Investment Highlights

• We maintain BUY on Salutica with a lower fair value of RM0.82/share (previously RM1.45/share) based on a CY19F PE of 15x (rolled forward from FY19F). We have slashed our FY18F-FY20F forecasts by 46-59% on the account of: 1) higher initial learning costs as well as research and development (R&D) expenses for new products; 2) lukewarm response for its new cableless earbuds due to unbidden connectivity issues; 3) lacklustre AirBar sales; and 4) a delay in the deployment of zForce modules in automobiles.

• In addition, the average USD/MYR hedged for FY18F has come off from 4.30 to 4.10 as the rate continued to trend down over the past few months.

• Management had earlier guided the setting-up of a facility for the mass production of zForce modules (the technology behind AirBar) in early 2018. However, due to protracted negotiations and qualification processes, the technology has yet to be adopted by any automotive players. For this reason, we have removed our contribution assumption from the product.

• Also recall, Salutica’s key customer launched a new set of cableless earbuds in September last year. The earbuds, plagued by connectivity issues, received a subpar rating from several online reviews and hence, a lukewarm response. To rectify the issues, both Salutica and its key customer had worked together to redevelop the product, incurring higher R&D expenses and overtime charges.

• On a brighter note, we understand that the company has secured two new customers in the wearable and headset segments. The group is currently in the product development and prototyping stage with the new customers, and expects the commercial launch in 2QFY19. In addition, its existing key customer is expected to launch two new products in September-October 2018.

• Till then, however, we do not expect any excitement as 3Q and 4Q are historically low seasons for the company. The group has been recruiting more engineers to facilitate R&D activities for the new products. Management expects this to eat into profit margins in the next 1-2 years.

• Putting the headwinds aside, Salutica’s 1-year forward PE of 13x appears undemanding. Its peers, SKP Resources and V.S. Industry are trading at 14x and 15x respectively.

Source: AmInvest Research - 23 Apr 2018