Frontken’s 9M19 core net profit of RM51m (+45% YoY) matched expectations. Relentless focus on operational excellence has yielded strong bottom line growth outpacing top line expansion. Outlook for both business segments remain positive: semiconductor to be driven by 5G while O&G to leverage on Petronas appointment. We lifted our projections leading to higher TP of RM1.95. However, we downgrade to HOLD and believe that share price is fairly valued.

Within expectations. 3Q19 core net profit of RM18m (+4% QoQ, +20% YoY) brings 9M19’s total to RM51m (+45% YoY), accounting for 73% and 75% of HLIB and consensus full year forecasts, respectively. 3Q19 one-off adjustment includes forex gain amounting to RM1m.

Dividend. None (3Q18: 0.7 sen per share). YTD distribution totalled 1 sen (9M18: 0.7 sen) per share.

QoQ. Turnover gained 9% attributable to higher contributions from Taiwan (+12%), Singapore (+12%) and Malaysia (+1%), offsetting the declines in Philippines and Indonesia (-8%). However, core net profit grew at a slower pace of 4% as core EBITDA margin (adjusted for one-offs) shrank 1.6ppt to 34%.

YoY. Top line’s 1% increase was solely driven by Singapore’s semiconductor seasonal strength (+19%) while Taiwan was flattish (dragged by TFT-LCD), more than sufficient to cushion the weakness in Malaysia (-3%), Philippines and Indonesia (-22%). However, core earnings jumped 20% to RM18m on the back of improved economies of scale and continuous operational excellence.

YTD. Revenue increased 5% to RM251m stimulated by Singapore (+20%) and Malaysia (+13%) offsetting slips in Taiwan (-1%), Philippines and Indonesia (-8%). However, core earnings strengthened 45% thanks to leaner operations and lower MI charge (due to higher AGTC holdings), despite higher D&A and effective tax rate (excluding withholding tax, 9M19: 24.5% vs. 9M18: 23.0%).

Semiconductor. Increased AGTC stake by 1.26% to 90.85% in Sept. Generated 77% of group revenue in 3Q19. Outlook remains positive leveraging on 5G proliferation driving robust electronic demand. One of its main customers indicated sequential improvement due to higher demand and new orders of its advanced high performance chips for 5G rollout. Frontken hopes that this will be translated into higher sales.

O&G. Accounted for the remaining 23% of group turnover in 3Q19 with sustainable profitability. It noticed that number of enquiries had picked up and have translated into orders since 2H19. It has been appointed as one of the panel contractors for the provision of manpower supply and also mechanical rotating equipment services and parts for Petronas which may lead to new income stream going forward.

Forecast. Tweaked revenue and EBITDA margin assumptions based both business prospects above. In turn, FY19-21 EPS are raised by 3%, 10% and 13%, respectively.

Our TP is higher at RM1.94, pegged to 25x of FY20 EPS but we downgrade to HOLD. Since our initiation (Aug 2018), its share price has rallied 230%. We still like Frontken for its 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) favourable O&G market; and (5) strong balance sheet (net cash of RM141m or 13.3 sen per share). However, we feel that the stock is fairly valued at current level.

Source: Hong Leong Investment Bank Research - 6 Nov 2019