KESM Industries Berhad (KESM) is associated with the Sunright Limited
group of companies, which is one of the world’s largest independent
providers of semiconductor test and burn-in services. KESM’s primary
objective is to manufacture specialized electronics and serve as a
sub-contractor to MNCs in the E&E sector. KESM focuses to provide
their services to communications, networking and automotive sectors,
which are the 3 largest consumer for semiconductors. The group operates
within this segment only. KESM operates in Malaysia (77.7%) and China
(22.3%) in FY2015.
What is burn-in services?
Semiconductors are used to make processor
chips, transistors and all other electronic parts, which are essential
in all electronic devices. Like all electronic devices, they get heated
up when in use. A defective electronic part will easily fail when it
gets heated up. Hence, burn-in services are important to filter out
these weak circuits. The process involves subjecting these electronics
to heat and voltage stress, exercising it through its limits of
performance.
Google Finance: KLSE:KESMSubstantial shareholders as at 30 September 2015:
- Sunright Limited (48.41%) – Indirect interest by director
- Citigroup Nominees (Asing) Sdn Bhd for Citigroup Global Markets Inc (Prime Finc Clr) (5.08%)
- Wong Tee Kim @ Wong Tee Fatt (4.99%)
| Valuation | OVERVALUED |
|---|---|
| Current price | RM 5.22 |
| Shares outstanding (approx.) | 43,014,500 |
| Market cap | RM 224.5 million |
| Fair value | RM 3.95 |
| Margin of safety | -32.2% |
HIGHLIGHTS
- Full access to earnings from KESM Test (M) Sdn Bhd
- Good visibility of dividends, yield of 3.8%
- Net cash company with steady cash flows
ANALYSIS
Financial Ratios @ Reuters: KESM.KL
Please note that I have computed all
ratios reported below from original sources unless stated otherwise. For
other various ratios, please refer to Reuters.
Growth driven management committed to maximizing shareholder’s return
KESM’s management team is led by Mr
Samuel Lim, a co-founder of the company. Under his guidance,
the management has an excellent track record in making good decisions
for the company’s prospects.
In annual report FY2014, management has
introduced Integrated Burn-In Management System (IBMS) which automates
the identification of defective semiconductors. Automating burn-in processes improves operating efficiency and protects against escalating labor costs,
in which KESM saw a decline in employee expenses by RM 1.3 million in
FY2016Q1 . The management has successfully reduced the impact of minimum
wage policy imposed by the government last year. Also, RM 68 million
was invested in new test equipments supporting a wide range of devices
to broaden KESM’s customer base.
In annual report FY2015, the management
has completed an acquisition for the remaining stake of KESM Test (M)
Sdn. Bhd, a subsidiary of KESM Industries Bhd. By doing so, KESM has the full share of net earnings instead of previously having to share 34.62% of earnings with Sunright Ltd. Accounting for this acquisition, KESM should be able to pay a consistent annual dividend of 5-9 cents.
The management also reported that they
have successfully completed the 4 year development program for the Test
During Burn-In (TDBI) process. TDBI accelerates defective failures by
performing tests at high temperatures and critical testing patterns,
thus saving time. It is a highly specialized process requiring high
degrees of process control. This testing method is in high demand by
automotive makers, and KESM is in a leadership position with the TDBI process.
This is useful for KESM to grow its market share in the automotive
industry in Malaysia and China. A quick lookup on the automotive
industry performance in 2015 and the outlook for 2016:
- Malaysia – Malaysia car sales set new record in 2015 (The Rakyat Post). Malaysia car sales likely to dip this year [2016] (The Rakyat Post).
- China – “Tax cuts sparks surge in China car sales but good times might not last” (South China Morning Post). China car sales growth slows further [in 2015] (Wall Street Journal).
The outlook does not too good in the
surface, nevertheless there is still opportunities for KESM to expand
further. The management also mentioned in their latest AGM that they are
considering a bonus issue/share split or other forms of entitlements to reward its shareholders.
To summarize, KESM has successfully
streamlined operations, reducing costs and improving product quality
along its way. This is demonstrated by the remarkable profit margin
expansion since FY2012. It is up to the management to focus on boosting
top-line growth, which has been a laggard in its growth ideas.
Solid balance sheet with uninterrupted cash flows
KESM holds cash and equivalents amounting to RM 2.56 per share which makes up 49% of its entire market cap.
The group has also maintained a healthy operating cash flow for the
past 4 years, averaging an increase in OCF of RM 1.78 per share per
annum. Excluding FY2014 and FY2015 due to capex mentioned above, KESM
has reported positive free cash flows in the past 4 years. Meanwhile,
FCF averaged at 77 cents, excluding FY2014 and FY2015 and 39 cents if
inclusive.
On a per share basis, adjusted for remaining 3 quarters of FY2016:
- Cash rich with cash of RM 2.56 per share
- Net working capital of RM 2.92 per share
- Potential OCF inflow of RM 1.78 (adjusted RM 1.07)
- Guidance from the management that capex for 2016 amounts to RM 82 million (RM 1.91 per share; adjusted RM 1.85)
Median working capital required for the
past 4 years is RM 2.02. Assuming this is the required working capital
that KESM requires now at its current firm size, this means KESM has an
excess cash of RM 8.776 million, or RM 0.20 per share. A payout of RM 0.20 cents as dividend translates to a reasonable DY of 3.8%. Additionally, KESM currently trades at 18% to its NTA of RM 6.35.
Capital intensive business model impairs ability to pay dividends
With the assumptions that capital
expenditures will eventually converge towards depreciation, the recent
financial statements indicate that capex are expected to exceed EBIT by
2.09 times moving forward. The management has to exercise caution in
handling cash flows, which means a lower and conservative payout rate to
conserve cash for upcoming capex.
VALUATION
Fair value of RM 3.95 based on a 10-Y DCF
valuation justified by; (i) 8% supernormal growth (ii) 8% required
return (iii) 1% terminal growth.
Thank you.
Shaun Loong
Disclosure: At time of publication, I own stocks in KESM. This article has been edited on 11 March 2016.
KESM (9334) - KESM, a Dividend Growth Story
https://megamicrocaps.wordpress.com/2016/01/24/kesm-a-dividend-growth-story/
