Investment Highlights

• We downgrade our recommendation on QES Group (QES) to HOLD from BUY with a lower fair value of RM0.21/share (previously RM0.30/share). We reduce our FY19F–FY21F earnings by 14–31% to account for lower equipment manufacturing revenue. Our valuation is based on an FY19F PE of 15x.

• 1HFY19 core net profit of RM0.3mil (-95% YoY) came in below expectation, accounting for only 2.1% our full-year forecast and consensus estimates.

• The sharp drop in earnings was mostly due to declining sales from the equipment manufacturing division. Customers are still holding back on orders, given the uncertainty of the US-China dispute. The equipment manufacturing segment, which typically yields higher gross profit margin compared with the distribution segment, only contributed 5% to revenue (vs. 24% in 1HFY18).

• The lower sales in the equipment manufacturing division was partially cushioned by better sales from the distribution segment (+21% YoY) and servicing fee (+9.8% YoY). Overall, revenue only dipped marginally to RM80mil (-4.5% YoY). Distribution segment contributed 80% to total group revenue (vs. 63% in 1HFY18).

• For 2QFY19, QES sank into the red, suffering a core net loss of RM1.5mil. On top of the 30% QoQ fall in equipment manufacturing orders, the company also recorded RM1.8mil impairment on trade receivables. However, revenue for the quarter in review rose 1.6% QoQ on higher sales from the distribution segment.

• Operationally, the company took a hit as EBITDA margin dropped 8.1ppts while pre-tax margin fell 8.7ppts. The precipitous revenue drop in the equipment manufacturing division led to severe margin compression.

• We still like QES for its: (1) manufacturing segment, which may lead to margin expansion with fully automated machines commanding 4x higher ASP compared with semi-auto ones; and (2) recurring revenue from its distribution and servicing business that remains defensive amid the trade war.

• However, we turn cautious given that the growth of the company relies significantly on the equipment distribution segment, which is facing headwinds from the US-China trade war.

Source: AmInvest Research - 27 Aug 2019