WHAT’S NEW

• 4QFY18 results were within our expectations. Denko Industrial Corporation (Denko) reported FY18 net profit of RM92.5m, accounting for 97% of our full-year forecast. Qoq comparison is not meaningful as the acquisition of IMS Group, the main earnings contributor, was completed only in 4QFY18. As expected, no dividend was declared.

• 4QFY18 sales rose 21.6% yoy, boosted by higher box-built orders from key customer and higher ASP on increased component costs. However, gross profit dipped 2% yoy due to: a) higher component costs as we note that quantum margin per unit assembled was relatively unchanged, and b) production inefficiency at assembly lines of new models, which will take a few months to fully ramp-up. EBIT declined 15% yoy on higher overheads which we believe were incurred in anticipation of higher orders from key customer. Due to a much higher effective tax rate of 26.1% (4QFY17: 15.9% due to tax incentives), net profit fell by a higher 26.5% yoy.

• More orders to come in FY19... Denko recently acquired two parcels of land with buildings in Jalan Hasil and Jalan Dewani, Johor Bahru, for RM43m and spent RM20m-30m on renovation and machineries, etc. These two facilities have a combined production floor space of 375,922sf, a 49% increase to the group’s existing production space of 773,519sf, to cater for higher demand from its key customer on new product launches.

• …and margins are expected to improve on better efficiency at assembly lines of new models.

EARNINGS REVISION

• No change to our FY19-20 net profit forecasts of RM128m and RM163m respectively. We introduce our FY21 net profit forecast of RM190m.

• Our 3-year net profit CAGR of 27.1% for FY19-21 assumes: a) revenue CAGR of 19.1% in FY19-21, driven by higher box-built and air filter sales; b) EBIT margins to expand to 6.1%, 6.6% and 6.6% in FY19-21 respectively on favourable sales mix and economies of scale; and c) effective tax rate to normalise to 24% in FY19-21.

RECOMMENDATION

• Maintain BUY and target price of RM1.75, based on 13x 2019F PE.

• Decent yields. Based on an estimated payout of 35%, yields are decent at 2.6-3.9% for FY19-21.

Source: UOB Kay Hian Research - 1 Jun 2018