Asia Essentials

We initiate on the Taiwan security service sector with Outperform rating onTaiwan SECOM, the largest security company in Taiwan. We like the sector’sstrong cash flow, high-margin profile, and defensive nature, supported by highbarriers to entry and a concentrated market. We believe the rising penetrationrate in the residential sector, fuelled by an aging population and growing demandin the smart-home segment, will drive long-term growth for Taiwan’s securityservice sector, given the penetration rate is still far below regional countries.

    Aging population + innovation = rising penetration rate

    Only 0.7% of homes in Taiwan are equipped with modern security systems,compared with 3-4% in Japan and 2-3% in Korea, implying ample room for longtermgrowth. The key growth driver is the region’s fast-growing population of theelderly, especially those living alone, which in Japan drove rapid growth inpenetration over 1990-2015. In addition, several innovative products have beenlaunched by security firms in the past few years—among them Taiwan SECOM’ssmart-home platform launched in 2015, which accelerated growth in residentialsubscriptions to +10% YoY vs. the historical avg. of 5%. SKS also reportspositive feedback for its self-developed homecare robot. A low churn rate in theresidential sector should also improve security firms’ profitability structurally.

    Brand reputation and quality are the keys to success

    Unlike the commercial sector, which tends to be more price-sensitive, we believebrand reputation and service quality are most critical to gain market share in theresidential market. Taking the Japan market as an example, SECOM has 350%more residential contracts than its nearest rival, but the gap is much narrower—90%—in commercial contracts. The emphasis on brand and quality rather thanpricing is also evident in the relatively resilient ARPU for residential compared tocommercial. As such, Taiwan SECOM, which has consistently been ranked asthe first choice by consumers (according to a survey by Business Today), shouldbe among the best performers in the sector.

    Subscription base set to surge on improving affordability

    Based on the experience in Japan, we conclude that improving affordability isone of the key catalysts for the rising penetration rate—the ratio of securityexpense divided by household income declined from 2.0% in 1991 to 1.0% in2015, pushing the proportion of residential contracts in SECOM’s business frombelow 10% to 53% in the period. We find that low ARPU haven’t been a drag onsecurity firms’ share prices, as profitability has risen on increasing subscriptionbases. Subscription base should be the key driver for the share price.

    Taiwan SECOM best positioned to rising aging population

    We believe Taiwan SECOM, the largest player in Taiwan, with over 50% marketshare, should be among the biggest gainers from the rising penetration rate inthe residential sector, thanks to its sound brand reputation on partnering withJapan’s SECOM, innovative smart-home platform, and solid quality record. Italso has highest operating margin (18% vs the regional average of 12%) andROE (19% vs 11%). The company is trading at 17.1x 2017E PER with 4.5%dividend yield, compared to regional peers’ 19.2x PER and 1.4% yield. It offersgood investment value amidst a world of global uncertainty.

    Risk to our view: Slower-than-expected rise in penetration, potential rate-hikecycle might hurt the sentiment for defensive yield plan.