We attended a briefing with Supercomnet Technologies Bhd (SCOMNET) and came away feeling re-assured over their current operations and future plans. While 1QFY23 earnings turned flattish QoQ, we reckon that earnings growth in 2HFY23 is largely on the cards. This is premised to (i) commercial production of new medical devices and products, (ii) normalising of orders post-inventory adjustment from Ambu (one of the major revenue contributors over the years), and (iii) fuel tank and wire harness mass production to boost automotive segment.
Improved margins. SCOMNET chalked in net margins at 18.8% in 1QFY23 vs. 16.3% recorded in 4QFY22. The said improvement came due to better sales of higher profit margin products that mitigated the higher operational expenses from the rising minimum wages and higher electricity tariff (that is expected to result in c.RM800,000 of additional expenses in each quarter). We reckon that margins to stay hit c.20% level in coming quarters, owing to the stronger orders in higher margins products. Meanwhile, SCOMNET continues to operate in a healthy balance sheet with cash position of RM171.1m together with zero borrowings as well as positive net operating cash flow.
Production capacity update. In 1QFY23, SCOMNET medical segment, automotive segment industrial segments are operating at c.80.0%, c.40.0% and c.70.0% respectively. We gather that SCOMNET is also adopting Lean Manufacturing and introduction of automation processes in bid to improve cost efficiency. At present, 20-25% of the group’s operations are being automated.
New products coming on stream. Orders for the Endoscopy Video Cables (EVC) for Covid-19 treatment remain downbeat during the quarter and we expect minimal orders for subsequent quarters. Nevertheless, SCOMNET will be introducing several new products in 2H23 to cater for the market demand. Meanwhile, Edward Lifesciences (one of SCOMNET’s major customers) is expected to undertake additional 20-30 new products over the next 3 years.
Stepping up medical segment. We also noted that SCOMNET has successfully registered for the FDA Class III which enables the group’s new medical products and devices that are implanted within the body over an extended period to be recognised by the US Food and Drug Administration. We are sanguine over the move which allow SCOMNET to tap into new avenue of growth. Already, the group is undertaking the development of vascular catheters for dialysis under their first Class III medical device production.
Automotive segment to chart new heights. Mass production for wire harnesses and fuel tanks may drive the automotive segment towards end-2023. The fuel tank mass production for the 1st model for Stellantis commenced in February 2023, while wire harness mass production will take place in 2Q23 before delivery in later 3Q23 onwards. We expect revenue contribution from the automotive segment to hit 25-30% towards end-2023 (from 20.0% registered in 1QFY23).
Healthy demand within the healthcare sector. We expect demand for healthcare services in Malaysia to remain stable, premised to the increase in domestic and international patients, aging population and return of elective surgeries. According to World Health Organisation (WHO), close to half of the global healthcare expenditure will be spent on three leading causes of death: cardiovascular diseases, cancer, and respiratory diseases. This augurs well for SCOMNET whereby their products are mainly catered for treatment to the abovementioned-related diseases.
Valuation & Recommendation
We made no changes to our earnings forecast, given that growth momentum in 2H23 is largely on the cards. Therefore, we maintain BUY on SCOMNET with a higher target price of RM1.90 as we rolled over our valuation metrics to FY24f. Our target price is derived by assigning a target P/E multiple of 38.0x to FY24f diluted EPS of 5.0 sen.
Risks to our recommendation include potential delay in FDA approval of new product launches which affects the prospects of growth in new income stream. Fluctuation in raw material costs may affect margins whereby material cost accounts approximately 75.0% of SCOMENT production costs. Another risk is the exposure to currency risk as most of their products are sold in USD.
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