• Burn in utilisation likely around the 30% level, broadly explaining the weak underlying earnings
• KESM posted its third consecutive quarter of growth, but profitable burn-in and test business is still 15% lower compared to a year ago
• We however remain optimistic on prospects, while near term supply chain tightness should work to its advantage. Maintain Buy and TP of RM20.60

Third Straight Quarter of Revenue Improvement

KESM reported a headline 2QFY21 net profit of RM6.3m. This however included a RM3.1m gain on disposal of PPE and a RM2.8m fair value gain on investment securities. Excluding these items, core profit for the quarter came in at RM0.4m, which was nearly similar to the RM0.7m recorded in 1QFY21. We believe that capacity is still operating at a sub optimal level of c.30%, largely explaining the meagre profitability, compared to a year ago. The weaker performance yoy is largely due to the cyclical slowdown the automotive sector faced, and likewise the company. While KESM has seen its third consecutive quarter of revenue improvement, the gains have also been underpinned by its EMS division, which accounted for 15-17% of revenue in 1H21, compared to 8-10% a year ago. As this division carries significantly lower margins, profitability has been impacted. 1HFY21 EBITDA margin was down 4.3ppts yoy to 23.1%.

..but Earnings Still Lagged

Due to the higher proportion of lower profit margin EMS works that KESM is engaged in, results continue to be weak compared to a year ago. 1HFY21 core net profit of RM1.1m was down 77% although we think that there is room for earnings to catch up in 2HFY21 given the current tightness in the supply chain. We thus deem the results to be inline with expectations.

Maintain BUY

We still believe that KESM is poised to benefit from increased semiconductor content in vehicles in the coming years and thus an excellent proxy to this long term secular trend. The continued sequential improvement in earnings suggests that KESM has already passed its worst and should see further recovery ahead. TP is unchanged at RM20.60 based on a target P/B multiple of 2.3x (+2SD its historical mean). Maintain our BUY rating as we like the company for its exposure to the electric and autonomous vehicle semiconductor market. Key downside risks include a loss of customers and a reduction in outsourcing opportunities

Source: Affin Hwang Research - 10 Mar 2021