1) Stronger-than-expected IA demand: China’s overall IA demand,
despitetougher comps, further accelerated to 17% YoY in 4Q17 (vs. +15%
YoY in 3Q and11-12% in 1H), pointing to potential upside for HOLI’s PA
A clean start; a clear recovery
2) Encouraging progress in FA: Leveraging on HOLI’s superior data
acquisition/integration capabilities and accumulated database/experience
for variousverticals, we expect HOLI to launch a monetizable flagship
HOLI’s FY17 earnings (core NP down 33% YoY) missed its guidance.
However,this is likely to be a non-event, as the Street well anticipated
it falling short. Withalmost all negatives now reflected in FY17
(delayed rail orders, ATP market shareloss, weak IA sales, etc.), we
believe a significant turnaround in FY18 is warranted.
3) Positive mix change in EMU procurement: We expect EMU deliveries
this yearto be largely for the 350km/h CEMU model. ATP pricing for this
model is 2x thatof the 250km/h model, which accounted for almost all the
EMUs procured anddelivered in HOLI’s FY17.
We see upside potential to management’s FY18 guidance of 43-57% YoY
NPgrowth, as 15-25% sales growth guided for the IA segment looks
conservativeagainst a 50%+ YoY surge in IA new orders in FY17, while the
upcomingATP procurement may add upside to rail revenue. With spiking
railway lengthcompletion and manufacturing upgrades further gaining
momentum, we believeHollysys has entered a multi-year robust recovery
trajectory. Hollysys is one ofour top picks for both rail equipment and
the IA sector.
Our FY18 earnings forecast of USD110 (non-GAAP NP) is already at the
highend of management’s guidance and tops the Street, but given the
above positivedevelopments, we see further upside potential. Along with
the FA breakthroughand considering the better outlook for FA (vs. PA),
we expect HOLI’s valuationdiscount to global IA peers to narrow. We
raise our TP to USD30.
Some green shoots in 4Q results; recovery trajectory reaffirmed
4Q headline NP (non-GAAP) came in at USD23m, down 34% YoY on a 7%
dropin the top line. Excluding one-off goodwill impairment of USD11m
relating toConcord, core NP was actually flattish YoY. This was a
significant improvementcompared to the previous three quarters (average
-40% YoY). In particular, IArevenue was up 6% YoY, the first positive
growth recorded since 3QFY15, asrevenue has started to reflect the
strong order momentum in the past fewquarters (average +c.40% over
1Q-3Q). With new ATP orders coming through in2Q-3Q, revenue for the rail
segment also reverted to a low-single-digit declinein 4Q after falling
by an average of c.50% in the preceding three quarters.
Moreencouragingly, IA new orders indeed accelerated, up 85% YoY in 4Q
(vs. c.40%YoY in 1Q-3Q), reaching USD80m+, a record high. Rail new
orders also jumpedYoY to USD70m in 4Q vs. an average of USD38m in the
preceding four quarters.
FY18 guidance largely in line with consensus, but we see upside
In the earnings release, management guided for FY18 revenue of
USD500-530m(or 16-23% YoY growth) and non-GAAP NP of USD100-110m (or
43-57% YoYgrowth), which is largely in line with consensus estimates.
Our NP projection ofUSD113m is above the high-end of company guidance.
In light of 52% YoY growthin IA new orders in FY17, we think 15-25%
sales growth guided by the companyfor the IA segment looks conservative.
For rail, HOLI is also guiding 15-25%revenue growth for FY18, which
assumes 75 EMU sets in the coming 2H17 andanother 300 sets in 2018.
Again, we think this looks conservative and the actualEMU bidding may
exceed that level, per the latest industry news (according toCaixin,
another 104 China Standard EMUs will likely come up for tender soon),
asHollysys Automation Technologies Ltd.
well as our bottom-up line-by-line calculations (DBe: 366 standard
sets of EMUswill be added in 2018).
Valuations look compelling against strong recovery; risks
We retain our current forecasts post FY17 results. We keep our
DCF-based TP ofUSD23 (WACC: 12.3% and TGR: 0%) unchanged and reiterate
Buy. Trading closeto three-year trough valuations, we believe the stock
is significantly undervalued,given multi-year earnings recovery ahead.
Key risks: unexpected slowdown inautomation upgrades and further delays
in ATP procurement.