Investment Highlights

• We downgrade our recommendation on Salutica to UNDERWEIGHT from BUY with a lower fair value of RM0.58 (previously RM0.95/share), pegged to an FY21F PE of 14x.

• We slash our FY20F earnings forecasts and now project a loss for the year due to the poor set of results and in anticipation of an even weaker remainder of FY20F as 3Q and 4Q are seasonally weaker quarters for Salutica due to offseason dips in headphone production. We also cut FY21F– FY22F forecasts by 28–39% as we adjust for a slower-thanexpected pickup in its headsets production and have adjusted mouse production estimates downwards.

• YoY, Salutica recorded a RM0.8mil core loss in 2QFY20, bringing 1HFY20 core loss to RM3.5mil. This is after stripping off net gains amounting RM1.2mil mainly from FV gains on short-term investments and claims made for obsolete materials. The results dashed our expectations of achieving our FY20F profit of RM15.8mil.

• Salutica’s 1HFY20 earnings were in the red due to a change in sales mix as the contribution for Bluetooth headsets was lower compared to mouse products, despite the headsets still being the main revenue contributor for the group.

• Group revenue fell 16% YoY on the back of lower sales volume of its current products that are reaching the end of their product life cycles and a slower-than-expected revenue recognition of its new generation wireless headsets that commenced production in August 2019. Sales of its products in its top 3 markets i.e. America, Asia ex-Malaysia, and Europe dropped by 10%, 43% and 7% YoY respectively.

• QoQ, Salutica posted a narrower core loss of RM0.8mil in 2QFY20 (vs. 1QFY20’s RM2.7mil loss) as revenue soared by 70% following higher sales of mouse products.

• In light of the recent coronavirus (Covid-19) outbreak, Salutica said it has experienced supply chain constraints although the extent of the impact was not disclosed. However, we believe that supply chain shocks on EMS players are a temporary disruption and thus do not yet guide for further earnings decline.

• Projects in the pipeline: On a more positive note, Salutica also shared that its plan to co-develop hearables with its Netherlands design partner is running according to plan, foreseeing that two of its current product development projects will reach mass production by 4QFY20. We have not factored in any earnings contribution from these projects yet.
   
• We recommend UNDERWEIGHT on Salutica as we believe that the group is still undergoing a gestation period, projecting that the group will return to the black only in FY21F but note its strategy to address the hearables market in the longer term.

Source: AmInvest Research - 25 Feb 2020