Investment Highlights

• We maintain our BUY recommendation on Denko Industrial Corporation (Denko) with unchanged forecasts and fair value of RM1.76/share, based on a CY19F PE of 13x.

• Denko’s FY18 results came in line with our expectations and consensus estimate at RM93mil, representing a YoY increase of 17%. The improvement was fuelled by a 27% expansion in revenue, which was driven mainly by stronger box-build orders. However, higher taxation has resulted in a smaller increase in earnings. The effective tax rate was 26% in FY18, vs. 18% in FY17 as some tax expenses in FY17 were deferred. We expect the tax rate to moderate to the normal statutory corporate tax rate of 24%.

• For 4QFY18, in spite of a 22% YoY jump in revenue, Denko’s net profit fell by 27% YoY due to initial production inefficiency for new products. In addition, taxation during the quarter was also higher compared to 4QFY17. We believe its operating margins will improve as utilisation picks up in the coming quarters.

• On a QoQ basis, however, revenue declined 20% while PBT shrank 45% due to seasonality. 3Q (the previous quarter) normally sees higher volume loading due to yearend spending.

• 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 1QFY19. These are expected to give Denko a significant earnings boost in FY19.

• We like Denko because: 1) it is a prime proxy to its key customer’s continuous innovation and robust growth prospects; 2) it is the largest supplier of filters for its key customer globally, commanding a formidable market share of 80-85% and 3) its PAT is expected to grow at a stunning CAGR of 24% for FY18-FY21F, underpinned by higher box-build orders from new products and a margin expansion due to better product mix.

Source: AmInvest Research - 1 Jun 2018