Tek Seng: Turning The Table Around

Monday, 22 February 2016

Since year 2011, I felt that Solar Energy could be "The Next Big Thing". 

At that time, Tek Seng which is involved in the manufacturing of PVC-related products, started to venture into solar cells manufacturing business.

Its share price was traded at around 35sen then.

In mid-2011, Tek Seng announced its intention to diversify into solar cells & modules manufacturing business. The first production line was started as expected in mid-2012.

It planned to add one more production line in 2013, and 2 lines in each of year 2014, 2015 & 2016 to achieve a total of 8 lines in 2016.

Tek Seng expected its solar division to generate RM130 to RM170mil revenue in 2012. 

However, it only manage to register revenue of merely RM0.2mil and RM12.4mil for 2012 and 2013 respectively from its solar division as no additional lines were installed as planned after the first line.

So, loss is inevitable.

The solar revenue increased significantly to RM47.4mil in 2014 though it was still operating at a loss.

Year 2015 is proven to be a turnaround year for Tek Seng which saw its solar revenue jumped 4x to RM185mil with its maiden net profit of RM13.1mil.

The quarterly results will show this turnaround more clearly.

RM mil	Revenue	PAT
14Q1	5.9	-3.4
14Q2	14.9	4.6
14Q3	16.6	-1.7
14Q4	10.1	-2.9
15Q1	16.8	-2.2
15Q2	29.6	-3.7
15Q3	55.8	7.5
15Q4	83.1	11.4

I have never invested in Tek Seng before even though I was interested to do so, as it was hard for me to predict how much Tek Seng can earn from this solar cells venture.

Now the earning level and visibility are becoming clearer.

Tek Seng operates this solar cell business through its 50.69% owned subsidiary TS Solartech (TSS), which is a JV with Taiwan's Solartech.

Obviously TSS achieved this turnaround from loss to profit by increasing its production capacity to achieve economy of scale.

After the first production line in 2012, 2nd line was only installed 3 years later in Feb15 while the 3rd line was in May15.

Currently TSS has 4 production lines with total capacity of 280MW. The 4th line should be installed some time around the end of year 2015.

The story does not stop here.

TSS is currently executing a plan to increase its solar cell production capacity by 2.6 times from 280MW to 740MW. It plans to spend RM237mil in capex to add 5 more lines and a new manufacturing plant in Penang Science Park.

The new 3-storey plant which can accommodate 10 lines should be near completion by now.

With this aggressive expansion, TSS is expected to have 9 production lines with total capacity of 740MW (156mil pieces) by Q3 of 2016.

Current price of solar cell has increased to USD1.61 per piece from USD1.40-1.50 per piece. So there is a potential of USD250mil (RM1bil) of solar revenue for TSS if the capacity is fully utilized.

Anyway, please be reminded that Tek Seng only has 50.7% stake in TSS.

In Tek Seng's FY15Q4 quarterly result, revenue from solar division (TSS) is RM83mil while PAT stands at RM11.4mil.

This result should be achieved through 3 to 4 lines, in which I think 4th line did not contribute fully to this quarter.

So, it should be alright to annualise this result to predict near future earning, as production is expected to increase and there is no other significant one-off item or forex gain.

The net profit margin for solar division stays stable at 13+% for the last 2 profitable quarters.

Using FY15Q4 solar division's earning, guesstimated net profit for TSS (without further capacity expansion) will be RM45.6mil, or RM23mil to Tek Seng.

Non solar division (PVC) net profit in FY15 is RM15.5mil (RM14.5mil in FY14). It's around RM15mil each year.

I would give a projected annual net profit of RM23+15 = RM38mil for Tek Seng.

Tek Seng currently has 271mil outstanding shares in the market, together with 89mil warrants which will be expired only in Jan 2020.

Unfortunately for small shareholders, Tek Seng has proposed a private placement of maximum 36mil shares (10%) which should be carried out soon to fund its expansion.

Tek Seng's shares will increase to no more than 307mil after the private placement if there is no warrant conversion.

Using this 307mil share base, guesstimated EPS for Tek Seng will be 12.4sen.

At current share price of RM1.18, projected PE will be 9.5x.

This calculation excludes the on-track expansion of solar production capacity from 280MW to 740MW.

Interestingly, investors do not have to wait too long as they are expected to be completed by Q3 of 2016.

If TSS's net profit can double after the expansion, it might contribute RM46mil to Tek Seng's bottom line. Together with non-solar contribution of RM15mil, Tek Seng might be able to achieve RM61mil net profit for its FY17.

