Quarz presses Sunningdale to address 'shareholder value destruction', quantify Penang losses

SINGAPORE (Mar 5): Quarz Capital Management activist fund has sent off a second open letter to the board of Sunningdale Tech, the Mainboard-listed high-precision plastic components maker, which was hit by another earnings miss.

In the latest open letter issued on Tuesday to Sunningdale, Havard Chi, head of research and director at Quarz, noted that Sunningdale’s new Penang plant continued to incur one-off start-up costs and duplicity in operating cost in 4Q18 as it retains its production in Shanghai.

This was largely due to the delay in the group’s shift of its entire Shanghai operations to its megafactory in Chuzhou, which would have increased production capacity, cost advantages and operating margins.

With this in mind, Chi is calling for Sunningdale to quantify the total gross and operating loss in Penang, as well as the cost of inefficiencies in maintaining duplicate operations and shifting between Shanghai to Chuzhou.

“This disclosure enables shareholders to separate one-off ramp-up costs from underlying operations and allows for better evaluation of the underlying fundamentals and intrinsic value of Sunningdale. The increase in transparency and higher quality information will enable shareholders to have greater clarity and forecast on long term profitability and the intrinsic value of the business instead of focusing on volatile quarterly financial reporting,” says Chi.

Since the company reported an 83.8% y-o-y decrease in 4Q18 adjusted earnings of $1.7 million last Thursday, Sunningdale shares have tumbled 13.2% to $1.37 as at 12.14pm .

In the filing last Thursday, Sunningdale CEO Khoo Boo Hor expected production and utilisation at the Penang facility to ramp up in the second half of 2019 after securing new projects with several customers and complete the shift in China operations to take place by the third quarter of 2019.

In his outlook, Khoo also expected business conditions remain challenging as the group continues to face headwinds in the form of rising labour costs, rising utility costs, price pressure and negative market sentiment surrounding the US-China trade war.

Chi says the fall in share price was a “strong negative market reaction” to the group’s 4Q18 financials and a result of a “significant lack of transparent and quality reported information, creating unnecessary uncertainty and shareholder value destruction”.

Quarz, which holds an almost 5% stake in Sunningdale, had previously issued a Dec 13 open letter last year highlighting the group’s “severe undervaluation” and the need to promote shareholder value. In order to do so, the activist investor suggested that the group raised its dividend distribution to 60% of its net profit, among others.

In its response, Sunningdale said it preferred to focus on the fundamentals of its business in order to bring greater benefits to its shareholders, although it would consider Quarz’s proposals.

Higher payouts are possible, says Chi

In Quarz's latest open letter, Chi reiterates that Sunningdale should further increase its dividend payout to its shareholders this year.

Based on Quarz’s estimates, he says Sunningdale can afford to generate more than $30 million of free cash flow in 2019 as the company continues its expansionary capex and continues to ramp up production.

“The increase in dividend can demonstrate that management is confident and committed to deliver on its growth strategies and enhancing of shareholder value. It also rewards its shareholders for their patience and unwavering support during this transitory period,” states Chi.

Quarz to further capitalise on share price weakness

In particular, Chi notes that Sunningdale’s stock trades (ex-dividend) at a depressed projected P/E 2020E of 8.2 times (core net profit of S$31.5million) with EV/EBITDA of 3.5 times – despite the company’s significant production ramp-up and profitability due to its new plants and projects from 2H19.

On this, the director says Quarz intends to retain a substantial stake in Sunningdale, as well as “add” to its position on further price weakness.

“We believe that our recommendations as detailed in our previous engagement and this letter can provide a potential total return of more than 40% for all shareholders in the mid to long-term. We call on board and management to take immediate action to address this shareholder value destruction and look forward to continuing to work with the company to increase value for all shareholders,” concludes Chi.