• Healthy order flows from common key customer to underpin future growth.
• Prospects also backed by encouraging orders from other multinational customers. Any potential contract wins as a result of the trade tensions and lockdown could provide upside to our earnings forecasts.
• We maintain our HOLD ratings for the EMS companies under coverage, and reaffirm Neutral on the sector.

2Q20 Review: Weaker Overall Due to MCO

The EMS sector’s aggregate core earnings plunged by 93% yoy in 2QCY20, largely due to the temporary production halt following the unprecedented Covid-19 Movement Control Order (MCO). VSI and AIB posted results that were in line with expectations, whereas MTAG’s exceeded our expectations on better-than-expected margins. Nonetheless, moving ahead we believe prospects for the EMS are bright.

The Force Is Strong With the Common Key Customer X

In spite of the rising Covid-19 cases in key markets, the order flows from common key customer X have remained strong, underpinned by the introduction of new/ upgraded models of products as well as organic growth of existing products. AIB and SKP have gradually ramped up production for the new projects awarded, and VSI has also not missed out this time with additional contracts. We gather that consumers in lockdowns are increasingly demanding a better quality of life at home, and in turn have greater regard for premium electronic appliances. Although the Philippines has eased its lockdown measures, we think key customer X will take precautionary measures by re-routing orders to its other Malaysian EMS contractors, to mitigate supply chain risk.

Encouraging Order Momentum From Other Multinational Customers

Besides the common key customer X, orders from other multinational customers are also growing, thanks to the rerouting of supply chain opportunities presented by the escalating trade tensions and Covid-19 pandemic. We learnt from VSI’s recent briefing that it had secured a new US-based customer, Victory, and orders from other non-key customer X have improved. AIB also had its fair share of success with new customer Y, a US-based crafting machine specialist. We gather that EMS companies under coverage are in expansionary mode, and gradually hiring local workers to reduce the dependency of foreign labour. Besides eyeing a piece of the pie from the potential MNCs’ supply-chain shift, the EMS companies are currently in discussions with a number of other prospective customers despite the difficulties with the travel restrictions. Any potential contract wins from new customers as a result of trade diversions and lockdowns could provide upside to our earnings forecasts.

Better efficiencies and vertical integration to enhance long-term margins

Over the long haul, we continue to expect gradual margin improvement on: 1) improving economies of scale and better operating efficiencies post the learning curve as the new assembly lines go into full swing, and 2) vertical integration.

Maintain Neutral

We maintain HOLD ratings on the EMS companies under coverage – while we are positive on their earnings outlooks, the current valuations have largely priced-in the positives, we believe. Maintain Neutral rating on the sector.

Source: Affin Hwang Research - 3 Sept 2020