Nicely Positioned

We remain upbeat on KESM after our meeting with management yesterday. While utilization rates at 80% may sustain into 3Q FY18 and are less than desirable, we believe the company is well positioned to capture an anticipated production ramp by 4Q FY18, once customer issues are ironed out. Nevertheless, near term KESM remains attractively profitable as it stays lean and efficient. Its capex cycle should remain high at RM70m annually over FY19-20E, which in our view will further consolidate its position as the largest independent burn-in provider globally, with a niche in the automotive space, an area where we anticipate strong structural growth. Reaffirm BUY call.

Likely Stronger Pick Up in Revenues by 4Q FY18

Although KESM invested heavily in capex (>RM215m over past 3 years), 3Q FY18 revenue may remain flattish due to issues at its customers and at assembly houses. Preliminary forecasts, however, point to a stronger 4Q FY18. Nevertheless, near term, despite weaker utilisation rates of 80% (vs. up to 85% in 1Q FY18), the EBITDA margin was slightly firmer at 35.6% (+0.1ppts qoq) a reflection of its favourable product mix and cost efficiency.

Capex Likely to Remain Elevated

Capex in 1H FY18 amounted to RM28m although on track to hit RM70m for FY18E and likewise to sustain at such levels over the next couple of years as KESM gears up for stronger growth in the automotive semiconductor segment. In FY17, KESM’s semiconductor chips burn-in and tested registered 19% yoy growth and we believe that a high growth trajectory can be sustained, in view of the company’s planned capex and the structural growth in the semiconductor automotive segment. Moreover as invested capex is spread beyond its major customers (69% of FY17 revenue came from 2 customers), growth should be even more prevalent. However, management guided that an even stronger capex spending plan could lead to sharper revenue volatility. We believe management will avoid such and target to pursue a more stable and yet strong growth strategy.

Reaffirm BUY and Target Price of RM21.80

We reaffirm our BUY rating and 12-month target price of RM21.80, based on 17x CY18E EPS. Key downside risks include a loss of customers and a reduction in the outsourcing opportunities.

Source: Affin Hwang Research - 16 Mar 2018