We hosted an investor meeting for KESM’s management at our office yesterday, which was attended by 16 clients. Although management did not provide FY18E earnings guidance, we sense a comfortable level of optimism. We see the high capex spent in recent years and the build-up of its automotive test business as supporting KESM’s underlying growth. BUY.

Further Margin Expansion Played Down

KESM’s FY17 EBITDA margin expanded to 33.6% from 32.2% in FY15 and from 27.4% back in FY10. Essentially, margin expansion has been driven by its move into the test segment and also accompanied by scale. Nonetheless, management continues to play down further margin growth in the near future although it believes that margins can further increase post a 18 to 24-month timeframe after the company’s continued investment into further improving its cost efficiency. Management cited the higher yield requirement by customers as an example. We have modelled into our forecast fairly stable EBITDAs of 33.7-34% over FY18-19E, but they could be conservative if capex continued to surprise on the upside.

Capex of Up to RM80m for FY18E

After a robust FY17 capex of RM107m (cashflow figure) from RM30m in FY16, management guided for preliminary capex of RM70-80m for FY18E. We understand that capex has been allocated for a combination of new automotive products and capacity increase of existing products. Factory utilisation levels were, however, lower in the first 2 months of 1QFY18 although they have picked up significantly in the final month, leading us to believe that 1QFY18 could be rather flat sequentially but still an improvement on a yoy basis.

Maintain BUY and Target Price of RM21.80

We have modelled in a FY18E expected effective tax rate of 15% although guidance is for this to be closer to 13% (8% in FY17), which could offer some upside. We leave our forecasts unchanged and reiterate our BUY call on KESM for a play on the automotive burn-in and test business, which we believe is undergoing strong structural growth. The 12-month target price is unchanged at RM21.80 (based on 17x calendar year 2018E EPS). Key downside risks include a loss of customers and a reduction in outsourcing opportunities.

Source: Affin Hwang Research - 12 Oct 2017