Investment Highlights

• We maintain our BUY recommendation on ATA IMS (ATA) with a lower fair value of RM1.85/share (previously RM1.91/share) pegged to an FY21F PE of 14x.

• We reduce our FY20F–FY22F earnings by 3% following a meeting with management amid expectations of a slight margin compression due to production inefficiencies arising from the key customer’s older floor care products reaching the end of their life cycles.

• Key takeaways from the meeting are as follows:

• Production inefficiencies expected as older products will be slowly phased out while lines producing newer products have not yet reached optimal efficiency: ATA’s key customer’s older floor care products will reach the end of their product life cycles soon. However, the group said that the box-build order volume for newer floor care products remains robust with newer variants likely to be introduced in future. Although the production of the newer floor care products is running smoothly, the assembly lines for their production as well as the two new lines for 2019 — one for a household product in production since March 2019 and another for a personal care product to commence in Oct 2019 — would take time to reach optimal efficiency thus slightly affecting margins.

• Progress of printed circuit board assembly (PCBA) capability: Meanwhile, Microtronics Technology Sdn Bhd, where Datuk Seri Foo Chee Juan is the executive director and major shareholder, currently has 14 surface-mount technology (SMT) lines for its printed circuit board assembly (PCBA) and battery pack assembly, with an additional 4 lines to be added soon. In line with its aim to reduce reliance on external suppliers, the aforementioned SMT lines are currently able to cater for ~60% of ATA’s requirements with the remainder being supplied externally. The full integration of Microtronic’s PCBA capability into ATA is slated for midCY2021.

• Progress of wire harness and brush bar assembly: There is a delay in wire harness production due to requirement of certain certifications while the group has submitted samples for the brush bar assembly. Both capabilities are expected to contribute meaningfully in CY2020.

• 1QFY20 and FY20F outlook: ATA shared that the group’s 1QFY20 results are likely to be impacted by the Hari Raya festive season as well as the group starting production of the key customer’s new household product in March 2019. Due to the introduction of the product, new operators need to be trained in assembling the new product which affected production efficiency.

Despite this, the subsequent quarters are anticipated to offset the anticipated weaker 1Q results, with FY20F earnings expected to be supported by strong topline growth with the addition of the two new assembly lines on the back of increased box-build orders.

• Actively looking to diversify customer base: ATA has been actively looking to secure new customers to diversify its customer base in order to manage risks and are also looking at manufacturing related to the Internet of Things (IoT) as it is keen the explore the potential of IoT capabilities. Furthermore, due to the US-China trade war, the group has been approached by multiple prospects and they are in the midst of active discussions with these prospective customers. We view this positively due to ATA’s modular expansion strategy which would support the group’s growth trajectory.

• We reiterate our BUY recommendation on ATA due to its positive prospects arising from: (i) it being the purest proxy for the growth prospects of its key customer as it is the key customer’s largest contract manufacturer producing the broadest range of products; (ii) its move to become a vertically-integrated player will improve margins and put it in a better position to secure orders and/or customers, and (iii) its positive growth trajectory with a 3-year core profit CAGR of 19% for FY19-FY22F underpinned by its modular expansion strategy.

Source: AmInvest Research - 17 Jul 2019