Investment Highlights

• We initiate coverage on Denko Industrial Corporation (Denko) with a BUY and a fair value of RM1.76/share based on a CY19F PE of 13x. This represents a premium to its listed peers in the region which are trading at 10x.

• We attach a premium to Denko given that it is a stronger proxy to its key customer, which enjoys robust growth prospects. Among its peers, Denko has the highest share of orders from the key customer.

• Denko is a prime proxy to its key customer's innovation and growth prospects. For 2017–2020, unit sales of the key customer are expected to grow at an astounding 3-year CAGR of 29%, underpinned by its constant innovation and fast-selling home appliances. Based on our projections, Denko should account for circa 30% of the key customer's total box-build requirements in CY18F (in terms of volume), rendering it the largest supplier for the customer. Being a major supplier to the key customer, Denko is expected to register robust growth through 2020, mirroring the prospects of its key customer.

• Denko has recently purchased 2 new factories with an additional 376K sq ft of production space, equivalent to a 49% increase from its existing 774K sq ft. This gives the group sufficient floor capacity to house 6–10 additional assembly lines. For a start, Denko is installing 4 additional assembly lines in the Dewani building to cater for new jobs that have already been secured – 2 for a floor-care product and 2 for a healthy lifestyle product. Currently, 2 of the assembly lines are already in production, while another 2 are scheduled to commence by the end of 1QFY18, just in time to give FY19 a full earnings boost.

• Denko is also the largest supplier of filters for its key customer globally, commanding a formidable market share of 80-85%. The heavy dependency on Denko for filter supplies demonstrates the trust and relationship the group has built with the key customer over the years. While revenue contribution from the business was a mere 10-15% in the past 2 years, gross margin of the filter business is distinctly more superior (4-5ppts) to that of the conventional box-build business. This gives the group better operating leverage relative to pure-assembly players, ceteris paribus.

• All-in, we expect PAT to register a stunning 2-year CAGR of 39% for FY17-FY19F, underpinned by higher box-build orders from new products and a margin expansion due to better product mix.

• Currently, the stock is a bargain with a PEG of 0.58x vs. the industry average of 0.67x.

Source: AmInvest Research - 7 May 2018