KESM’s 3QFY19 results remained weak and continued to disappoint largely due to the inventory adjustments in the semiconductor automotive space. To get through this slow period, additional EMS work was undertaken to ensure its overheads are kept at bay. We cut our EPS forecast and lower our 12-month TP to RM6.80 (from RM8.00) based on an unchanged 12x CY20E PER. Maintain HOLD.

9MFY19 Core Earnings Declined 84% Yoy, Below Expectations

KESM’s 9MFY19 core earnings contracted by a sharp 84% yoy to RM4.6m although revenue only fell 11% yoy. This was largely due to the loss of operational leverage and hence a collapse in EBITDA margins (-7.8ppts yoy). The unfavourable shift in revenue mix towards the lower margin EMS work had also partially buffered the revenue decline, while negatively impacting margins. Results were below our expectations accounting for 59% of our FY19 estimates and the variance was due to lower-thanexpected margins.

3QFY19 Earnings Sequentially Weaker

KESM’s 3QFY19 revenue contracted by 9% qoq while core profit declined a higher 52% qoq largely due to the low base. We believe the revenue decline was due to lower EMS works undertaken during the quarter, resulting in the slight improvement in 3QFY19 EBITDA margins (+0.6ppts qoq).

Maintain HOLD With a Lower Target Price of RM6.80

We cut our revenue and margin assumptions and revise down FY19-21E EPS by 26-32% given a prolonged inventory imbalance in the automotive space. As revenue mix tilts increasingly towards the lower-margin EMS business, group profitability would also be impacted over the near term. At 12x CY20E PER, valuations are however trading close to its historical mean and we believe that risk-reward is balanced as believe that longer term prospects remain favorable given KESM’s captive burn-in and test segment for the automotive industry. Maintain HOLD with a lower TP of RM6.80 based on the stock’s long-term (c.20 years) mean PE of 12x applied on our CY20E EPS. 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 - 7 Jun 2019