We initiate coverage on the Electronics Manufacturing Services (EMS) sector with an Overweight call, not merely as a beneficiary from the trade diversion but also to ride on the rapid expansion of their common key customer – a global renowned household appliances brand. ATA IMS (BUY, TP: RM1.80), is our preferred sector pick, as we expect the group to continue charting strong growth on the back of capacity expansion coupled with margin enhancement from further vertical integration. We also initiate coverage on V.S. Industry (BUY, TP: RM1.60) given the group’s diversified customer mix and strong ability in securing new contracts, which makes it a prime beneficiary of trade diversion. Elsewhere, we highlight 3 other companies, namely SKP Resources (Non-rated, RM1.08), i-Stone (Non-rated, RM0.18) and MTAG (Non-rated, RM0.42), which form part of the “D” ecosystem.

Riding on the Key Customer’s Innovation & Growth Prospects

V.S. Industry (VS), ATA IMS (ATA), and SKP Resources (SKP) are the three largest home-grown EMS players in Malaysia (with a combined market cap of US$1.3bn), serving a common key customer. We expect the sector continue to grow on the back of rising demand for the key customer’s premium household appliances, underpinned by: i) a growing middle class, ii) improving standards of living in developing countries, and iii) rising demand for high-tech household appliances. The key customer is able to enjoy a lower cost of production with its entrenched ecosystem in Malaysia and will continue its investment in technology which should benefit the Malaysian supply chain.

Window of Opportunity From Trade Diversion

With the escalating US-China trade tension and rising cost of manufacturing in China, most of the EMS players have received increased enquiries from multinational corporations (MNCs) looking to shift or diversify their manufacturing base away from China, and are in discussion with their prospective customers for potential new opportunities.

Initiate With Overweight Rating

Sector PE valuations have de-rated over the past 2 years due to lowered growth expectations. Trading below its historical mean PER of 13x on CY2020E, the sector’s risk-reward is looking favorable in view of the: 1) growth upside of a major global household appliances brand, of which the three collectively produce >50% of the key customer’s global production; and 2) positive impact from trade diversion which could positively enhance the sector’s CY18-21E core net profit CAGR of 12%. Downside risks: i) key customer risk; ii) reliance on foreign labor, iii) competition risk, iv) downturn in household appliances industry, and v) economic slowdown.

Source: Affin Hwang Research - 10 Oct 2019