KESM remains one of our high-conviction plays as it is poised to benefit from an automotive structural growth story which is underpinned by rising electronic content in vehicles and fullyautonomous vehicles in the near future. KESM’s FY17E PER of 10.5x looks compelling against a 3-year forward EPS CAGR of 22%. BUY.

Capex spending to rise in FY17-19E

We hosted KESM at our office yesterday which was well attended. Apart from running through the FY16 financial performance, management provided some guidance on its capex plan, which we believe suggests a stronger performance ahead. Although capex declined to RM30m in FY16 (-62% yoy) due to delays by its customers in rolling out new products, capex should normalise to the RM70-80m/per annum range over the next few years.

Earnings momentum should remain positive

To recap, KESM’s FY16 revenue grew at a faster 9% YoY compared to the preceding 3 years’ growth of 3-5%. We understand that bulk of the capex over FY14-15 was a contributing factor while the impact from the capex in FY16 should begin to filter through in the coming months. We thus believe that KESM’s earnings momentum should be positive and strong considering the relatively robust automotive business (70-80% of revenue) that underpins its business. KESM is set to release its 1Q17 results by late November.

Potential room for margin enhancement

While we have built into our model a flattish EBITDA margin of 33% over FY17-19E, we think that there could potentially be upside to this as we understand that future capex is geared more towards test rather than burn-in, where the former carries better margins. Any pressure on margins is likely to be related to costs involved in obtaining the necessary qualifications and accreditations required in the automotive business although we think that this will generally pay for itself, through higher volumes, in the subsequent years.

Maintain BUY and target price of RM11

We maintain our BUY and 12-month TP of RM11, based on a CY17E PER of 12x). We like KESM as we believe it is poised to benefit from the structural growth in the automotive semiconductor space underpinned by rising electronic contents. Risks: enhanced competition and loss of customers.

Source: Affin Hwang Capital Research - 14 Oct 2016