Elec & Eltek International - Yield issues may only be partially resolved

Utilisation should have improved, production yield problems may still be around. We expect capacity utilization at Elec and Eltek ("ELEC") to have improved sequentially from 84% in 1Q07 to about 90% in 2Q07. Revenue in the June quarter should therefore record sequential growth from US$123.2m in 1Q07. However, sub-optimal production yield at ELEC’s Kaiping plant that was highlighted in our previous report may still be an issue in 2Q07.
2Q07 net profit may fall short of our forecast. We expect 2Q07 revenue to be in-line with our forecast of US$132.2m. Net profit in the second quarter may fall short of our estimate of US$10.4m, as gross margins may be lower than our 18% assumption due to yield issues mentioned above. In fact, gross margin could still be in the 15% to 15.5% range (15.2% in 1Q07), in which case 2Q07 net profit would only be approximately US$7.3m compared to US$6.6m in 1Q07. The current production hiccup at Kaiping is temporary. We expect full resolution by end 3Q07, which is later than what we had anticipated earlier. Therefore, full-year gross margins may be lower than our earlier estimate of 17.9% (probably closer to 16.5%), and net profit should also decline more than our earlier forecast of -25% YoY to US$43.3m. We expect ELEC to pay out 60% of its FY07 net earnings, or 14.5 USD cents per share, for a dividend yield of 7%. Actual payout should be slightly lower as we are likely to revise downwards FY07 EPS estimates after 2Q07 results have been released sometime in mid-August.
Undervalued but still a Hold. We continue to believe that ELEC is well positioned to compete in the PCB industry given its size, experience and access to its parent’s (KingBoard) network of resources. As mentioned previously, we also think FY07 net profit will not be reflective of ELEC’s earnings potential. Given its double-digit ROE and nature of business, ELEC should be worth between 1.5-2.0x NTA, i.e. US$2.78-3.70, per share. We will keep our current fair value per share of US$3.32 as it falls within this range. Although ELEC has an upside potential of 59.6%, and is currently trading at undemanding 7.3x TTM EPS, 8.6x FY07E EPS, and P/NTA of 1.1x, we will maintain our HOLD recommendation as we are still unable to find any strong share price catalyst in the next six-to-nine months. Longer-term investors who are attracted by its yield and undervaluation may add or initiate a new position, as we doubt the stock price will go down much further from current levels. We guess downside is probably at the US$1.90 level, or -8.7%, giving the stock an attractive risk/reward for the longer-term investor.