KESM’s 1HFY19 core profit collapsed 81% yoy due to an ongoing inventory adjustment and unfavorable revenue mix. There is a risk that this imbalance may continue judging by the weak newsflow within the automotive space. We cut 2019E EPS by 23% and lower our TP to RM9.15 based on an unchanged 17x CY19E PER. HOLD.

2QFY19 Earnings Declined Sequentially

KESM’s 2QFY19 earnings continued to decline sequentially due to weak utilisation levels and an unfavourable revenue mix as it took up more lowmargin EMS work, which helped mitigate a sharper decline in revenue for its burn-in services. Hence, although revenue slipped a mere 0.6% qoq, the EBITDA margin shrank to 26.3% (-2.5ppts qoq) contributing to the 65% qoq decline in earnings. The slowdown in 2QFY19 was nevertheless well within expectations as the automotive industry underwent an inventory correction due to weak demand, which has impacted both ASPs and hence margins. Management had also earlier guided that the weakness would continue till January this year.

1HFY19 Core Earnings Declined 81% Yoy, Below Expectations

1HFY19 core earnings was a stark contrast to that of a year ago, declining a sharp 81% yoy to RM4m. While 1HFY19 revenue fell only 11% yoy, the EBITDA margin (-8ppts yoy) also took a toll due to the lower operating scale and revenue mix. The latter was the key reason behind the lowerthan-expected margins and therefore the earnings miss.

Maintain HOLD With a Lower Target Price of RM9.15

Judging by recent news on the automotive semiconductor company, Renesas Electronics Corp, which has plans to halt production at six plants in Japan for up to 2 months this year, the inventory imbalance may be far from over. We cut our 2019E EPS by 23% after lowering our margin assumption, and lower our 12-month target price to RM9.15 based on an unchanged 17x target on our CY19E EPS (previously RM10.15). The riskreward is balanced given the 45% fall in the stock price in the past 6 months while longer-term prospects remain favorable given its captive burn-in and test segment for the automotive industry. Key risks include a loss/gain of customers and a reduction/gain in outsourcing opportunities as customers increase/lower their in-house burn-in and test function.

Source: Affin Hwang Research - 13 Mar 2019