KESM’s 1Q19 core profit of RM3m (-72% yoy) was below expectations due to persistent weakness at both its automotive business and consumer related burn-in business. There could possibly be another quarter of weak results before the impact of the inventory imbalance wears off fully. We cut our 2019-21E EPS by 27-58% leading to a lower 12-month TP of RM10.15 based on an unchanged 17x CY19E PER. Maintain HOLD.

1QFY19 Core Earnings Declined 72% Yoy, Below Expectations

KESM’s 1QFY19 core earnings of RM3m fell 72% yoy largely due to weakness at both its automotive business (80% of revenue) and consumer related burn-in business (20% of revenue). Management guided that the auto sector could remain weak until early 2019 due to an inventory imbalance which is also impacting ASPs. Its China operations, which focuses on burn-in for white goods, have seen a similar slowdown. This has impacted the 1QFY19 EBITDA margin which has declined 6.7 ppts yoy to 28.8%. Due to the market softness, management also scaled back its expansion plans – capex amounted to RM5.9m in 1QFY19 vs. RM107m in FY17 and RM42m in FY18.

Earnings Declined Sequentially

1QFY19 depreciation charges remained high due to the previous year’s capex expansion. As revenue slipped 4% qoq due to weaker demand, core earnings took a hit, falling 69% qoq. The EBITDA margin slipped 4.3 ppts qoq due to weaker operating leverage.

Maintain HOLD With a Lower Target Price of RM10.15

We cut our 2019-2021E EPS by 27-58% to take into account a weak 1HFY19 in view of the current operating environment. Based on an unchanged target of 17x on our CY19E EPS, our 12-month target price is reduced to RM10.15. Longer term, we still believe that KESM is well positioned in the captive burn-in and test segment for the automotive industry, which will likely see strong structural growth in semiconductor content. Key risks include a loss/gain of customers and a reduction/gain in outsourcing opportunities as customers increase/lower their in-house burnin and test function.

Source: Affin Hwang Research - 23 Nov 2018