With this figure, EPS will be around 20sen (assume no dilution from warrant conversion) and 13sen (with full warrant conversion).

Anyway, is 2x increase in TSS's net profit after full expansion in capacity too conservative? I think we should assume that the capacity will not be fully utilized.

Expansion plan is always prone to delay, and increased capacity might not be utilized fully.

As mentioned earlier, Tek Seng has once delayed the expansion of its solar capacity by more than 2 years, and its "guided" revenue in 2012 was way off the mark!

Furthermore, there is a possibility that recent surge in solar cells demand in 2015 & early 2016 might not be sustainable.

This is because US solar investment tax credit policy, which is directly related to solar energy demand in US, will expire on 31 Dec 2016 and this will cause solar energy demand to surge before the expiry date.

Solar Investment Tax Credit (ITC) is a US policy to support its solar energy industry.

ITC is a 30% tax credit for solar system on residential & commercial properties. I think it is something like a tax relief here in Malaysia.

ITC was first implemented in 2006 and since then, annual solar installation in the US has grown by over 1600%, a whopping CAGR of 76%.

Current ITC which was extended once in 2008, will expire in the end of year 2016 and the tax credit will be reduced to 10% and 0% for commercial and residential properties respectively.

So, ITC extension is extremely important to US's solar industry and those companies who export their solar components etc to the US.

From SEIA website, without ITC extension beyond 2016, solar capacity is expected to fall sharply from 11.2GW in 2016 to 3.2GW in 2017, after a surge in demand in 2016.

Besides, US will also lose up to 100,000 solar related solar jobs if no ITC extension is granted.

Can US afford to lose so many jobs?

In contrary, with the extension of ITC, 61,000 more solar jobs are expected to be created, and solar capacity will be able to continue its uptrend.

However, there will be no surge in 2016's solar demand if ITC is extended but gradual growth in demand will continue.

In Dec15, the US congress has passed a bill that extends solar ITC until year 2022, in which current rate of 30% will remain the same until 2019, after which it will fall to 26% in 2020, 22% in 2021 and 10% in 2022.

Definitely this will give a big boost to the solar industry not only in the US, but also around the world.

For TSS who also exports its solar cells to US besides Canada, China, Taiwan & East Europe, this is definitely a good news as the demand for solar energy in US will continue to grow beyond 2016.

If US's ITC is not extended, recent solar cell manufacturing capacity expansion by Tek Seng might be "dangerous" even though other countries might still sustain the demand.

Recently two China solar energy companies Jinko & JA Solar have set up its manufacturing plants in Seberang Perai, Penang, perhaps to avoid anti-dumping duties by US & EU. This might adds some competition but it shows that solar industry has a bright future ahead.

The upcoming TPPA might also boost export of solar cells from Malaysia to US/Canada.

Anyway, US only makes up a small part of the world's solar energy consumption. Asia especially China, Japan and may be the upcoming India are still the main market and I think solar energy should get more and more common in other emerging countries.

Another piece of news that might concern Tek Seng's investors is European Union's extension of China's anti-dumping duties on solar panels to Malaysia & Taiwan, as some companies from China & Taiwan set up plants in Malaysia to avoid this heavy duty.

Even though TS Solartech is said to be the first "made-in-Malaysia" solar cells/modules manufacturing company, it has Taiwan's Solartech as its strategic partner & shareholder.

I'm not sure whether EU's latest anti-dumping duties will affect TS Solartech. TS Solartech does export its products to Eastern Europe though I think the volume should not be too significant.

The linked article above mentions that there are some companies exempted from the duties. Is TS Solartech part of it?

Furthermore, TS Solarch manufactures solar cells & modules, and seems does not assemble them to solar panel. Will it still be related to the anti-dumping duty by EU?

US also has its own solar products anti-dumping duty on China & Taiwan. Will TS Solartech ever get affected?

Tek Seng manage to achieve positive operating cash flow in FY15 but spent as much as RM162.5mil for PPE purchase (capex).

Its has a debt/equity ratio of 0.6x and will continue its expansion plan in FY16.

Upcoming private placement will help to ease its financial burden but it will dilute its earning of course.

I think it should not have much capex after 2016 and should be able to enjoy good operating cash flow after that if the sales of its solar cells can grow along with its expansion.

However, in its website TS Solartech says this:

It seems like TS Solartech is not satisfied being only a manufacturer of solar cells & modules...

It's almost certain that Tek Seng's FY16 financial result will be better than FY15, and FY17 will be better than FY16. However, is it worth to invest in Tek Seng at current share price of RM1.18?

Decision is yours.