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.

• We came away from Denko’s analyst briefing reassured of its positive earnings prospects. The key takeaways from the briefing were:

1. Denko is in the midst of renegotiating pricing terms with its key customer. At the top of its agenda is to pass on rising raw material costs and foreign workers levy. This is expected to improve GPM going forward, consistent with our assumption.

2. Denko is also striving to secure additional jobs from its key customer for an upcoming 187K sq ft plant in Jalan Hasil, Johor Bahru, which is slated for completion in September 2018. We have not factored in any contribution from this pending further earnings clarity. Meanwhile, its 116K sq ft warehouse is approximately 60% completed, and is targeted to be ready by August 2018. This will increase the existing warehouse space by circa 55%.

3. The higher effective tax rate in FY18 was due to a smaller amount of tax savings from a special tax incentive announced in the Budget 2016 as well as adjustments for underprovisions in FY17.

4. The original Denko operations (ex-IMS) broke even in FY18, and only 2 months of financial results were consolidated. Moving forward, the group will consolidate full financial results of the original Denko operations. Management indicated that the operations are likely to turn profitable in FY19F on increased sub-assembly jobs.

• In its recently built factory in Jalan Dewani, Johor Bahru, two assembly lines for a new floor-care product have already been commissioned. Additionally, another two assembly lines for a new healthy lifestyle product are scheduled to commence in July-Aug 2018. These are expected to give Denko a significant earnings boost in FY19.

• We continue to 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 on greater cost efficiencies.

Source: AmInvest Research - 6 Jun 2018