KESM reported a stronger 4Q18 core profit of RM9.9m (+51% qoq) but still fell short of expectations. FY18 results only made up 91% of our forecast as a stronger recovery in revenue failed to materialize. KESM’s FY18 core profit of RM38m (-12% yoy) was impacted by wafer and material shortages and coupled with poor yields of its customer’s new devices. We cut our FY19-20E EPS forecast by 16-19% respectively. Our 12-month TP is reduced to RM18.55 based on an unchanged 17x 2019E EPS. Downgrade to HOLD from Buy.

4QFY18 Core Earnings Jumped 51% Qoq

KESM’s 4QFY18 core earnings jumped 51% qoq although this was driven ultimately by a positive tax charge. At the core pretax level, earnings was up 3% qoq due to the higher revenue, up 4% qoq. It appears that the wafer shortage issue that KESM had been facing since 3QFY18 has not fully recovered. 4QFY18 revenue growth could also likely have been due to its low margin EMS business rather than its burn in and test revenue, resulting in the weaker EBITDA margin of 33.1% during the quarter (-1ppts qoq).

FY18 Core Earnings Fell 12% Yoy - Below Expectations

Despite the stronger 4QFY18 earnings, results still fell short of our expectations – accounting for 91% of our forecast. The variance was largely due to lower than expected revenue. Meanwhile prior year capex investments had resulted in higher depreciation of RM78m (+18% yoy). While FY18 capex has tapered down to RM41m (from RM107m in FY17), depreciation will likely remain a drag over the near term unless revenue picks up. Management however sounds cautious in their notes to the accounts, concerned over the escalation of trade war and M&A in the semiconductor industry disrupting material supplies. However with the lower FY18 capex, management decided to return excess cash to shareholders, with a higher FY18 DPS of 18.5 sen (FY17: 12.5 sen). This was above expectations.

Downgrade to HOLD With a Lower Target Price of RM18.55

We cut our 2019-2020E EPS by between 16-19% to take into account a weaker recovery in revenue. Our 12-month target price is thus reduced to RM18.55 (based on an unchanged 17x 2019E EPS). Key risks include a loss/gain of customers and a reduction/gain in outsourcing opportunities as customers lower/increase their in-house burn-in and test function.

Source: Affin Hwang Research - 24 Sept 2018