KESM Industries’ FY19 core earnings collapsed 76% yoy largely due to the ongoing inventory correction. However, there was a strong earnings improvement in 4QFY19, albeit off a low base, and this could signal that its weak earnings momentum has bottomed. We have modelled for a further earnings recovery in FY20E, projecting a growth of 127%, although profits are not expected to reach the previous peak in FY17, at least over the next 3 financial years. Maintain HOLD with a slightly higher 12-month TP of RM7.00 based on an unchanged 12x CY20E PER.

Strong 4QFY19, above expectations

KESM reported a strong 4QFY19 set of results that was above expectations. The surprise was largely driven by better-than-expected margins during the quarter. Core net profit for the quarter jumped 738% qoq, albeit from a low base, largely due to margin improvement. The 4QFY19 EBITDA margin jumped 2.1ppts qoq as product mix improved, a likely result from lower EMS work while the proportion of revenue generated from its burn-in and test increased. Management has guided for a progressive recovery barring any escalation of trade tensions and the global macro slowdown, in line with our current FY20 forecast. We make some slight adjustments to our FY20-22E EPS post the results.

FY19 core earnings declined 76% yoy, but DPS pleasantly surprises

FY19 core earnings contracted by a sharp 76% yoy to RM9m although revenue only fell 12% yoy. This was largely due to the loss of operational leverage and hence a collapse in EBITDA margins (-6.9ppts yoy). The unfavourable shift in revenue mix towards the lower-margin EMS work had also partially buffered the revenue decline, while negatively impacting margins. Despite the weaker set of results, management announced a FY19 DPS of 9 sen, or a payout of 62%, above its historical range of 10-31%.

Maintain HOLD with a higher target price of RM7

Amidst the inventory correction that KESM is facing, we believe the company remains well managed, as reflected by its healthy quarterly performance and net cash position. We remain positive on the company’s long-term prospects as the company is well positioned as a captive burn-in and test provider for the automotive industry. Maintain HOLD with a higher TP of RM7.00 based on the stock’s long-term (c.20-year) mean PE of 12x applied to our higher CY20E EPS. Key downside/upside risks include a loss/gain of customers and a reduction/gain in outsourcing opportunities.

Source: Affin Hwang Research - 20 Sept 2019