BUY GOLDPAC (3315 HK) H O N G K O N G. R e t a i l M a r k e t M o n i t o r Tues day, 01 April Riding On Structural Growth Of Smart Cards

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1 MONEY TALK GOLDPAC (3315 HK) Riding On Structural Growth Of Smart Cards VALUATION/RECOMMENDATION Initiate coverage with BUY and target price of HK$9.5, based on 28x FY14F PE. Goldpac is the largest supplier of financial cards in terms of sales value and the third largest by sales volume with 19.2% and 18.2% market share respectively in 212. The group is the only company in China certified by all six of the largest payment card corporations to make financial cards and provide card personalisation services. We believe the group will benefit from a structural increase in demand for smart cards and from the high entry barriers to the industry. INVESTMENT HIGHLIGHTS Beneficiary of migration from magnetic strip cards to smart cards. Sales value of financial cards in China reported a 37.5% CAGR from 28 to 212, and is expected to maintain a 3.1% CAGR from 213 to 217. The rapid growth is attributed to continuing economic growth and urbanisation as well as the migration from magnetic strip cards to smart cards, resulting in a higher prices, and thus sales value. Supportive government policies fuel growth. Since 1 Jan 13, all POS and ATM terminals in China have been upgraded to accept financial smart cards and all domestic commercial banks are required to issue financial smart cards to their customers. Also, starting 1 Jan 15, commercial banks in the developed regions of China or operating in some key industries should issue financial cards for all renminbi bank accounts. These policies will accelerate the card migration process. High entry barriers. The financial card industry is highly concentrated where the top 5 financial card suppliers generate 68% of the sales value in China. It usually takes a long time to establish a relationship between a card issuer and a card manufacturer, and issuers are reluctant to change manufacturers frequently. In addition, card manufacturers must have five years of relevant production experience to obtain certification from payment organisations. This sets a high entry barrier for new entrants. SHARE PRICE CATALYSTS Strong financial results and supportive government policies BUY Share Price HK$7.43 Target Price HK$9.5 Upside 28% COMPANY DESCRIPTION Goldpac Group manufactures, supplies and distributes financial cards, card personalisation services, on-side card insurance system solutions, magnetic strip cards and authentication of smart cards in China. GICS sector Bloomberg ticker Technology Hardware 3315 HK EQUITY Shares issued (m): 3315 Market cap (HK$m): 83 Market cap (US$m): 6,673 3-mth avg t over (HK$m): 916 PRICE CHART (lcy) GOLDPAC GROUP LTD Goldpac Group Ltd/HSI Index Volume (m) Dec 13 Jan 14 Feb 14 Mar 14 Source: Metastock (%) KEY FINANCIALS Year to 31 Mar (HK$m) F 215F 216F Turnover 677 1,112 1,557 1,791 2,238 EBITDA Trading profit(loss) Net Income Basic EPS (cent) PE (x) 42.9x 35.x 21.9x 19.7x 19.6x P/B (x) 28.9x 4.4x 4.5x 3.8x 3.2x Dividend Yield (%) \ Profit Margin (%) Net Debt/Share Equity (%) EBIT/total interest exp (x) Return on Equity (%) ANALYST Allen Wong allen.wong@uobkayhian.com.hk w w w. u t r a d e. c o m. h k 1

2 Company Background Goldpac manufactures financial cards and provides card personalistion services and on-site card issuance system solutions in China. According to Frost & Sullivan, Goldpac is the largest financial card supplier in terms of sales value and the third largest by sales volume, with 19.2% and 18.2% market share respectively in 212. The group is the only financial card manufacturer and the only card personalisation services provider in China certified by all six of the largest payment card corporations, namely Visa, MasterCard, American Express, UnionPay, JCB and Diners Club. The certification means Goldpac s products meet international standards, a recognition of its manufacturing capability and product quality. The financial card segment accounted for 74% of Goldpac s total revenue from 21 to 212, followed by the card personalisation services segment (14%) and on-site card issuance system solutions segment (12%). Major clients of the group s financial cards are banks and financial institutions (87%), the government (1%) and others (3%). FIGURE 1: FY12 REVENUE BREAKDOWN BY CLIENTS FIGURE 2: FY12 REVENUE BREAKDOWN BY PRODUCT/SERVICES Gov ernment 9% Others 3% On-site card issuance sy stem solutions 14% Personalisati on serv ice 12% Banks and Financial institutions 88% Magnetic strip cards and smart cards 74% The major raw materials used to make financial cards are IC chips, PVC panels and holograms, representing 65%, 3% and 1% of Goldpac s 1H13 production costs respectively. PVC panels are used in most financial cards, including both magnetic strip cards and smart cards. Holograms are key for credit cards, while IC chips are important components of smart cards. All their ASPs have declined from 28 to 212, especially bank card IC chips, which dropped 1% over the period, or a 3% decrease annually. FIGURE 3: 1H13 PRODUCTION COST BREAKDOWN FIGURE 4: ASP OF PVC PANELS Other materials 9% Labour 8% Others 7% (Rmb/tonne) 2, Ov erlay 1% 19,5 Holograms 2% 19, PVC 3% On-site card issuance sy stems 6% IC chips 64% 18,5 18, w w w. u t r a d e. c o m. h k 2

