ECS Holding

UOBKayhian on 17 Aug 2012

Results
· Slightly below expectation. ECS Holding’s (ECS) 2Q12 net profit declined 24.2% yoy to S$8.2m. Results were slightly below our expectation as 1H12 net profit accounted for 45.4% of our full-year forecast.
· Revenue edged lower. 2Q12 revenue slipped 3.0% yoy to S$823.6m. Distribution revenue declined 5.5% yoy due to lower sales of PC and notebooks, while Enterprise Systems and IT Services grew 3.5% yoy, driven by higher sales of enterprise software and storage products.
· Margin compression. 2Q12 profit declined largely due to a 0.6ppt yoy dip in gross margin from a change in product mix towards lower-margin tablet devices.
· Better cash conversion cycle. In 2Q12, ECS improved on working capital management, with its cash conversion cycle declining from 44 days in 2Q11 to 39 days in 2Q12.

Stock Impact
· The worst is almost over. We believe contribution from the distribution business will bottom out over the next two quarters, driven by: a) a resurgence in notebook sales with more Ultrabook models being launched, b) a PC upgrading cycle after the roll-out of Windows 8 this year, and c) a turnaround in its largest vendor HP’s PC business following more stability in top management.
· Positive on enterprise. In 2013, we forecast enterprise systems revenue to grow 20% yoy, as regional telcos plan higher capex spending on data centres and enterprise servers. In a bid to grow market share, ECS will also work closely with major vendors Oracle and Huawei to increase its product and service offering.
· Diversifying into cloud services. We see a potential re-rating catalyst from the group’s transformation from a low-margin hardware distributor into a high-margin service and software provider. In the near term, we believe ECS could diversify into cloud-based software solutions targeted at SMEs, providing a source of recurring income.

Earnings Revision
· Reduced forecast. We have reduced our 2012 and 2013 profit forecasts by 4.1% and 9.1% respectively, accounting for lower-than-expected margin arising from a change in product mix towards lower-margin tablet devices.

Valuation
· Upgrade to BUY with a higher target price of S$0.60 (previously S$0.57), implying a 25% upside. We roll over our valuation basis to 2013, and peg our target price at 6.5x FY13F PE, a 27% discount to peers’ average of 8.9x.
· Possible PE expansion. We see further room for PE expansion if ECS successfully transforms itself from a low-margin hardware distributor into a high-margin service and software provider.