We hosted KESM at our office last week, post the recent results. KESM recently delivered a strong 9MFY17 results with earnings up 39% yoy. Our revenue growth expectations is raised, judging by the even stronger capex planned for FY17E. Maintain BUY but with a higher target price of RM21.80.

Solid Results

Management ran through the recent results, providing better clarity on the 9MFY17 net profit growth of 39% yoy and the sequential 5% net profit growth in 3Q17. Essentially, profit growth has continued to be driven by revenue expansion, which has been underpinned by recent years’ capex expansion. While 3QFY17 EBITDA margins improved 1.5ppts qoq, management guided that increased investments in automation may provide a check on margins over the near term. We however think that, with a smaller proportion of low-margin EMS work being undertaken, the more favourable product mix should also help with KESM’s margin expansion.

Major Capex Upcycle… Even Higher Now

We last revised our capex assumption in Mar 2017, raising FY17E capex to RM90m (from RM70m). Given the strong capex to-date of RM81m and management’s guidance that visibility and client demand remain strong, we raise our FY17 capex assumption to RM120m. Recall that the bulk of the capex that KESM is spending is being focused on the automotive business, predominantly for the highly critical advanced driver assistance systems (ADAS) segment. This includes burn-in and testing for microcontrollers, processors and TPMS chips.

Maintain BUY But at a Higher Target Price of RM21.80

Taking into account our higher capex assumptions, we raise our revenue forecasts and hence FY17-19E EPS by 2-7%. We like KESM’s strong growth prospects in the automotive burn-in and test space, which is expected to offer strong structural multi-year growth. Maintain Buy but with a higher 12-month target price of RM21.80 (from RM16.40) after rolling forward our valuation horizon to calendar year 2018E EPS and on an unchanged 17x PER. Key risks include a loss of customers and a reduction in outsourcing opportunities as customers increase their in-house burn-in and test functions.

Source: Affin Hwang Research - 13 Jun 2017