KESM reported a modest 3% qoq growth in 1H18 earnings although they are up 11% yoy, in tandem with better demand for its burn-in and test services. Although accounting for only 44% of our FY18 estimate, we deem the earnings to be in line, and expect the wafer constraint to be resolved. Maintain BUY and 12-month target price of RM21.80.

2QFY18 Revenue Up for 12th Quarters in a Row

KESM’s 2QFY18 revenue rose for the 12th consecutive quarter, underpinned by its strong capex upcycle in recent years. This has pretty much been driven by increased demand for automotive semiconductors as the vehicle electronic content increases and hence an increase in burn-in and testing services. Core earnings rose 3% sequentially on the back of both revenue and margin expansion. Although the EBITDA margin at 35.6% appears to be consolidating (+0.1ppts qoq), it is already tracking ahead of our expectation of 34% for FY18. Moreover, we think that once revenue picks up in 2H18, there is a possibility of further economies of scale and hence potential for further margin expansion.

Stronger Margins and Core Earnings Sequentially

1HFY18 core earnings (+11% yoy) accounted for 44% of our FY18 estimate. We deem this to be in line as revenue and earnings should accelerate in 2H18 after some softness in the supply chain, which we understand was due to a wafer constraint. More importantly, there was a 3.3ppts yoy improvement in the EBITDA margin driven by the increased operating leverage (revenue is up 12% yoy) and also aided by the move into testing. The sharp increase in capex in recent years is reflected in the 27% yoy increase in depreciation charges in 1H18. While the 1H18 capex figure was lower at RM28m vs. RM43m in 1H17 and tracking behind our FY18 capex estimate of RM90m, we think that this could be due to timing differences. That said, we believe there was sufficient capex in the past to sustain both revenue and profit expansion over the near term.

Maintain BUY and Target Price of RM21.80

We maintain our BUY rating and 12-month TP of RM21.80 (based on 17x CY18E 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 - 9 Mar 2018