004 122 m
2005 174 m
2006 213 m
2007 288 m
2008E 369 m
2009E 483 m RMB
Net income:
2003 74 m RMB
2004 111 m
2005 147 m
2006 184 m
2007 247 m
2008E 320 m
2009E 419 m RMB
Diluted EPS:
2003 7 cents RMB
2004 11 cents
2005 14 cents
2006 17 cents
2007 21 cents
2008E 31 cents
2009E 39 cents RMB
Some background on the business:
Company was founded in 1997 and had is IPO in May 2006 at 1.26 HKD. Importantly, the company has a history of successfully and profitably entering new business segments: manufacturing of public phones (1998), manufacturing of smart card vending machines (2001), and then building a network of smart card vending machines (2007). The company also manufactures transmission connection equipment (i.e. optical distribution frames and optical passive devices). An important advantage for DBA is its sales network in mainland China (27 regional offices, growing to 35 by end of 2008; largely commission-based), which is important for maintaining close relationships with its customers (the 300+ local, municipal levels of the major Chinese telecom operators: China Telecom, China Netcom, China Mobile, and China Unicom). DBA can spend a modest 150 m RMB to increase its manufacturing capacity, which should be sufficient for the next five years. The company’s businesses have some great tailwinds: growing penetration of phone booths in China (about 0.3% versus 2% in U.S.), high urban growth (10-20 m Chinese move to cities each year; new road construction), strong replacement cycle of phone booths (every 5-7 years), and growing advertising opportunity (local telecom operators have six month payback on phone booths just with advertising sales, excluding telecom sales).
Manufacturing of public phones (1998): Public telephones were first installed in 1998 in China. Now, there is an installed base of about 4.4 million units. Penetration is about 0.3%, considerably lower than 2% in the U.S., and the installed base could grow to well over 10 million units (implying penetration of 0.9%). DBA has steadily maintained gross margin of around 40% (due to its cost-plus model). Market share is around 14%, up from 12% a couple years ago. Typical contracts are twelve months (with a fixed mark-up based on raw materials cost), and the company does not install or maintain the systems. DBA sells the units for about 3,800 RMB, and telecom operators typically generate a return of 7,600 RMB in the first year (1,600 RMB from telecom revenue and 6,000 RMB in advertising revenue from surfaces for advertisements on the unit), a payback of about six months. With a replacement cycle of 5-7 years and the large installed base, about 65% of DBA’s public telephone sales are now replacement sales. Including sales of wireless business telephones and set-top boxes, this segment generated 248 m RMB in sales in 1H08 (30% of total sales), and sales continue to grow 15+% a year.
Manufacturing of smart card vending machines (2001): The installed base of smart card vending machines in China is only about 40,000 units (about one-third manufactured by DBA). DBA entered the market in 2001 and currently has about 32% market share. DBA has about 15 models, with 5-7 new models a year. Like public phones, typical contracts are twelve months with a fixed mark-up based on raw materials cost. As background, the Chinese telecom market is about 95% pre-paid (creating need for smart cards) and only 5% post-paid. Also, utility (gas, water) and landline phone services are generally pre-paid. Smart card vending machines are growing rapidly in China due to superior economics than service counters: no staff salaries or rent, open 24/7, no counterfeit cards. DBA maintains gross margin of about 45% (again, due to its cost-plus model). This segment generated about 175 m RMB in sales in 1H08 (21% of total sales), and sales continue to grow 20+% a year.
Company-owned network of smart card vending machines (“self service business”; 2007): In 2007 (after trials in Fuzhou), DBA started rolling out its own network of smart card vending machines. Currently, DBA is the only non-telecom operator with its own network in China (DBA expects to operate about 3,500 units as of end of 2008, versus total of over 40,000 units in mainland China). DBA has about 1,000 units in Fuzhou and expects to add 2,500 by end of 2008 in Beijing, Shanghai and Chongquig. The investment is about 45,000 RMB per unit (including 15,000 RMB in working capital). After 3-6 months, the units generate about 400,000 RMB in annual sales (selling about 10 cards a day at 100 RMB), with about 7.5% gross margin (the average commission generated by DBA). After costs like rent and maintenance, operating profit contribution is about 3.5%, which gives a 1.5 year payback, excluding working capital. This segment already represents over 28% of the company’s sales (with a much lower gross margin). Reaching 10,000 units in 2-3 years (adding about 3,000 a year) would require about 450 m RMB in capital and could generate sales of 4 B RMB and operating profit of about 140 m RMB, which would contribute over 0.10 EPS and could eventually lead to a higher valuation for the company as the company evolves into more than a manufacturer.
Overall, we believe the company has a good business and the valuation is incredibly cheap (trading at less than net cash for a profitable company with a ten-year history of profitable growth and many years of profitable growth ahead). Catalyst
1) Continued growth in each major segment (public phones, smart card vending machines, network of smart card vending machines)
2) Continued cash generation
3) Dividend and possible dividend increase