Venture hit a ten-year low of S$3.90 recently on continuousliquidation prior to its removal from the MSCI Index. With the stock down70% year-to-date and the final round of index-linked selling over, webelieve now is a good time to start accumulating Venture on the cheap.
In revisiting our assumptions, we have slashed FY08 earnings by 33%to fully provide for the remaining S$90m CDO given worsening credit spreadin October. We have also trimmed FY09 earnings to reflect conservativedemand outlook, which we believe could potentially pressure FY09/10 revenuegrowth although Venture should hold up margins better relative to peerswith its higher value-added ODM services.

In spite of our steep earnings cut, Venture looks oversold at anall time low of 5.7x FY09 earnings and 0.6x P/BV. This implies that markethas priced in a lot of negatives including the entire CDO write-off plus aworst-case scenario of massive write-downs for DMX and goodwill from thepurchase of GES (see scenario valuations). However, we think a totalwrite-off is unlikely because 1) management continues to perceive DMX as along-term strategic investment, and 2) GES is still benefiting the companywith stronger customer relationships and cross-selling opportunities. Ourbase case FY09 forecast encompassed complete write down of CDO and 10%amortization of intangibles over a ten-year period.

Valuation aside, Venture is highly FCF generative (c. S$150-200m/ yr) andcan therefore comfortably pay off debts (S$8m net debt at end 3Q08), andstill sustain dividend payment of S$0.50/shr, translating to a solid 12%dividend yield, amid falling profits. With our revised assumption, we nowsee fair value at S$6.40, still pegged to 9x FY09 P/E. Upgrade to Buy.

Expect record CDO write-downs in Q4. As of end 3Q08,Venture’s CDO holdings were S$90.7m, equivalent to 54%of the host value. Given that credit spreads have continuedto widen from 168bps at end Sep to 280bps currently, webelieve the mark-to-market losses in 4Q08 would be evenbigger than the S$29.8m recorded in Q3. To date, Venturehas already provided for 46% of the host value of S$167.8mand it is likely that management will fully provide for theremaining value to remove overhang on the share price. Tobe prudent, we have assumed a full provision of S$90.7m in4Q08 for the remaining CDO value.

Near term, Q4 outlook is unexciting as like the rest of itscompetitors, Venture noted a lack of seasonal uptick thisyear. Management has not seen a major slowdown inorders but cited higher pricing pressure as customers striveto cost-down, with many tightening control on inventoryand focusing more on cash preservations.

While difficult to forecast with precision the impact of themarket’s falloff on each customer, management’s outlookfor FY09 is muted as weakness in the technology sector isexpected to continue. In light of the worsening demandoutlook globally, our forecast have cautiously built in a 15%y-o-y decline in FY09 sales to S$3.2bn, compared to previousforecast of a 5% drop. Compared to a 2% sales decline in2001 and another 4% in 2006, our forecast has assumedthat this would be Venture’s biggest revenue decline in thelast fifteen years. We have imputed a broad-based contraction in all of Venture’s divisions. On a positive note, astronger USD and more outsourcing from new customerscould help to mitigate the slowdown for Venture.

Slight moderation on margin assumption. AlthoughVenture’s higher value added proposition in terms of cost-effective designs and component cost-down would likelyhelp the company defend its margin better than peers, wethink it is unlikely that Venture can escape current aggressivepricing environment unscathed. In our forecast, we havereduced gross margin by 90bps from 12.4% to 11.5%.

We continue to like Venture’s strong free cash flow. With anall time low PE of 5.7x and P/B of 0.6x plus a dividend yield ofover 12%, one is buying Venture on the cheap and is gettingpaid to wait out the economic downturn. Upgrade to Buy