Description

HCT Co is a small-cap Korean certification, inspection, & testing (“CIT”) company with a focus on IT devices. This is an attractive, oligopolistic industry with good secular double digit growth and 20% operating margins. HCT has a relatively new niche business testing EV batteries which could grow into a material business and add thematic appeal. Despite having a good track-record of mid-teens sales and earnings growth, with a high-teens ROE, the stock trades at only 9x trailing P/E and an estimated 7.5x 2022e P/E. This is in part due to a weak Q4 2021 result which was impacted by temporary start-up costs for a US office and testing center. Comps in the industry trade at 15-40x P/E so we see plenty of scope for HCT to re-rate with continued earnings growth and diminishing concerns about the Q4 2021 result.

Description

HCT was established in 2000 after it was spun out of SK Hynix. The company then IPOed on the KOSDAQ in 2016. The Chairman, CEO, and Vice President have spent their careers in the CIT industry and all have material stock ownership, totalling 36%.

HCT is one of the largest CIT companies in Korea, with approximately 70% of sales coming from this division. The majority of HCT’s CIT revenue is from IT devices testing, especially mobile devices and networking equipment. HCT estimates they have 50% domestic market share in 5G networking equipment testing and 30% market share in testing other 5G mobile devices. Domestic CIT competitors include DT&C (187220 KS) and smaller unlisted companies. The rest of HCT’s CIT revenues are derived from testing auto components and batteries, including EV batteries. CIT testing revenue is driven by the number of new client product launches, rather than the volume of products. Therefore, CIT industry revenues tend to be less cyclical than IT device industry revenues.

HCT is one of the top five global CIT companies for IT devices, with 7.7% market share of testing FCC registered 5G NR devices in 2021. HCT’s global market share benefits from strong relationships with Korean OEMs such as Samsung and LG, but they also have numerous non-Korean clients. 

VIC members should read Griffin’s excellent write-up of Sporton posted in November 2018 for a good summary of the CIT industry for IT devices. Sporton is the global leader in 5G device testing with about 25% market share. HCT benefits from the same industry drivers as Sporton, such as an increasing number of 5G device launches which command higher pricing for testing services. We also like Sporton but it trades at about double the P/E multiple of HCT.

HCT’s rapidly growing EV battery testing business is an exciting growth opportunity. Although it accounted for less than 10% of HCT’s CIT revenue in 2021, the segment has been growing at more than 50% p.a. with this growth likely to continue. Major battery customers include LG Energy, SK Innovation, and Samsung SDI. 

HCT’s other main business is Calibration testing, which is a consulting service provided to clients to measure the accuracy of various manufacturing processes. Calibration accounts for about 30% of HCT sales, and SK Hynix and Hyundai Mobis are large customers. This business is not expected to grow as quickly as CIT, but HCT still expects low double digit growth and 10% operating margins. HCT believes they have about 20% domestic market share in Calibration and are a top five competitor.

Valuation

HCT is trading near the low-end of its own historical valuation range at 9.0x trailing P/E (see chart below). HCT’s valuation also compares favorably vs. global CIT peers which trade at 15-40x forward P/E. 

We think the stock’s attractive current valuation is in part due to weak Q4 2021 results which caused local investors to sell the stock. Q4 earnings dropped 40% y/y because HCT incurred one-time costs related to opening an office and testing center in San Jose, CA. The company established this office at the request of US-based clients such as Microsoft and HP, who wanted HCT to test devices in the US. The company purchased an office building for $16 million, and incurred one-time costs to modify the property and sublease half of the space. We think some investors questioned the one-time nature of these expenses, but Q1 2022 earnings did rebound 70% q/q suggesting that the Q4 expenses were one-time in nature. The US business is still very small but the company hopes to build it into a material source of revenue in the next several years. Part of this plan includes expanding the EV battery CIT business to the US and they are in discussion with one major EV battery maker in the US right now.

Catalyst

Improved earnings growth momentum following weak Q4 2021 results

Growing scale and recognition of the EV battery testing business