Investment Highlights

• We maintain our OVERWEIGHT recommendation on the electronics manufacturing services (EMS) sector as prospects are positive in the sector amid expectations of strong order flow from multiple customers supported by capacity expansion plans. The sector has been a beneficiary as companies diversify their supply chains away from China and into Southeast Asia, leading to the securement of higher orders and/or new customers. In our view, the pullback in share prices following recent news flow presents a window of opportunity for investors.

• Covid-19 restrictions limit production capacity: With the reimposition of the movement control order (MCO) from 12 May 2021, which has since been extended until 28 June 2021, the electrical and electronics sector is operating at a 60% workforce capacity with the approval of Malaysia’s Ministry of International Trade and Industry (MITI). During MCO 1.0 in March 2020, the production of ATA IMS (BUY, fair value RM3.34) was halted for almost a month and operations were allowed to resume thereafter gradually at 25%, 50% and later back to full workforce capacity in early May 2020. The group was then able to make up for order backlogs. However, we note that there is a possibility of a further extension to MCO 3.0 due to the high number of daily cases which could pose a larger risk to earnings depending on the duration of enforcement of restrictions. On a positive note, Covid-19 vaccinations are being rolled out nationally and picking up pace.

• However, order forecasts remain strong across multiple customers: The common main customer’s order forecasts remain strong despite the Covid-19 pandemic. Furthermore, the said customer aims to double its product portfolio by 2025, expanding its existing product categories as well as venturing into new areas such as in artificial intelligence, robotics, and batteries. We believe this would benefit ATA due to the group’s position as the main customer’s largest contract manufacturer globally, producing the broadest range of products. Besides this, ATA was recently awarded its third project for its key US customer to produce a yet-to-be-launched full-sized machine, which is currently undergoing test runs, while its 1st and 2nd projects have been running since 3QCY20 and 2QCY21 respectively. The group continues to be in discussion to secure a new ODM project for said customer.

• Capacity expansions to cater for order growth: ATA’s 228K sqft factory and 150K sqft warehouse in Pasir Gudang are both operational, with the factory expected to be fully utilized by mid-2021. ATA is on the lookout for a new factory to cater for growth in customer orders.

• Customer diversification efforts to continue: ATA is aiming for a more diversified customer base in FY22, projecting its main customer to contribute 70% of its top line while the remaining 30% would come from other customers. Its FY22F growth is expected to be chiefly driven by order growth for both its main customer and key US customer.

• Forced labour allegations denied: ATA rejected allegations that it has been using forced labour as the company complies strictly with Malaysian labour laws. Furthermore, foreign worker recruitments also comply with international standards whereby a zero-recruitment cost policy is in place (foreign workers are not required to pay any third-party or agent fees). The group also ensures that its recruitment agents undergo due diligence to comply with such practices. Additionally, all workers are paid above minimum wage and overtime (OT) work is done on a voluntary basis with compulsory rest days in place. Hostel accommodation is provided for its foreign labour and is regularly audited by its key customers, global retailers, and external independent auditors. ATA is a member of Sedex, the world’s leading ethical trade membership organisation that seeks to improve working conditions in global supply chains membership. ATA also holds OHSAS 18000 certification, which ensures its practices are in adherence with internationally recognized standards.

• We have an OVERWEIGHT recommendation on the sector but we may downgrade the sector to NEUTRAL/UNDERWEIGHT if: (i) Covid-19 weakens global economic conditions which could potentially dampen demand in customers’ products, especially if vaccine progress is delayed; (ii) labour issues arise relating to labour costs and worker shortages; (iii) sudden loss or orders and/or key customers; and (iv) worsening performance of overseas operations due to longer-than-expected recovery in sales orders.

• Our top pick is ATA IMS (BUY, RM 3.34) due to its: (i) role the purest proxy to its main customer’s growth prospects by virtue of being its largest contract manufacturer; (ii) efforts towards being vertically integrated; and (iii) customer diversification efforts driven by strong order momentum for both its key customer and other customers which is supported by the group’s modular expansion strategy. The group has a 3-year profit CAGR of 22% for FY21–FY24F. We prefer ATA as the recent correction in its share price presents an opportunity to accumulate the stock.

Source: AmInvest Research - 16 Jun 2021