Boer Power (1685.HK) – Initiating Coverage (Business Overview)

Given the recent bullish run of its counter and also the upcoming FY2011 result release in the next 2 months, I thought it will be good to cover Boer Power again, so as to provide a better understanding of its business scope and determine whether there are any new changes to its valuation.

Investment Thesis for Boer Power (1685.HK):

• Good micro aspect: Strong business nature with sustainable high margins & top quality customers
• Favourable macro aspect: Industry favoured by Chinese government (12th 5 year plan)
• At last done price of HK$2.83, 43% of market cap is pure net cash & 5.28x P/E ex. net cash
• Poor 1H FY2011 results believed to be temporary

Overview of Boer Power’s Business:

Boer Power is a HK-listed company (listed on Oct 2010) which mainly engages in the building of system for electrical distribution. Its business can be categorised into 4 segments:

i. Electrical Distribution System (EDS)

EDS are mainly used in power connection between the power mains and the facilities of its customers. In short, you may think of its EDS business segment as one which provides conventional switchgear equipment to its customers. The competitive nature of this industry is very fierce as product differentiation is minimal in switchgear equipment. The product nature is less technological demanding and the industry is saturated with domestic competitors.

From FY2007, EDS has been the bulk contributor of Boer’s revenue, accounting for 71.3%. However, its proportion has been diminishing over the years, with a mere contribution of only 2.2% of 1H FY2011 revenue. The decline was a result of intensified competition, with throat cutting margins. Moreover, the high-speed railway industry, which was seen as a huge driver for this segment, had changed its contract bidding to be simply awarded based on prices alone. Hence, this increased price competitiveness in the industry. As of early FY2011, Boer has signaled intention to move its focus away from this segment and more on to the other three.

ii. Intelligent Electrical Distribution System (iEDS)

The iEDS is an improved version of its EDS solutions. Compared to the EDS solution which has no automated features, iEDS provides a scope of automatic data collection and analysis, allowing user to analyse electrical distribution on an off-site basis. In short, iEDS solution provides data which allow the user to better manage its electrical consumption.

This alongside with EE, will be Boer’s new concentrated source of growth. Ever since FY2007, its revenue has increased 8-fold to FY2010 (RMB54m to RMB490m)! Proportion of its revenue contribution has jumped from a little 15.2% to 69% in 1H FY2011. The prospect for such industry growth potential is huge as Boer management has also forecast an overall 11% growth for the industry.

I too believe that the iEDS and EE segments will be a strong driver for Boer’s sales & profits. Unlike EDS, iEDS require more technical know-hows which small domestic firms might not be able to replicate. With such, there is a reliable competitive advantage for Boer and this can be translated into sustainable profit margins, averaging 35% since FY2007. Secondly, the scalability of China’s market potential is huge. Once a project is deemed to be successful, firms are likely to scale out similar projects to its other outlets, resulting in new business for Boer – something that has been evident in Boer’s current customer list – China Mobile and MacDonald’s.

iii. Energy Efficient (EE)

As compared to EDS & iEDS, EE solution is more customised and it is more of a service than a product. On top of the data analysis provided by iEDS, Boer offers the EE solution through offering solutions, measures and proposals to its customers on how its current electrical business system can be better upgraded, repaired or improved. Some of the tasks offered include site diagnostics, on-site and remote monitoring and energy efficiency improvement. In other words, EE is the value-added component of Boer’s business.

EE is probably still in its early starter stages, contributing less than 1% of Boer’s revenue since FY2007. However, a small glimpse of its potential was when its segment revenue surged nearly 20-fold  through a single 1H FY2011 revenue of RMB20m, as compared to an entire FY2010 revenue of RMB1.5m. Given the customised service EE provides, profit margin for EE segment will naturally be high and sustainable as it is differentiated by human knowledge capital – margin averages 66.4%. Though Boer management did not indicated any fixed growth given the lumpiness of EE contracts, they did foresee that the growth will be faster than iEDS. Again, with the value-added component, EE possess the same scalability attractiveness as iEDS.

iv. Components & Spare Parts (CSS)

Apart from the above 3, Boer also engages in the sale of components & spare parts of such electrical solution system. Though CSS is typically not recognised as the core business of Boer, it still plays an important role as it provides much needed cost-savings for its own system manufactures and in the case of technological advancement, some components & spare parts may add on to Boer’s competitive advantage.

A potential growth story with slight undervaluation

Overall, from the above description, it offers a glimpse of Boer’s growth potential. With labour cost increasing inevitably and cost of raw materials being volatile and limited to only hedging tools, it is no wonder that energy efficiency is a core cost-cutting issue for many firms. Coupled with the strong electrical demand in China economy and the alignment of interest from China’s 12th 5-Year Plan, I am certain Boer will stand to benefit from the rising tide.

In the latter half of 2011, pessimism on Boer prove to be too overweight given its poor but temporal 1H FY2011 results, failed bid for SMB United and also the global sell-down. Hence, I managed to include Boer into my portfolio at a reasonable HK$2.25 unit cost – a valuation of 3.37x P/E ex. cash; not considering the potential of the net cash to be used as earnings-accretive opportunities.

Next Post: An analysis on Boer’s financial figures