Investment Highlights 

• We downgrade our recommendation on Pentamaster Corporation (Pentamaster) to UNDERWEIGHT from HOLD with a lower fair value of RM3.21/share (previously RM3.30/share ex-bonus issuance of 1-for-2 shares), pegged to an unchanged FY21F PE of 23x.

• We cut our FY20F–FY21F forecasts by 2–10% after accounting for: (i) the weaker-than-expected 2QFY20 results, and (ii) Pentamaster’s move to diversify into the medical device business by producing single-use medical devices.

• Pentamaster’s 2QFY20 results came in below expectations at RM17mil, bringing 1HFY20 core profit to RM33mil. This is after excluding a net exceptional gain of RM2mil mainly from unrealized forex gains offsetting losses from fair value changes of foreign currency forward contracts. The results accounted for 36% of our full-year forecast and 39% of consensus’ estimates.

• YoY: 1HFY20 core profit declined 23% mainly due to revenue falling 15% as a result of lower automated test equipment (ATE) sales impacted by Covid-19, which were partially offset by higher demand for factory automated solution (FAS). By customer segment, sales declines in the telecommunications and automotive sectors were partially offset by growth in the medical and semiconductor sector (Exhibit 3).

• Segmental review:
  • ATE: Sales slumped 32% YoY, impacted by travel restrictions relating to Covid-19 which affected Pentamaster’s project delivery schedule and site installation of products, and consequently the group’s revenue recognition. Furthermore, the MCO had limited production capacity due to workforce constraints.
  • FAS: Sales surged 88% YoY after accounting for the contribution of TP Concept and higher demand for its i-Arms solutions for the automotive, and consumer & industrial segments due to increasing adoption of Industry 4.0 and artificial intelligence.
  • Smart control solutions system (SCSS): A wider LBT of RM0.6mil was recorded as sales declined due to Pentamaster’s i-Hub solution not yet contributing positively pending finalization of its modular system.
• QoQ: 2QFY20 revenue and core profit rose by 3% and 6% respectively on higher sales from customers in the semiconductor sector due to higher project delivery.
   
• Medical sector update: Pentamaster has announced its move to diversify into the medical device business via the incorporation of its new subsidiary Pentamaster MediQ Sdn Bhd. According to an interview with StarBiz, the group is in the process of obtaining approvals from the US Food & Drug Administration (FDA) and Malaysia’s Medical Device Authority (MDA) for this business and will utilize its Batu Kawan plant to produce: (i) dual-safety pen needles for diabetic patients to administer insulin shots; and (ii) safety IV catheters to administer drugs or fluids and to draw blood.
  
  Production is set to commence in 1HFY21 and the medical segment is anticipated to contribute ~10% of revenue in FY21, growing to approx. 30% contribution in 2023. Furthermore, the group has earmarked RM60mil for the production of these devices in the next 3 years. We have factored in growth relating to the medical sector in our earnings forecasts, but await further details on plans for Pentamaster MediQ in an upcoming analyst briefing.

• Outlook:
  • Earnings recovery is expected in 2HFY20 as the group is anticipated to ramp up production after resuming production post- MCO at full workforce capacity and after resuming travelling for project site installations though still on a restricted basis
  • Long-term growth drivers:
    •  Pentamaster sees that growth from the telecommunications sector will be driven by its broadening exposure to the optoelectronics and 3D sensing technology in smart devices such as smartphones and tablets.
    • Furthermore, its automotive segment portfolio has broadened with the addition of silicon carbide-based solutions, end-to-end solutions for insulated-gate bipolar transistor (IGBT), AC/DC power inventor and multilayer ceramic capacitors – all of which are underpinned by advancements in autonomous driving, higher sales of electric vehicles (EVs) and electrification of the automotive industry.
    • Extending reach into the medical segment via TP Concept and Pentamaster MediQ.
       
• Although we continue to like Pentamaster due to its positive prospects, we deem that the stock is overvalued given the recent run-up in its share price. Pentamaster’s positive prospects are driven by: (i) growth in the ATE segment due to higher demand of smart sensors in devices; (ii) FAS growth supported by the adoption of Industry 4.0; and (iii) margin expansion from portfolio diversification efforts across all market segments. Meanwhile, key risks include: (i) delays in Covid-19 earnings recovery; and (ii) the escalation of US-China trade war tensions leading to order uncertainty

Source: AmInvest Research - 17 Aug 2020