For 1QFY20, HPMT registered core PATAMI of RM1.0m (QoQ: -58.2%, YoY: - 64.6%); this was below our expectations, forming 8.3% of our full year forecast. HPMT did not see much raw material cost pressure in 1QFY20 and new capacity installation will be deferred to FY21. On the outlook, should the Covid-19 breakout continue to persist, we believe it may pose a downside risk towards the demand for HPMT’s products moving forward. Cut FY20-21 earnings forecasts by 8-40% our and maintain BUY rating with lower TP (based on FY21 core EPS of 3.5sen pegged to 12x PE) of RM0.42.

Below expectations. HPMT reported 1QFY20 results with revenue of RM17.7m (- 1.8% QoQ, -19.2% YoY) and core PATAMI of RM1.0m (-58.2% QoQ, -64.6% YoY) which accounted for 8.3% of our full year forecasts, falling below our expectations.

Dividend. No dividends were declared for the quarter (1QFY19: nil).

QoQ. Core earnings fell by -58% QoQ as a result of cautious buying behaviour from its distributors and end users due to the uncertain global economic outlook, compounded by the pandemic. In particular, slower demand was seen from the Asia region (especially from China). Operations during the quarter were also impeded by the imposition of the MCO, of which a 2 week suspension period was reflected in 1QFY20.

YoY. Similarly on a YoY basis, core earnings declined -64.6% mainly due to cautious buying behaviour on the back of the continued uncertainty regarding trade relations, further inflamed by a pandemic breakout. In tandem with the Covid-19 breakout in Asia, HPMT saw significantly cautious buying patterns from the region in 1QFY20.

Outlook. HPMT received approval from authorities to restart operations in the third week of April and is fully focused on clearing backlog of orders amounting to RM5.6m. Nevertheless, its usual business visibility is only c.1 month. While the average raw material price (tungsten carbide) has declined due to weaker global demand, we gather that the cost per unit for HPMT has been stagnant as it was offset by rising air freight costs as well as unfavourable exchange rates. The company is exploring alternative logistics alternatives including shipping to reduce its costs. On the capacity front, no new capacity was added in 1Q20 and plans for capacity additions have been delayed to FY21 due to lingering demand uncertainty. Given the Covid-19 outbreak and its ensuing lockdowns, coupled with emerging risks of reinfections, this may pose a longer than expected slowdown in global economic activities. In the event these risks do materialise, we believe it may pose a key risk to the demand for HPMT’s products moving forward.

Forecast: Cut FY20-21 earnings by 40% and 8% respectively after recalibrating sales assumptions on the back of the uncertain environment. Introduce FY22 core earnings of RM12.9m.

Maintain BUY; TP of RM0.42. Apart from the earnings cut, we also lower our PE target from 13.5x to 12x (at the lower end of its peer’s mean PE over the past 2-years; Halcyon Tech at 11.5x and NS Tool at 16.8x) but this is partially offset by rolling over our valuation horizon to FY21 as it better reflects the normalised earnings of the company. All in all, our TP falls from RM0.46 to RM0.42.

Source: Hong Leong Investment Bank Research - 29 Jun 2020