3 FIGURE 5: ASP OF HOLOGRAMS (Rmb/piece) FIGURE 6: ASP OF IC CHIPS (Rmb/piece) Bank card IC chip 32k social issuance card IC chip There are five major types of payment modes - financial cards, cash, cheque, online payment and prepaid cards. They are used to satisfy various payment demands and have their own advantages and disadvantages. Compared with other means of payment, financial cards are portable and convenient to use. They can be used for small payments, like prepaid cards, as well as for large transactions. There are two types of financial cards, namely magnetic strip cards and IC cards. People may have safety concerns over the former as they can be easily counterfeited. Therefore, there is a global trend of migrating magnetic strip cards to IC smart cards as the latter has better security and larger storage capabilities. FIGURE 7: PAYMENT METHODS Financial cards Cash Cheque Online payment Prepaid cards Advantages Convenience and portability Applicable for both large and small payments Traditional method Widely accepted Mature regulations Widely accepted for large payments Convenience Clear transaction records Specialised usage Diversified issuers Disadvantages Safety concerns over highvalue and overseas payments Limitations on portability and safety Mainly or small payments Inconvenient procedures payment The value chain of the financial card industry can be broken into five areas. Before a financial card is produced, the issuer needs to go through pre-production activities, including consulting services and card design innovation. After confirming the specifications and designs, the supplier will start manufacturing various types of cards, depending on the issuers requests. Some of the cards may require personalisation services so this involves inventory management and data processing. In addition, the supplier may also support the issuers by carrying out post-production activities, such as on-site card issuance system solutions and card reader terminals. Potential risk of information security Relatively complex Not widely accepted Limited number of accepting Mainly for small payments w w w. u t r a d e. c o m. h k 3

4 FIGURE 8: VALUE CHAIN OF FINANCIAL CARD INDUSTRY Card Consulting Services Card Design Innovation Card Production Card Personalisation Card Issuance Solutions Application Specifications System requirements Card design Material innovations Technical innovations Magnetic Strip cards EMV cards Contact smart cards Inventory management Data processing Magnetic strip encoding Card issuance machines Supplies Equipment maintenance BENEFICIARY OF SMART CARD MIGRATION Sales volume of financial cards in China has been growing steadily at 13.4% CAGR from 28 to 212. Frost & Sullivan expects this to increase at 8.5% CAGR from 213 to 217. Sales value, however, grew much faster at 37.5% CAGR from 28 to 212, and is expected to grow at 3.1% CAGR from 213 to 217. The rapid growth is attributed to continuing economic growth and urbanisation as well as the migration from magnetic strip cards to smart cards, resulting in higher prices and thus sales value. FIGURE 9: SALES VOLUME OF FINANCIAL CARDS IN CHINA (m units) 1,8 1, CAGR: 8.5% FIGURE 1: SALES VALUE OF FINANCIAL CARDS IN CHINA (Rmbm) 12, 1, CAGR: 3.1% 1, CAGR: 13.4% 8, 9 6, 6 4, CAGR: 37.5% 3 2, F 216F Source: Goldpac, Frost & Sulliva, UOB Kay Hian F 216F Source: Goldpac, Frost & Sulliva, UOB Kay Hian Replacing Magnetic Strip Cards With Smart Cards Currently, magnetic strip cards are widely used in China, and are read by swiping the card s magnetic strip past a magnetic reading head on the card reader. The cards are able to store data by changing the iron-based magnetic particles on the card s magnetic materials. Since the early 198s, magnetic cards have gained wide popularity in China. Given its long history, convenience of use and lower production costs, magnetic cards are used extensively in ATMs and POS terminals. However, financial institutions are replacing magnetic strip cards with IC cards as the former has weaker security and can be easily counterfeited, resulting in the leaking of personal information. The low storage capacity also limits its developments. IC cards, or smart cards, have been getting popular since 2. It is a plastic card embedded with IC chips. Compared with the traditional magnetic strip cards with a mere 125 bytes of memory, IC cards have substantially larger data storage capacity of megabyte. They can be used to store words, sounds and pictures. In addition, the card s memory can be divided into different areas of application, which make multifunctional capabilities possible. IC cards have higher security than magnetic strip cards. The former can be programmed with read-write protection and data encryption interfacing with ATMs and POS terminals to verify transactions. w w w. u t r a d e. c o m. h k 4

