Despite the seasonal weakness, Frontken recorded strongest 1Q ever with core net profit of RM15m (+118% YoY, -21% QoQ) which beat expectations. This outstanding performance was driven by both semiconductor and O&G segments. In the “more than Moore” era, wafer fabrication process multiplies in terms of frequency and complexity and will lead to more cleaning requirements. Our upward forecast revisions have led to higher TP of RM1.55, pegged to 25x of FY19 EPS. Maintain BUY.

Above expectations. 1Q19 revenue of RM84m translated into core net profit of RM15m, accounting for 25% and 24% of HLIB and consensus full year forecasts, respectively. This is considered an outperformance as 1Q is seasonally weak and historically only account for 10-20% of full year earnings. 1Q19 is another milestone for Frontken as the strongest 1Q ever.

QoQ. Due to seasonal weakness (lesser working days as a result of long festive holidays), turnover moderated 6% attributable to lower contributions from Taiwan (- 5%) and Singapore (-24%), offsetting the growth in Malaysia (+20%). Core net profit fell by 21% after being dragged by higher D&A and effective tax rate (1Q19: 27% vs. 4Q8: 18%), nullified the lower MI charge subsequent to the increased stake in AGTC.

YoY. Top line’s 18% gain was driven by both semiconductor and O&G businesses with expansions registered in Singapore (+39%), Malaysia (+58%), Philippines (+14%) and Taiwan (+4%). With better economies of scale and continuous operational excellence, core net profit swelled 118% to RM15m.

Semiconductor. Management shared that although the general outlook for the sector is somewhat tepid, the recent positive development following the settlement of a long outstanding dispute by major players had somewhat boosted the outlook and is positive for the company. Since Moore’s Law has reached the physical limitation, the industry has entered “more than Moore” era to further scale transistors. As foundry continuously develops smaller node, wafer fabrication process multiplies in terms of frequency and complexity and will lead to more cleaning requirements.

O&G. Recorded 4th consecutive quarterly profit with RM2.5m in 1Q19. It noticed that number of enquiries had picked up and hope that they will be rendered into orders. Recognizing that the unresolved trade spat remains a key risk, it will relentlessly enforce capital discipline, portfolio realignments and productivity efficiencies. We believe the turnaround story remains intact and this performance is sustainable going forward considering Brent crude price remains stable at current levels.

Shariah compliant. Although cash and equivalents are piling up (RM149m as end of FY18), they are still below the 33% threshold and we do not see any disqualification risk.

Forecast. Tweaked both semiconductor and O&G EBITDA margin assumptions as well as housekeeping adjustments based on FY18 audited account. In turn, FY19-21 EPS revised upward by 5-6%. Reiterate BUY with a higher fair value of RM1.55 from RM1.18, reflecting the earnings revision. Our TP is pegged to 25x (previously 20x) of FY19 EPS, matching regional peers’ average PE (see Figure #2). We expect Frontken to experience multi-year growth ahead on the back of (1) sustainable global semiconductor market outlook; (2) robust fab investment; (3) leading edge technology (7nm and below); (4) O&G recovery; and (5) strong balance sheet (net cash of RM144m or 13.7 sen per share).

Source: Hong Leong Investment Bank Research - 24 Apr 2019