Investment Highlights

• We upgrade our recommendation on QES Group (QES) to BUY from HOLD, and raise our fair value to RM0.28/share (previously RM0.21/share) based on a rolled-forward FY20F PE of 12x which represents a 50% discount to the average PE of 24x of larger equipment makers. We keep our earnings forecasts unchanged.

• We attended a meeting with the group and gathered the following key takeaways:

o 1HFY19 results recap: Group revenue declined 5% YoY due to lower sales in equipment manufacturing (-80%) amid the slowdown in the semiconductor sector as the US-China trade war uncertainty caused customers to hold back orders. This was partially mitigated by higher distribution revenue. Meanwhile, core PAT tumbled 95% YoY due to margin compression from the equipment manufacturing division’s decline in sales, and a change in product mix for the distribution segment which had higher volume products but with lower margins.

o Anticipation of a better 2HFY19 based on the following:

• Manufacturing segment: (i) To expand from post-wire bonding to include two new automated optical inspection (AOI) product series i.e. post-dicing inspection and postprobing inspection, which is targeted for beta-testing by March 2020 and commands higher margins; (ii) To expand sales out of Asean especially in China, Taiwan & Europe; (iii) Expects higher orders from semiconductor customers in 3QFY19, based on shipments seen in July and August 2019.

• Distribution segment: (i) Continue to increase and sustain recurring income with service and spare parts continuing to be the key contributor; (ii) Newly secured power sag regulating project estimated to contribute RM4mil to revenue and to be recognized in 2HFY19; (iii) Energy-saving projects in Malaysia & Thailand to distribute cooling additives to existing customers for cooling tower maintenance.

o Potential securement of new orders: QES is discussing with a potential customer on a solution to be incorporated into the lapping and polishing process. It has been working on the solution for 3 years and after a successful demo, the customer is interested to purchase roughly 200 machines which could contribute US$4.5mil (equivalent to RM19mil) to revenue in 2020. As the order is not yet confirmed, we have not imputed this into our forecasts.

• We recommend a BUY on QES in view of its positive prospects based on its long-term expansion plans for its manufacturing segment and its resilient recurring revenue from its distribution segment.

Source: AmInvest Research - 24 Oct 2019