Unisem posted a headline loss in 3Q19 due to one-off charges. Nevertheless, 9M19 core profit was still weaker by 37% yoy as its customers were hit by the Huawei ban. Outlook remains cautious and management is guiding for another lacklustre quarter, while further one-off charges relating to Batam are expected. The recent run-up in stock price lacks merit in our view. Maintain Sell rating and TP of RM1.77 (based on an unchanged PE of 15x on 2020E EPS).

3Q19 Headline Loss Due to One-off Severance Charges

While Unisem reported a RM3m headline loss in 3Q19, this was due to severance payments for its Batam operations as the factory there is being shut down progressively. This amounted to RM22m for the quarter although there would be similar expenses in the coming quarters as the Batam operations are likely to sustain till 1Q20. Partly due to the termination and partial shutdown, the group recorded a deferred tax charge of RM6.5m which bumped up its tax expenses. Excluding this, we estimate a core net profit of RM21m in 3Q19, which represents a sharp 94% qoq improvement. The gain was largely due to the 3.5ppt qoq improvement in EBITDA margin, and likely due to lower contribution from the loss-making Batam operations. In 2018, Batam contributed nearly 10% of group revenue.

9M19 Core Earnings Below Expectations

9M19 core profit shrank 37% yoy largely due to weaker revenue as Unisem was impacted by the Huawei ban, aside from the inventory correction and hence weaker demand. Results were below our expectations due to weaker than expected revenue. Meanwhile, borrowings have jumped by nearly RM100m ytd, contributing to higher interest expenses. Although gearing is still manageable, its net cash position is fast eroding (RM111m vs RM270m at end-2018).

Maintain SELL and TP of RM1.77

Maintain Sell rating with an unchanged target price of RM1.77 (based on an unchanged 5-year mean PE of 15x on the 2020E EPS). Valuations remain expensive while earnings risk remains on the downside as the global economic growth engine falters. Key upside risks: a sharp depreciation of the RM, which will positively impact earnings, increased outsourcing opportunities, and shareholder Huatian Technology increasing business flows to Unisem.

Source: Affin Hwang Research - 29 Oct 2019