SINGAPORE (Jan 15): While the bottoming out of plastics components manufacturer Fu Yu Corp’s earnings might have been a cause for concern to some investors, the stock could well be poised for a turnaround as earnings are set to pick up. 

DBS Group Research is initiating coverage on Fu Yu with a target price of 35 cents, representing a 40% upside for the stock. 

In a Wednesday report, analyst Ling Lee Keng has highlighted a few reasons why a re-rating is on the horizon for the group in the coming year. 

Firstly, Ling notes that Fu Yu has manufacturing facilities in China, Malaysia and Singapore - all of which are slated to experience a turnaround in manufacturing sectors. 

“We believe that this will lead to an uptick in earnings for Fu Yu,” says Ling, adding that the three countries’ purchasing manager index (PMI) figures have improved significantly.

For China, Ling highlights how PMI had come in at above 50.0 points after six consecutive months of contraction, while year-on-year percentage change in the plastic production volume turned positive in May last year following 16 consecutive months of negative growth.

Likewise, PMI figures in both Malaysia and Singapore had picked up after six and 14 months of contraction respectively. 

“With the bottoming out of the manufacturing PMIs, we are positive that the negative growth in these regions will reverse in FY20,” says Ling. 

Secondly, Ling hones in on the group’s recent shift in product mix which entails a greater focus on products with higher profitability and growth potential. These include consumer, medical and automotive products. 

“Fu Yu, which produces plastic parts via injection moulding, is focusing on products with longer life cycles and higher growth potential,” says Ling.  

“These products generally command higher margins due to the high-quality design specifications and higher demand, as compared to products in other segments like the printing and imaging division,” adds Ling. 

Apart from delivering higher returns, these segments are also projected to grow at a faster rate, or high single digits, compared to the plastic manufacturing industry growth of less than 5%. 

Apart from the shift in focus, Fu Yu is also looking to expand its margins through cost enhancement initiatives. The way Ling sees it, the group’s redevelopment of its factory in Singapore to improve productivity and efficiency is one such example. 

“The layout of the new building will incorporate a seamless workflow across tooling, moulding, and assembly operations, to enhance productivity and efficiencies, and to ensure faster time-to-market for its customers,” says Ling. 

Fu Yu is simultaneously selling its industrial property at 5 Tuas Drive 1 to partially offset the redevelopment costs. 

Ling also observes that the group is streamlining its operations in China, amid Shanghai’s higher operating costs. This will result in Fu Yu transferring its assets from its factory in Shanghai to Suzhou, but will continue serving its Shanghai customers from the new location.  

“This will further improve the utilisation of the resources and cost structure,” says Ling. “We are expecting the closure of the operations in Shanghai to shave off $2.4 million from its depreciation expense, representing 1.2% of its sales in FY18,” adds Ling. 

Ling also notes that Fu Yu has had an increase in productivity amid initiatives to optimise its production processes through lean management and automation. 

For instance, the non-executive employee count had declined by 8.5% from 2016 to 2018, while the revenue generated per non-executive employee increased by 8.9% during the same period.

Finally, Ling opines that Fu Yu’s “strong financial positioning” in terms of its high cash position and absence of borrowings, is noteworthy. 

In addition, the group has been paying out dividends amounting to more than 80% of its PATMI from FY15 to FY17, surpassing its dividend policy which mandates payments of at least 50%. For FY19, Fu Yu has paid out interim dividends of 0.6 cent per share, unchanged from FY18. 

“Based on its cash level, business performance, and funding needs, we expect Fu Yu to at least pay a final dividend of 1.0 cent, translating to a total dividend payout of 1.6 cents per share in FY19, similar to FY18, which is equivalent to a dividend yield of 6.4% based on its current share price,” says Ling. 

“The current recovery of the manufacturing cycle across its operating regions, as well as its business strategies, presents an opportunity for a re-rating of the stock’s forward price-to-earnings (PE),” adds Ling. 

Shares in Fu Yu Corp closed three cents higher, or 12% up, at 28 cents on Wednesday. This translates to a PE ratio of 9.5 times and a dividend yield of 7% for FY20F according to DBS valuations.