Investment Highlights

• Overweight on manufacturing sector with selective picks on stocks that have competitive advantages in niche segments. Our Top BUYs are Ancom Nylex (FV: RM1.43/share) and Lee Swee Kiat Group (FV: RM1.21/share).
  
  We like Ancom Nylex (Ancom) as it is trading at a compelling CY24 PE of 10x, which is an unjustified 52% discount to its 5- year mean of 21x. Ancom’s agrichemicals segment is expected to benefit from:
  
  (a) trade diversion by multinational corporations from China to Southeast Asia,
  
  (b) shift in demand from expensive patented herbicides to cheaper generic versions amid an expected global economic slowdown, and
  
  (c) commercialisation of Product T by Jan 2024.
  
  Lee Swee Kiat Group (LSK) currently trades at an undemanding CY24 PE of 8x, 32% discount to its 5-year median of 11.7x. We like the stock for:
  
  (a) being the largest natural latex mattress manufacturer in Malaysia, (b) its expanding market share in the natural latex mattress industry,
  
  (c) its collaboration in marketing the A-series mattress via rental-based business models such as Cuckoo’s platform, and (d) recovery in the export market.
  
  For electronic manufacturing services (EMS), we like Cape EMS (Cape), which is expected to ride on multiple rising secular growth trends:
  
  (a) adoption of 5G,
  
  (b) evolution of digital payment eco-systems, (c) Internet of Things,
  
  (d) electric vehicles (EVs), and
  
  (e) shift towards e-cigarettes from conventional alternatives.
  
  We expect V.S. Industry’s (VSI) revenue and net profit in FY24F to be weaker YoY, as demand from key customers remains sluggish after VSI posted a lower-than-expected 1QFY24 result.

• LSK’s export demand recovered in 3QCY23 and will improve further. To recap, the export segment has been sluggish since 2022 due to the weak global economy. However, LSK registered a recovery in the export market in 3QCY23, especially from European customers. Consequently, the plant utilisation rate (PU) of the 2 latex foam plants increased to 60% in 3QCY23 from 45% in 2QCY23. We expect the PU to improve to 80% in 4QCY23 and CY24F.

• Consumer sentiment to remain soft in 2024F. Malaysian Institute of Economic Research (MIER) consumer sentiment index in 3Q23 declined by 13% QoQ to 78.9 points. This reflects concerns on job opportunities, inflation worries and income growth. Moving forward, we believe consumption spending will taper off as consumers become more discerning in purchasing goods. We expect consumer spending to be cautious due to lower disposable income and subsidy rationalisation on food. Nevertheless, we believe that the negative developments in the consumer space would be offset by LSK’s expanding market share in the natural latex mattress industry and collaboration in marketing the A-series mattress via rental-based business models such as Cuckoo’s platform.

• Ancom moves towards a higher ASP playing field. Ancom has unveiled a new active ingredient (AI) called Bromacil. This was commercialised in 3QFY22 as a herbicide for the cultivation of cotton and pineapple. Demand is gradually increasing with the AI commanding an average selling price (ASP) of mid-teen US$/unit, compared to existing products with an ASP of low-to-mid single-digit US$/unit. To move further up the value chain, Ancom targets to commercialise Product T by Jan 2024, and S in FY25F. Product T is currently selling at US$15-17/litre with Product S at US$40/litre as compared to existing products (except Bromacil) with an ASP in the low-to-mid single-digit US$/unit. The higher ASP allows Ancom to secure higher profit/litre.

• EMS players seek to expand clientele via acquisitions. Both Cape and VSI carried out acquisitions to increase their clientele base. In May 2023, VSI acquired a 40% equity stake in Malaysian-based HT Press Work (HTPW) and increased the equity stake to a controlling 51% in Sep 2023. Going forward, VSI plans to realise HTPW’s full potential by: (a) purchasing and constructing a new production line for a newly secured US-based multinational corporation (MNC), (b) improving working conditions for HTPW’s employees to secure further orders from customers who are sensitive to labour issues, and (c) collaborating with HTPW to obtain potential orders of up to RM100mil (2% of VSI’s FY24F revenue) from the MNC. In Sep 2023, Cape entered into a conditional stock purchase agreement (SPA) for the purchase the entire equity interest in US-based iConn. Cape believes that iConn's design and engineering capabilities would allow the group to expand its range of services to existing and potential customers, particularly from US. It would also improve demand from Customer T, a US-based supplier of laboratory instruments and life sciences solutions which was onboarded to iConn’s clientele base since 2023.

• Key downside risks for downgrading the sector to Neutral: For LSK, risks are (a) a spike in natural latex prices; (b) further increase in interest and inflation rates that would dampen discretionary spending in domestic and global economies; and (c) outbreaks of another pandemic or contagious diseases. Risks for Ancom are (a) spike in raw material prices; and (b) adverse weather conditions such as droughts or floods in the region where Ancom’s clients operate, which would lead to crop failures and drop in demand for agricultural chemical products. Risks for EMS players are (a) deeper-than-expected global recession; and (b) losing key customers.

• Pivoting towards sustainability. As chemical manufacturing is an energy-intensive industry, Ancom’s approach to energy-saving focuses on reducing direct and indirect energy consumption. Moving forward, the group intends to integrate its operations into more renewable energy sources, specifically solar and hybrid sources. Ancom has also made a commitment to achieve 45% carbon intensity reduction by 2030 compared to 2005. LSK produces mattresses which use natural latex as most of its core material, this indirectly promotes the planting of rubber trees. According to the Malaysia Rubber Board, rubber trees help to reduce global warming through carbon sequestration. In addition, LSK has launched organic latex since beginning of 2020 to discourage the use of artificial fertilisers and pesticides. As the manufacturing process of latex mattresses is energy intensive, LSK uses an electricity generator with qualified green technology recognised by Malaysia Investment Development Authority (MIDA) in production systems to minimise energy consumption and reduce carbon emissions. The EMS sector previously suffered from negative publicity of forced/unethical labour practices. However, we believe that local players are more cautious towards this issue and would pay attention to any potential breach. For instance, to ensure supply chain partners adhere to standards set by Malaysian labour laws and the International Labour Organisation, VSI imposes Ethical and Environmental Code of Conduct on its suppliers. The code of conduct outlines that suppliers must adhere to the minimum legal working age and policies on the prevention of forced labour.

AmInvest Research

Source: AmInvest Research - 27 Dec 2023