5 In China, magnetic strip cards accounted for 8.7% of the total financial card sales volume in 212. In spite of its dominant position, its market share has been eroded gradually by smart cards. In 28, smart cards made up only 1% market share in terms of sales volume. They have since grown to 19.3% share in 212. Moreover, as the price of smart cards is 1 times higher than that of magnetic strip cards, smart cards represented almost three-fourths of the total sales value of the market. FIGURE 11: SALES VOLUME BREAKDOWN OF FINANCIAL CARDS IN CHINA FIGURE 12: SALES VALUE BREAKDOWN OF FINANCIAL CARDS IN CHINA Magnetic strip card Smart card Magnetic strip card Smart card The rapid growth is mainly attributed to better security and functionality of smart cards than magnetic strip cards. First, with better risk management parameters, smart card holders are verified in a more robust and less expensive way, which will protect them from counterfeit, payment fraud and transaction disputes. Second, smart cards support not only retail purchases, but also online transactions, catering to the demand from fast growing online shopping. Third, with larger storage capacity, smart cards allow complex loyalty schemes, which benefit retailers. Supportive Government Policies Fuel Growth Government regulations also contribute to the growth of smart cards. To reduce fraud and improve bank services, the government formulated policies to accelerate the migration to smart cards. One such policy is the Opinions of the People s Bank of China to Promote Applications of Financial IC Cards. Since 1 Jan 13, all POS and ATM terminals have been upgraded to accept financial smart cards and all domestic commercial banks are required to issue financial smart cards to their customers. Also, starting 1 Jan 15, commercial banks in the developed regions of China or operating in some key industries should issue financial cards for all renminbi bank accounts. On the other hand, the Hong Kong Monetary Authority announced in Jun 11 that all financial cards in Hong Kong are required to be upgraded to IC cards by end-15. These polices encourage the adoption of smart cards, driving strong demand by 215. Given banks and financial institutions face more intense competition, they have strong incentives to outsource peripheral operations, such as the production and personalisation of financial cards, and focus on their core businesses. Suppliers of financial cards are in very good position to benefit from the growing demand. In view of supportive government policies, Goldpac has been transforming its production capacity from magnetic strip cards to smart cards in order to capture the growth. Its magnetic strip card capacity dived 66% from the peak of 27m units in 211 to an annualised capacity of 71m units in 1H13. On the contrary, its smart card production capacity surged 118% from 22m units in 211 to an annualised capacity of 48m units in 1H13. With the substantial increase in capacity, Goldpac is set to grasp the migration opportunity. w w w. u t r a d e. c o m. h k 5

6 FIGURE 13: PRODUCTION CAPACITY OF MAGNETIC STRIP CARD (m units) (%) H13 Designed production capacity Actual card production volume Utilisation rate ( RHS) FIGURE 14: PRODUCTION CAPACITY OF SMART CARD (m units) (%) H13 Designed production capacity Actual card production volume Utilisation rate ( RHS) HIGH ENTRY BARRIERS Sticky Customer Relationships The financial card industry is highly concentrated where the top 5 financial card suppliers generate 68% of the sales value of China market. Goldpac is the largest player with a 19% market share, but there is no big difference in the market shares of the top three suppliers. It usually takes a long time to establish a relationship between a card issuer and a card manufacturer as the former places strong emphasis on reliability and security of clients information. This requires a long period of observation and understanding to build trust. As a result, card issuers are reluctant to change card manufacturers frequently and tend to stick to their existing manufacturers. This creates an entry barrier to new entrants and a competitive edge for existing players. Goldpac has established stable and solid relationships with large national and regional commercial banks in China. One of its major clients is Bank of China, which is also one of its major shareholders with a 1.87% stake. Goldpac also serves banks in Hong Kong, Macau, Vietnam, Mongolia and the Philippines. Apart from financial cards, it also produces social insurance cards for some municipal jurisdictions in China, as well as public transportation and toll facilities for transportation agencies in different cities and regions. FIGURE 15: FINANCIAL CARD MARKET SHARE IN TERMS OF SALES VALUE IN 212 FIGURE 16: PERSONALISIATION SERVICES MARKET SHARE IN TERMS OF SALES VALUE IN 212 Others 32% Goldpac 19% Others 36% Goldpac 29% G&D 15% Tiany u 1% China Banknote 1% Hengbao 14% Tiany u 7% China Banknote 8% Hengbao 1% G&D 1% w w w. u t r a d e. c o m. h k 6

