We are keeping our POSITIVE stance post meeting, premised on stronger 2H18 prospect which will see higher ramp-up from new/existing customers. Though industry-wide components shortages still persist, new contracts with higher design flexibility and complexity should fend off the systemic impact, with full fruition to be seen in FY19. We make no changes to our earnings estimates. Maintain OP with a higher rollover TP of RM2.00 (14.0x FY19E PER).
Short term still plagued by component shortages. Recall that 1Q18 sales dropped 10%, with CNP plunging sharply to RM1m, hampered by both unfavourable forex as well as industry-wide component shortages. We gather that if not for these issues (hence operational deleveraging), decent top-line growth alongside mid-high single-digit NP margin would have been achieved, translating into much better CNP.
Staging for a stronger 2H18. Management noted that while 2Q18 should continue to see drawback from such issue, seasonal ramp-up alongside higher allocation from its Telecommunication, Bar-code scanners and raw cable customers should help the group to achieve a mid-to-high single-digit top-line growth YoY for FY18. To fend off such systemic impact, the group is also looking at new contracts by allocating higher capex allocation of c.RM15m in FY18 (vs. previously guided RM5m, for more SMT lines). As the new contracts i.e. industrial printing and production as well as medical segment, involve more complicated manufacturing processes with sizeable volume potentially, we believe the margins should be higher and hence, should be able to help the group to weather through the weaker dollar (or stronger ringgit) environment. Mass production could be seen earliest by 4Q18 with full earnings contribution in FY19 to comfortably support our forecast 2-year revenue/CNP CAGR of 11%/14% with expectation of the subsiding component shortage issue.
Other updates. On the labour supply, we understand that the group has secured enough quotas for the coming new contracts, with c.1/3 utilisation thus far. To mitigate the potential minimum wage hike, the group is in the midst of relocating labour intensive jobs to Thailand. Meanwhile on the currency front, management noted that it is comfortable with the current rate of c.RM4.03/USD, as long as there is no high volatility. For FY18/FY19, we have conservatively assumed RM3.90/USD as the base case. Based on our sensitivity analysis, every 1% fluctuation in the USD from our base case assumption of RM3.90/USD will impact Fwd. NP by c.2%.
Maintain OP with a higher TP of RM2.00 (from RM1.60). Post meeting, while we made no changes to our FY18E/FY19E earnings, we roll over our valuation base year to FY19 based on a 14.0x Forward PER, which is EMS players’ 3-year average forward PER. We see good value proposition following the overdone share price correction, with its Forward PER at only 12.4x, a 16% discount to its closest EMS peers which is trading at 14.7x PER. Note that this is all against the backdrop of its relatively higher NP margin, more advanced manufacturing capabilities as well as having strong parentage support from Foxconn Technology Group, which we think is unjustified. Maintain OUTPERFORM.
Risks to our call: (i) slower-than-expected sales, (ii) loss of orders from its key customers, (iii) severe components shortages, (iv) labour issues, and (v) adverse currency translations.
Source: Kenanga Research - 12 Jul 2018
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