We initiate coverage on QES Group (QES) with an Outperform recommendation. Our TP of RM0.86 is pegged to 26x FY25 EPS, a 10% discount to the industry average of 29x, which we deem justifiable given the i) lower earnings base, ii) relatively small manufacturing earnings compared to its industry peers and iii) higher risk given the low entry barrier for its distribution division. Nevertheless, we think the distribution division can be a two-pronged sword for the Group as the business environment is recession-proof and there is low investment requirement while the turnover period is short. It can provide steady recurring cash flows for the company to drive its manufacturing growth going forward.

• Background. QES is principally involved in the distribution of inspection, test and measurement equipment, materials and engineering as well as manufacturing of optical inspection equipment and automated handling equipment. To-date, QES has > 4,000 diversified customers and installed base of 14,859 units of equipment spreading across ASEAN and China with sector exposure to semiconductor, automotive, electrical and electronics and others.

• Penetrating into new markets. Management has indicated its plan of venturing into aerospace engineering and medical technology for automation projects by 2H 2024. We believe the entry barrier of both industries are relatively high and it might take a while before they can secure the first purchase order. Alternatively, they can take over an industry player to transfer the patents to Malaysia.

• Benefiting from growing recurring maintenance income. QES’ recurring income segment, comprising of service, maintenance and sales of consumable parts, has contributed RM55m-60m per annum to the Group. We expect this to expand further, leveraging on its sturdy sales in the past, once the maintenance cycle kicks in. It’s after-sales team currently comprises of 129 technical personnel. The Group is also looking to roll out a customer relationship management software to better monitor its customers’ equipment status and initiate service calls. Thus, in our view, it would help to improve the repair and maintenance revenue and supply of spare parts in the long-term.

• Ramping up manufacturing revenue. Management has been putting in efforts to develop new products or introduce enhanced version under its manufacturing division, mainly for the semiconductor industry. These products are advanced equipment aimed at reducing operating cost and improving product yield through higher precision, integrated processes as well as automation. We believe the successful launching of these products could help to expand its manufacturing earnings contribution, which typically commands relatively superior profitability. Going forward, it expects the manufacturing segment to grow at double-digit and aims to expand manufacturing revenue contribution from the current 13% to 30%-35% of Group revenue.

Source: PublicInvest Research - 23 May 2024