Elite Client Idea #29

SK-Electronics Co., Ltd. (TSE Ticker: 6677; Price: ¥1091/share)

SK-Electronics (‘company’) is a manufacturer of large photomasks, which are the original plates required in manufacturing of liquid crystal (LC) panels - used in the smartphone, personal computer, flat-panel television, and automotive industries.

Its manufacturing facilities are based in Japan (73% of property, plant, and equipment) and Taiwan (27%).

It generated 90% of its sales outside Japan. Geographic split: China (53%), Taiwan (20%), Korea (17%), and Japan (10%).

It generated sales from a handful of prominent customers such as Samsung, Innolux, etc. but the largest customer didn’t account for more than 16% of revenues.

The company faces intense competition necessitating cost efficiencies. The industry is technology-intensive, and requires large capital expenditures to stay competitive.

It is also dependent on the capital investment plans of LC manufacturers; and LC prices have been on a continuous downtrend since July 2021, exacerbated by expansion of LC manufacturing capacity in China.

Moreover, the company is increasingly exposed to geopolitical risks of conflict between China and Japan.

Despite declining LC prices, demand from 5G smartphone, IT, and automotive panel manufacturers held up sales of photomasks in FY22.

The company reported TTM (and FY22 ending September 30th) sales of ¥24.9b (FY21: ¥20.4b), ebitda of ¥6.8b (FY21: ¥4.7b), and net profits of ¥3.3b (FY21: ¥1.1b).

Though the industry is dynamic, earnings have averaged ¥2.2b over the recent past.

The financial position is strong with net cash of ¥11.5b, net current asset value of ¥15.4b, and net tangible assets of ¥28.6b.

Receivables (relative to sales) and inventories (relative to cost-of-sales) are higher than the recent past. To stress test the net current asset value, we’ve adjusted them down to historic averages by ~¥2.5b.

Adding in market value of stocks (mainly Screen Holdings; ticker: 7735) of ¥366m, we arrive at an adjusted net current asset value of ¥13.2b.

The equity is currently selling for ¥11.3b, which is below adjusted net current asset value, 3.4x ttm earnings, and ~5x average earnings.

Management have committed to a payout of at least 20% of profits and the latest dividend declaration this month amounted to ¥64/share. Adding in TTM repurchases of ¥99m, the shareholder yield exceeds 6.5%.

Prospects aren’t bleak as the company is seeking to expand product offerings in the RFID and healthcare fields.

At the current price, the investor has limited downside and a remunerative earnings yield. Net of cash, the operating business is available for less than nothing.