Investment Highlights

• We upgrade Salutica to BUY from SELL with a higher fair value of RM0.61/share (previously RM0.20/share). We doubled our FY20F–FY21F net profit owing to new catalysts from the trade diversion and Customer A’s product regaining positive traction after fixing a connectivity issue. Our FV is pegged to an FY20F PE of 14x (previously 10x).

• Customer A is releasing its third generation of true wireless earbuds with an upgraded Bluetooth chipset developed by Salutica, in collaboration with a Netherlands company. The new Bluetooth chipset promised to rectify the connectivity issue which has plagued the previous 2 models, resulting in Salutica’s declining profit.

• Just two weeks into the launch, the new earbuds have earned a reputable rating of 4 to 4.5 stars on top technology reviewers TechRadar, WIRED, Android Central and CNET. Feedback indicated that the new earbuds surpassed market-leading brands from the US and Denmark in its size (compact), battery life (longer) and audio quality (better).

• We foresee Customer A making up lost ground with the new earbuds that allow L/R simultaneous connection to the audio source for a more stable connection. Meanwhile, the US and Denmark rivals are still using conventional master/slave connection that relies on cross-head Bluetooth transmission, which is prone to connection drops. Moreover, Customer A’s earbuds run on Bluetooth 5.0, while its rivals are still on Bluetooth 4.0.

• Seeing little hope for the US-China dispute easing, Customer A has begun to move production of certain computer mouse models from Suzhou, China to Salutica. These are everyday use wireless mouse and are mostly sold to the US.

• There are a total of 4 models being passed on to Salutica. The first model has commenced production in July 2019 while the remaining 3 are slated to begin production in 2QFY20. The volume for mouse production is 7x larger than that for headset.

• We envisage the non-seasonality of everyday mouse to cushion the off-season dips of headset production, particularly in 3Q and 4Q. This will help to the company avoid negative surprises. We forecast sales from mouse production to contribute 46% of the group’s revenue in FY20F while headset contributes 48%.

• We still expect 4Q to be in the red and maintain our FY19F net loss forecast of RM1.3mil. However, contribution from the new earbuds and mouse production will be captured in FY20. Currently, Salutica is trading at a discounted 1-year forward PE of 11x, representing a 27% upside to our FV.

Source: AmInvest Research - 19 Aug 2019