• Through its wholly-owned subsidiaries, the group principally involved in the manufacturing of precision engineering components used in the photonics, E&E, semiconductor, telecommunication and optoelectronics industries.

• We project a 3-year earnings CAGR of 14.9%, with core PAT expected to reach RM17.8-RM24.2m over the next three years. This growth will be supported by (i) the expansion of operational facilities and (ii) sustainable growth in the local and global semiconductor and telecommunications sectors.

• We assign a fair value of RM0.76 (upside of 52.0% against IPO price of RM0.50) for Northeast. Our valuation is based on a P/E ratio of 25x, pegged to the mid-FY26f EPS of 3.04 sen as Northeast operates in the Industrial Products and Technology sectors, where the long term P/E stands at 24.8x-32.2x.

Investment highlights

Capacity expansion. As of the LPD, the group has a total production area of ~109k sq ft, which includes Factory 1, Factory 2, and Factory 3, all of which are currently fully utilized. In FY23, the group acquired Lot 1143 in Pulau Pinang and plans to build a new factory with a built-up area of around 228k sq ft. This will increase the total production floor space to about 188k sq ft, with operations expected to commence in 2027. The construction of this plant will involve capital expenditure of approximately RM40m, which we assume will be utilized equally over the next three years. However, the CNC machines are still having potential to ramp up further.

The World Semiconductor Trade Statistics. Looking ahead to 2025, the WSTS projects a CAGR of 30.5% or 12.5% growth in the global semiconductor industry, reaching an estimated USD687bn. This growth will primarily be driven by the Memory and Logic sectors, with each expected to exceed USD200bn in 2025. Memory is projected to grow over 25%, while Logic is expected to increase by more than 10% compared to the previous year. Other segments are likely to experience single-digit growth. We anticipate that all developing regions will continue to expand, with the Americas and APAC expected to maintain double-digit year-over-year growth.

Well-positioned to ride semiconductor upcycle. Upon completion of the fourth manufacturing plant in FY27, along with the purchase of new machinery, including: (i) 20 CNC milling machines, (ii) 4 CNC turning machines, (iii) 3 CNC turn-mill machines, (iv) 3 CNC automatic lathes, and (v) 6 CNC indexers, the group will be well-positioned to capitalize for all the sectors that Northeast operates amid the growing global semiconductor market. This is further supported by rapid advancements in telecommunications, such as 5G standardization, and a strong outlook for fibre deployment.

A proven track record and resilient margins. Northeast has a strong 20-year track record in the industry. Over 70% of its revenue is generated from exports, with a key strength being its ability to meet stringent internal QA/QC standards and internationally recognized certifications. This has enabled Northeast to build longstanding relationships with its customers. Additionally, the group has consistently improved its PAT margins, rising from 17.5% in FY21 to 19.7% in FY23, and standing at 19.9% as of FPE24.

Company background

The group, through its wholly-owned subsidiaries, is principally involved in manufacturing precision engineering components for the photonics, E&E, semiconductor, telecommunications, and optoelectronics industries.

Business overview

The group manages the entire process of manufacturing precision engineering components, with in-house expertise spanning from process engineering to mechanical sub-assembly. However, certain pre-machining and surface finishing services are outsourced to subcontractors when required.

Pre-machining is a manufacturing process undertaken before precision machining, where parts of raw material are removed through milling, cutting or turning, into a form closer to the desired shapes and dimensions for precision machining. The group outsource the pre-machining of certain types of raw materials, including hardened steel and large-sized metal materials. Pre-machining is outsourced to subcontractors to speed up its production lead time and to allow the group to focus its resources on process engineering and precision machining which require higher expertise.

The group also outsources certain surface finishing services, including powder coating and finishing that uses certain plating materials such as nickel sulfamate, rhodium and certain types of gold. These surface finishing processes are generally not commonly requested by its customers and thus, the group did not invest in inhouse capabilities to provide these finishing services.

Financials

Revenue highlights. Northeast reported revenue of RM93.3m in FY23, a decrease of 35.4% YoY, mainly due to lower revenue generated from its photonics, semiconductor and E&E segments which mainly attributable to lower volume of orders received due to: (i) no orders for new precision engineering components from its existing customers, (ii) the slowdown in global semiconductor and E&E industries in response to, amongst others, weakening demand in the end user markets, and (iii) over-stocking by its customers in FY22. Core earnings decreased by 51.8% YoY, reaching RM18.4m.

Earnings forecasts. However, we project a 3-year earnings CAGR of 14.9%, with core PAT expected to reach RM17.8m, RM20.8m, and RM24.2m over the next three years, largely supported by (i) the expansion of operational facilities by 72.4%, along with the purchase of new machinery and (ii) sustainable growth in the local and global semiconductor and telecommunications sectors. Additionally, the robust outlook for the semiconductor and telecommunications industries is expected to create more opportunities for Northeast.

Valuations

We assign a fair value of RM0.76 (an upside of 52.0% against the IPO price of RM0.50) for Northeast. Our valuation is based on a P/E ratio of 25x to the mid-FY26f EPS of 3.04 sen as Northeast operates in the Industrial Products and Technology sectors, where the long term P/E stands at 24.8x-32.2x, and we deemed it is fair. Meanwhile, compared to its peers, the assigned P/E reflects a discount of 47.1% to 64.4%, based on the average historical and forward P/E ratios, respectively.

Investment risks

Dependent on its major customer, customer A. Any loss of its major customer, namely customer A (24.5% in FPE24) and inability to replace this major customer with new customers or with additional orders from existing customers in a timely manner, could result in a loss of revenue and will have an adverse impact on the group’s financial performance.

Dependent on skilled manpower. Any shortages in the supply of skilled manpower could adversely affect the quality standards and timely delivery of manufactured components, which in turn may adversely affect Northeast’s reputation, business operations and financial performance.

Exposed to foreign exchange fluctuation. Any unfavourable movements in the exchange rates may affect Northeast profit margins as most of the contracts are mainly transacted in USD.

Dependent on key senior management. Discontinuation of service of the key senior management may disrupt key decision making within Northeast’s business operations.

Source: Mplus Research - 30 Sept 2024