Investment Highlights

• We initiate coverage on Frontken Corporation Bhd (Frontken) with a BUY call and target price of RM4.33. We opine that this under-researched company deserves to be re-rated in view of its: 1) Bright outlook to benefit from Fifth Generation (5G) technology investment ; 2) Serving the niche market with low competition and high entry barrier; 3) Nimble business model; 4) Diversified business; and 5) Well-managed balance sheet.
• A leader of providing precision cleaning services in the region. Frontken is the leading precision cleaning service provider origins from Malaysia and now has strong footprints in Malaysia, Singapore, Taiwan, Philippines, and Indonesia.
• Indirect beneficiary of huge 5G investments – Frontken mainly provides precision cleaning, specialty coating, surface treatment, parts supply et cetera to improve machinery lifetimes and yielding for semiconductor/chip foundries. Seeing huge investments taken place by 5G developers such as Huawei, Nokia, Ericsson, Samsung, and others as well as launching of corresponding end-user applications (ex. Virtual Reality, A.I, Cloud Computing), 5G infrastructure market is expected to grow at 53.01% CAGR from 2020 to 2025. We believe a massive amount of semiconductors and chips are needed in the next 5 years in order to cater to the demand of 5G smart devices including smartphones, laptops, wearable devices and tablets. As a result, foundries will need more maintenance services for machinery to fulfil substantial chip orders from global smart device developers.
• Commendable earnings growth. We are projecting a CAGR growth of 16.6% for Frontken’s bottom line from FY2019 to FY2021. The growth is underpinned by its semiconductor division while the O&G engineering division is expected to grow moderately due to the persistent low crude oil prices. We expect the growth engine driven by margin expansion instead of magnificent top line growth due to its business nature. Frontken will be providing more value-added services (higher margin) for the latest commercial viable 5nm nodes chips to one of the largest foundries in the world. In addition, Frontken has already been involved in the advanced precision cleaning for the 3nm R&D line which 3nm chip will go into commercial production sometime in 2021/2022. Meanwhile, new lines have been added in Taiwan plant recently with low cost incurred due to building upon existing facilities, hence further propel the Group’s capacity to take up more works n the future. Besides that, IoT, automotive semiconductors, and consumer electronic would need more chips in order to materialize seamless interaction between humans and machines. 
• Less competition in the niche market with high entry barrier – Frontken has been the top-notch in the segment for almost a decade globally. The segment has not seen any new player for 5 to 8 years due to its huge initial investment and fast-changing technology development. We understand that there is no direct competitor in Malaysia but the closest one is in Taiwan which is Shih Her Technologies Inc. (3551 TT MK) while others are non-listed companies. Shih Her Technologies’ performance has been lagging behind Frontken as it recorded lower operating efficiency for the past 5 years. Closer to home, local technology players such as ATE manufacturers and OSAT companies are facing fierce challenges globally in the likes of competitions from world leading players of ATE manufacturers such as Teradyne Inc. (U.S.), Advantest Corporation (Japan), and LTXCredence (U.S.); and OSAT players who dominate in Taiwan and China namely ASE Technology, JCET Group, and Universal Scientific Industrial. Regional players located in the U.S, Taiwan, China, and Japan have advantages over Malaysian players due to its comprehensive value chain and strategic locations.
• Nimble business model - The Group’s strategy to emphasize R&D in order to enjoy higher margin has successfully transformed itself in 2017. Frontken started to invest heavily in FY16 and FY17 in right timings to cater the demand of 10nm & 7nm nodes technology which would be commercialized in 2018 and 2020 respectively. The Group has been enjoying impressive profit growth in which EBITDA margin lifted to 34% in 2019 from 22% in 2017 amid restrained revenue growth of CAGR 4.63% from 2017 to 2019.
• Diversified business – Even though it is unlikely for semiconductor sector to experience immediate downturn in the near future, Frontken has expertise in serving other fields such as TFT/LCD which command lower margins as compared to semiconductor segment. Frontken has been switching from low margin business to high value added semiconductor along the years and benefit substantially from that with its significant capex and opex investments.
• Expansion backed by sturdy balance sheet – Frontken registered RM246.6m cash pile (44% of total assets) as of 2QFY2020. The Group’s net cash position forms a good platform to increase investment and capitalise any opportunity during turbulence time which results in a bigger scale of the leading position in its business segment post-pandemic. We estimate the Group will continue to remain in net cash position for the next 2 years on the back of disciplined balance sheet management. Meanwhile, Frontken has not fixed any dividend policy but dividends delivered to shareholders are traditionally increased in tandem with earnings growth. Hence, higher dividends shall be rewarded to investors for FY20-21F, estimated at 0.83-1.07% yield as the Group achieving higher profit in the near term.

Valuation/Recommendation

• BUY with a target price of RM4.33 - The TP was derived by ascribing a 41x PER to the Group’s FY2021F EPS, which is slightly below +1 SD of 5-year mean PER on the back of accelerating of 5G development post COVID19. Our TP renders an upside of 25% from its closing price of RM3.47

Risks

• Lower-than-expected demand for smart devices.
• Slowdown in 5G roll out as the Sino-US technology war intensifies.
• Potential natural disaster in Taiwan such as earthquake which would disrupt plant’s operation.
• Stringent Standard Operating Procedure (SOP) for business reopening in relation to the pandemic.
• Business shutdown due to the second wave of the pandemic