Looming Uncertainty Over SMIC

• Malaysian operations back to full swing, Singapore labour efficiency has improved from 30% to 70-75% since mid-August, while China activities are stronger on higher SMIC job execution
• The liquid carbon dioxide (LCO2) plant is now operating at 40%, a vast improvement from the 14% level seen in 2Q20, due to the MCO
• While we still opine that the China structural growth story will well support KGB’s long-term prospects, we downgrade our rating to HOLD on the looming uncertainty over near-term outlook with 35% of its order book derived from SMIC (inclusive of the recent RM61.8m job) possibly at risk

3Q20 Activities Likely to Improve

KGB’s labour efficiency in Singapore has resumed to 70-75% (from 30% seen in July) after the government completed the testing of all its foreign labourers in midAugust. This would suggest a sequential gradual recovery from its Singapore operations. China activities are also expected to gradually ramp up with the second batch of SMIC contracts secured in August.

Ongoing Contracts Seen No Impact From Monday US Threat So Far

On Monday, it was reported that the US government was considering imposing export restrictions on SMIC over accusations of aiding China’s military and defence apparatus. SMIC has since rebutted this with a statement citing false accusation. Amid this negative development, we understand that KGB’s current contracts with SMIC are still ongoing (35% of its current order book). If the US ban does take effect, we gather that SMIC may source the tools and equipment from Japan and Korea as an alternative for its 14nm and 28nm chips. SMIC’s expansion timeline for the 7nm chips may, however, be delayed as such tools are still largely sourced from the US. But fortunately, its existing contracts are not affected by the 7nm, though the company may face long-term order book replenishment risks due to the potential expansion timeline delay.

Downgrade to HOLD

With more than one-third of KGB’s order book exposed to a single customer (SMIC) currently under scrutiny, this may put KGB’s near-term earnings at risk. We make no changes to our RM1.22 target price, based on unchanged 21x CY21E EPS, but downgrade to Hold (from Buy) following the recent share-price appreciation, which leaves only 8% upside to our target price.

Source: Affin Hwang Research - 9 Sept 2020