HPMT expects to register a stronger 2H20 with operations having substantially recovered from pandemic lows. Orders have recovered to roughly 10% lower than pre-pandemic baseline. So far, demand from key regions like East Asia and Europe are gradually recovering. Nonetheless, recent pandemic flare ups may dampen demand recovery for its products. Going forward, management intends to focus on cost control and embark on digital transformation to benefit from an eventual economic recovery. Maintain forecasts. Downgrade to HOLD rating with lower TP (based on FY21 EPS pegged to 11x PE) of RM0.39. Stock offers a cyclical exposure to an eventual economic recovery which we reckon warrants a revisit once a firmer recovery footing is established.

We Met With Management Recently With the Following Key Takeaways:

Recap of 2Q20. Core earnings increased by 65.7% and 11.5% respectively despite weaker revenue growth (-1.3% QoQ, -9.8% YoY) as margins improved on the back of implementing cost efficiency measures, further boosted by government subsidies for wages. This negated the impact of lower revenue contributions as we gather operations only resumed towards end-April.

Gradual recovery. We gather from management its orders on hand have expanded to RM44m from RM5.6m during peak lockdown. Demand for its cutting tools has been largely fuelled by resilience in smartphone and electronics end markets. Meanwhile, management remains cautious on outlook from automobile as well as aerospace industries whereby the latter is fraught with uncertainties and near term challenges. Geographically, contribution from China, Japan and Taiwan has recovered on the back of successful handling of the pandemic while orders from Europe are recovering gradually. On an overall basis, orders are still roughly 10% lower compared to prepandemic baseline. In terms of pricing, uncertainties and weak business environment has led to a slight decline in ASPs likely in the low single digit percentage range.

Relief from lower costs. Generally, raw material costs have trended downwards further helped by discounts (low to mid-single digit) given by suppliers. Earnings impact should be reflected in 4Q20 given the usual lag. In response to the higher air freight costs in 1H20 (have since subsided), some shipments have been diverted to its sea freight channel. Nonetheless, we believe the company still substantially relies on air routes.

Rising Covid-19 cases. Despite easing lockdowns, various European countries are seeing resurgence of Covid-19 cases. Case in point is the flare ups in France, Germany as well as Italy of late. We reckon this could put a dampener on the rate of demand recovery for HPMT’s products given that Europe remains a key market. To combat this, management is focused on cost control as well as embarking on a digital transformation to adapt to the new normal.

Forecast. Unchanged as Meeting Yielded No Surprises.

Downgrade to HOLD; TP of RM0.39. We downgrade the stock to HOLD with slightly lower TP of RM0.39 (from RM0.42). Our TP is derived from pegging FY21 EPS to 11x P/E multiple (from 12x previously) to account for higher earnings risk from reemergence of Covid-19 uncertainty. Stock offers a cyclical exposure to an eventual economic recovery which we reckon warrants a revisit once a firmer recovery footing is established.

Source: Hong Leong Investment Bank Research - 21 Oct 2020