We maintain our HOLD rating on Scicom with an unchanged price target of RM0.92 based on a 13.5x CY20E PER (-1SD from 5-year average). We forecast Scicom to see a 34% yoy decline in FY19 core net profit due to lower contributions from the e-solutions segment and higher tax rate. Nonetheless, the weak earnings outlook is largely reflected in its weak share price performance (-54% in past 1 year), we believe. Moving into FY20-21E, we expect Scicom’s earnings to grow organically by 5-6% p.a. on higher transaction volume. Upside risk: major contract win (ie. foreign worker tracking, Integrated Immigration System). Downside risks: further earnings disappointments and an unfavourable outcome from the Originating Summons filed by EMGS.

We Expect FY19E Core Earnings to Fall 34% on Lower Margin, Higher Tax

Scicom is scheduled to release its 4QFY19 results at end-August 2019. To recap, the group’s 9MFY19 core net profit declined by 44% yoy to RM15.9m due to lower contributions from the e-solutions business and normalisation of the effective tax rate, partly cushioned by higher revenue from the Business Process Outsourcing (BPO) segment. While we expect a sequential uptick in 4Q19 earnings, Scicom’s FY19E core net profit should still come in weaker yoy (-34%) due to the abovementioned reasons, translating to a lower full-year dividend of 6.3 sen (from 9.0 sen in FY18A).

Moving Into FY20-21E, Organic Growth May Lift Earnings by 5-6% P.a.

Going forward, we forecast Scicom’s FY20-21E core net profit to grow by 5-6% per annum, driven by higher revenue contributions from both the BPO and esolutions businesses on higher transaction volume.

(i) BPO: Management expects the newly secured clients in 2019 to gradually contribute to an increase in revenue for the BPO business. Elsewhere, Scicom also expects some prospective clients to start contributing revenue in FY20E; and

(ii) e-solutions: In an interview with The Star, Shahinuddin Shariff, the CEO of Education Malaysia Global Services (EMGS) said the company is going to sell education better than it used to do. “It’s going to be targeted and data driven”, he said. He also mentioned that EMGS is on target (to achieve 200,000 international students by next year) but not raising the bar so as to be realistic. To recap, EMGS is one of the largest customers for Scicom’s e-solutions business.

Opportunities / Upside Risks: Major Contract Wins

Scicom is hopeful of soon winning a contract to track foreign workers in Malaysia. The contract will be awarded by a source country that exports thousands of workers to 12 countries, including Malaysia – according to an article by The Edge, quoting Scicom’s CEO Leo Ariyanayakam.

The Edge also reported that Scicom is bidding for other governmental processing systems, with the largest one being the Integrated Immigration System (IIS), for which the Ministry of Home Affairs issued a request for proposals in May 2019. The deadline for the submission of bids is mid-August 2019 and the contract is worth about RM1bn and will run for five years. According to another article by The Edge, the IIS has a two-stage tender process that is likely to go on until December 2019. The other potential bidders for the project are Iris Corp Bhd and HeiTech Padu Bhd.

We did not factor in new contract wins in our FY20-21 earnings forecasts. Securing a major contract would materially improve Scicom’s earnings prospects. However, we observe that the competition in the IIS tender is stiff and the award of other major governmental processing systems (ie. foreign workers tracking) may take longer than expected due to the (typically) prolonged approval process.

Downside risks: unfavourable outcome from the originating summons by EMGS, earnings disappointments

As announced, Scicom was served an Originating Summons on 24 July 2019 filed by EMGS, pursuant to an agreement dated 1 November 2012 between Scicom and EMGS wherein EMGS is seeking to enforce a right under the said agreement. Scicom has obtained legal advice that the Originating Summons filed by EMGS is without merit. Management believes the Originating Summons has no material financial implications on the company.

We did not incorporate any changes to our revenue forecasts in relation to the services provided to EMGS. An unfavourable outcome from the Originating Summons and / or substantial deterioration in the working relationship between Scicom and EMGS may negatively affect the long-term earnings contributions from EMGS-related services.

Maintain HOLD With An Unchanged TP of RM0.92

We maintain our earnings forecasts, HOLD rating and 12-month price target of RM0.92 based on a 13.5x 2020E PER. Scicom’s weak FY19E earnings outlook is, in our view, largely reflected in the weak share price performance (-54% in the past 1 year). At a 13.3x CY20E PER, Scicom now trades at -1 standard deviation from the 5-year average forward PER of 18.7x (Fig 6), and looks fair considering the weak earnings outlook as well as the risks associated to the Originating Summon filed by EMGS. Key positive re-rating catalysts are securing major new contracts and better-than-expected earnings.

Source: Affin Hwang Research - 8 Aug 2019