Taiwan’s Plant 2 phase 1 expansion is slightly ahead of schedule and to be completed by 1H21. Although Plant 2 land size is almost the same as Plant 1, the former’s production capacity can be more than double as new technology requires less floor space. It is in negotiation with an OEM customer (existing client in Taiwan) on a large volume-based project to support Singapore foundries. If this project materializes, expansion will be required and it plans to repurpose the idle space in O&G site. Reiterate BUY with lower TP of RM3.20, pegged to 30x of FY23 EPS. We like its unique exposure to leading-edge semiconductor frontend supply chain.

Recently, we hosted a virtual meeting to better understand its corporate developments amid this volatile market, plagued by macro uncertainties and risks. Below are the major takeaways:

Taiwan expansion. Plant 2 phase 1 expansion is slightly ahead of schedule and to be completed by 1H21. Phase 2 and 3 extensions are expected to be completed by next year. Although Plant 2 land size is almost the same as Plant 1, the former’s production capacity can be more than double as new technology requires less floor space. It is still negotiating with seller for another piece of land as pricing is at the top end of market and management is not desperate. This land is meant for its expansion plan for next 8 years based on business projection.

Singapore. Currently, Frontken is in negotiation with an OEM customer (existing client in Taiwan) on a large volume-based project to support local foundries. It has received first part/tool for qualification purpose. If this project materializes, expansion will be required and it plans to repurpose the idle space in O&G site. Capex for this project is estimated to be RM3.5-4.0m including the purchase of testing and measuring equipment. Labour issue has improved after CNY and it managed to hire some from China. O&G business has improved a lot with more works and enquiries to the extent of insufficient space to put equipment while customers are very demanding. It has yet to observe any impact due to China’s Covid-19 lockdown and customer from Dalian continues to send parts to Singapore for cleaning.

Cost management. So far, raw material costs are stable and under control. Frontken has adjusted staff wages in certain regions but not expected to affect the group’s cost structure in a big way. It anticipates expanses to increase in the near term due to the commencement of AGTC Plant 2 as well as O&G setup in Pengerang.

Outlook. Demand projection remains strong and no order reduction thus far. Frontken shared that it continues to experience the price pressure norm despite foundries are increasing their ASPs. EBITDA margin should increase thanks to improvement in O&G and expecting O&G to achieve double digit growth at PAT level.

Forecast. Based on the latest corporate update, we pencil the contribution from Taiwan Plant 2 phase 1 expansion which lifted FY23 core net profit by 22% while FY22’s remain unchanged. Reiterate BUY but with a lower TP of RM3.20 (previously RM4.36) based on PE multiple of 30x (previously 50x) of FY23 EPS. Considering US Fed’s hawkish stance to tame inflationary economy, we lower Frontken’s PE valuation to 30x, which is 0.5 SD above its 5-year PE mean of 24x. We 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), and (4) strong balance sheet (net cash of RM315m or 20 sen per share) to support its Taiwan expansion.

Source: Hong Leong Investment Bank Research - 26 Apr 2022