9MFY17 core earnings grew 39% yoy on the back of growth in the automotive burn-in and test business. Earnings momentum remained positive and was ahead of expectations due to stronger-thanexpected revenue and margins. KESM continues to offer a compelling proposition in the automotive burn-in and test space, which is expected to see strong structural growth ahead. BUY.

9MFY17 Core Profit Up 39% Yoy, Above Expectations

KESM’s 9MFY17 core profit of RM30m (+39% yoy) was ahead of expectations, accounting for 79% and 78% of our and street FY17E estimates. The positive surprise was due to better than expected revenue and EBITDA margin coming in slightly ahead of our forecast at 33.2%. 9MFY17 earnings growth was driven predominantly by revenue expansion (+17.5% yoy). This was due to the strong capex upcycle that KESM has undergone since 2014, whereby KESM invested in new equipment targeting the automotive test market. Impact from this has been promising, contributing to positive quarterly revenue growth momentum since 2QFY15. The even stronger planned capex of RM90m over FY17-18E should ensure that growth is sustained in the quarters ahead. Sequentially, 3QFY17 core profit was up 5% due to revenue growth (+4% qoq) and 1.5ppt improvement in EBITDA margin.

9MFY17 EBITDA Margin Improvement Despite Start-up Costs

9MFY17 EBITDA margin improved 0.8ppts yoy despite continued start-up cost on new investments. Besides, we understand that the company is enhancing the production process by increasing the level of automation, which should be long-term positive. On this account, we think that the margin improvement is thus impressive, probably driven by prudent cost measures and improved product mix.

Maintain BUY and Target Price of RM16.40

We leave our forecasts unchanged pending an update with management. Overall, we like KESM’s strong growth proposition in the automotive burn-in and test space which is expected to offer strong structural multi-year growth ahead. Maintain Buy and a target price of RM16.40 (based on 17x calendar year 2017 EPS). Key downside risks include a loss of customers and a reduction in the outsourcing opportunities as customers increase their inhouse burn-in and test function.

Source: Affin Hwang Research - 2 Jun 2017