7 Third-party certification requirements Card issuers must obtain certifications from payment organisations, such as Visa, MasterCard, Union Pay, American Express, JCB and Diners Club International, to become financial card suppliers. Suppliers who apply for the certification must have at least five years of relevant production experience and meet a set of assessment criteria, including product quality, production and management capacity and safety management. If a supplier wants to manufacture financial cards in China, it is required to obtain additional certifications by Union Pay and the Ministry of Human Resources and Social Security of China. These create entry barriers to new entrants as they need to invest a large amount of time and resources to become only a certified supplier, which does not mean they will get orders from financial institutions. Being the sole card manufacturer certified by all six payment organizations, Goldpac enjoys a strong competitive edge over new entrants. VALUATION At HK$7.43, Goldpac is trading at 21.9x 214F PE, lower than that of A-share peers. Based on consensus estimates, Eastcompeace (217 CH), Hengbao (214 CH) and Tianyu (325 CH) are trading at 92.5x, 37.1x and 38x FY14F PE respectively. Goldpac is the only financial card manufacturer listed in Hong Kong and we expect its trading multiple to reach 28x FY14F PE, close to that of Hengbao and Tianyu. Hence, our target price is HK$9.5. RISKS Lower-than-expected earnings growth and slower-than-expected economic growth in China. w w w. u t r a d e. c o m. h k 7

8 Financial Information Recommendation Buy Sell Hold Valuation F 215F Target Price (HK$) 1 P/E 42.9x 35.x 21.9x 19.7x Upside 28% EV/EBIT 42.6x 28.5x 18.4x 16.2x EV/EBITDA 38.4x 26.1x 17.3x 15.2x P/S 9.1x 5.5x 4.x 3.4x Income statement (HK$m) F 215F P/B 28.9x 4.4x 4.5x 3.8x Turnover 677 1,112 1,557 1,791 Div Yield (%) \ Gross Profit Trading profit(loss) Profitability (%) F 215F Pretax income Gross Margin Net Income EBITDA Margin Basic EPS Operating Margin Dividends per Share \ Profit Margin Payout ratio \ Return on Assets EBITDA Return on Equity Source: Bloomberg, UOB Kay Hian Peer Comparision Mkt PE P/B Dividend yield ROE Company Ticker cap Trailing Forecast Trailing Forecast Trailing Forecast Trailing Forecast (HK$m) (x) (x) (x) (x) (%) (%) (%) (%) GOLDPAC 3315 HK 6, n.a. 3.1 n.a EASTCOMPEACE 217 CH 4, n.a HENGBAO 214 CH 9, TIANYU 325 CH 5, n.a Source: Bloomberg, UOB Kay Hian w w w. u t r a d e. c o m. h k 8

9 Disclosures As of 1 April 214, the analyst and his/her immediate family do not hold positions in the respective securities recommended in this report. We have based this document on information obtained from sources we believe to be reliable, but we do not make any representation or warranty nor accept any responsibility or liability as to its accuracy, completeness or correctness. Expressions of opinion contained herein are those of UOB Kay Hian Research Pte Ltd only and are subject to change without notice. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of the addressee only and is not to be taken as substitution for the exercise of judgement by the addressee. This document is not and should not be construed as an offer or a solicitation of an offer to purchase or subscribe or sell any securities. UOB Kay Hian and its affiliates, their Directors, officers and/or employees may own or have positions in any securities mentioned herein or any securities related thereto and may from time to time add to or dispose of any such securities. UOB Kay Hian and its affiliates may act as market maker or have assumed an underwriting position in the securities of companies discussed herein (or investments related thereto) and may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those companies. UOB Kay Hian (U.K.) Limited, a UOB Kay Hian subsidiary which distributes UOB Kay Hian research for only institutional clients, is an authorised person in the meaning of the Financial Services and Markets Act 2 and is regulated by Financial Services Authority (FSA). In the United States of America, this research report is being distributed by UOB Kay Hian (U.S.) Inc ( UOBKHUS ) which accepts responsibility for the contents. UOBKHUS is a broker-dealer registered with the U.S. Securities and Exchange Commission and is an affiliate company of UOBKH. Any U.S. person receiving this report who wishes to effect transactions in any securities referred to herein should contact UOBKHUS, not its affiliate. The information herein has been obtained from, and any opinions herein are based upon sources believed reliable, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions and estimates herein reflect our judgement on the date of this report and are subject to change without notice. This report is not intended to be an offer, or the solicitation of any offer, to buy or sell the securities referred to herein. From time to time, the firm preparing this report or its affiliates or the principals or employees of such firm or its affiliates may have a position in the securities referred to herein or hold options, warrants or rights with respect thereto or other securities of such issuers and may make a market or otherwise act as principal In transactions in any of these securities. Any such non-u.s. persons may have purchased securities referred to herein for their own account in advance of release of this report. Further information on the securities referred to herein may be obtained from UOBKHUS upon request. MCI (P) 116/3/214 RCB Regn. No E w w w. u t r a d e. c o m. h k 9