SINGAPORE (Dec 6): UOB KayHian is maintaining Venture Corp at “sell” given increasing risk production share of IQOS (I quit ordinary smoking) devices could be shifted away to another contract manufacturer by Philip Morris which is seeking to improve economics.

In a Thursday report, analyst Foo Zhi Wei says UOB channel checks into the IQOS supply chain indicate that the second manufacturer, Flex has reached the supplier concentration limit for Philip Morris although UOB was not able to ascertain as to whether Venture has similarly hit a production ceiling.

Venture is currently producing “heat not burn” tobacco products IQOS 2.4+ and IQOS 3 products while Flex is currently producing IQOS 2.4+ and IQOS 3 Multi products. From what UOB understands, Philip Morris is likely to introduce a third manufacturer which will likely produce IQOS 2.4+.

Foo says a third manufacturer entering the fray will likely try to do so at a competitive price compared to the current incumbents with Flex likely to be more cost effective with a lower cost base between the two.

“Logically, Philip Morris will want to shift some of its higher cost production to this new manufacturer to improve economics on its IQOS devices,” says Foo, adding that Flex could be involved in IQOS 3 production as well.

In a Dec 3 release, Nikkei’s Malaysia Manufacturing PMI came in at 48.2 for Nov, a decline from 49.2 in Oct. Foo says this points to a sharp deterioration in the manufacturing sector since May and extends the current period of decline to two months.

Venture has significant capacity based in Malaysia and as the production outlook of other clients may slow down in 2019, this points to earnings downside risk for the company.

“Maintain “sell” with an unchanged target price of $12.90,” says Foo.

Shares in Venture are down 49% from its April peak of $29.51 at $15.01 or 25 times FY19F earnings.