KESM Industries’ 1QFY20 headline profit jumped 98% qoq and 72% yoy, but only due to one off-gains. Excluding this, core earnings were still weaker both qoq and yoy, a sign that the tough operating environment has yet to improve. We are nevertheless comforted that costs are being well contained and that management has continued to sustain profitability despite these conditions. We maintain our HOLD rating but with a higher TP of RM8.21 after raising our CY20E target PE multiple to 14x.

Headline Profit Masked by One-off Gains

KESM’s headline 1QFY20 net profit of RM4.5m showed a 98% qoq and 72% yoy improvement, which looks rather impressive. Nevertheless, there was a significant gain on disposal of PPE amounting to RM1.6m. After excluding this and other one-off gains, core profit of RM2.7m was down 37% qoq and 10% yoy, which is reflective of the still-weak environment that KESM is operating in. With slowing global growth and especially the sharp deceleration in China’s economy, demand for automobiles has taken a hit and consequently impacted KESM.

Costs Being Contained, Margins Stable

On a more positive note, we are comforted that revenue and margins have held up steadily despite the weak environment. The 1QFY20 EBITDA margin was lower by 1.1ppts qoq likely due to unfavourable product mix but has held up relatively well at the 27-29% level, as management contains operating costs. 1QFY20 depreciation for the quarter also declined by 15% yoy, and hence puts KESM in a better position once demand picks up.

Maintain HOLD With a Higher Target Price of RM8.21

We raise our CY20E target PE multiple by 2 points to 14x, which is above its long-term mean PE of 12x as risk appetite for the sector improves. Our TP is raised to RM8.21 but we maintain our Hold rating as results do not give any sense of a sustainable recovery. However, we still like KESM as a proxy to the semiconductor automotive space, which we believe should provide better growth prospects once global growth improves. Key downside/upside risks include a loss/gain of customers and a reduction/gain in outsourcing opportunities.

Source: Affin Hwang Research - 21 Nov 2019