Investment Highlights

• We initiate coverage on Foundpac Group Berhad (Foundpac) with a BUY call and target price of RM1.30. We opine that this under-researched company deserves to be re-rated in view of its: 1) Bright outlook to benefit from chip R&D investment and mass productions; 2) Strong earnings growth; 3) Nimble business model; 4) Capacity expansion; and 5) Well-managed balance sheet.
• A leader of providing precision engineering parts. Foundpac is principally involved in the design, development, manufacture, marketing and sale of precision engineering parts namely stiffeners, test sockets, hand lids, laser stencils and related accessories. The Group supplies to world-renowned customers in the semiconductor industry and plays a critical role in the value chain of the sector.
• Direct beneficiary of huge IC chip R&D investment & mass productions. Foundpac mainly provides precision engineering parts (PCB stiffener, sockets, hand lids, and laser stencil) to fabless semiconductor player, chip foundries, Outsource Assembly and Testing (OSAT), R&D lab, and PCB design houses. Seeing huge investments in IC chips taken place by semiconductor players such as Qualcomm, Broadcom, Texas Instrument, TSMC, and others as well as launching Fifth Generation (5G) connection, the whole semiconductor market is expected to grow at 6.3% CAGR from 2020 to 2025. We believe a massive amount of semiconductors and chips are needed in the next 5 years to cater to the demand for 5G smart devices including smartphones, laptops, wearable devices, automotive, and tablets. As a result, the whole value chain of semiconductors would need a significant number of testing in both stages before launching out any products to fulfill substantial chip orders from global smart device players.
• Robust earnings growth. We are projecting a CAGR growth of 13.0% for Foundpac’s bottom line from FY2020 to FY2022F. The growth is underpinned by its stiffener and sockets division while the laser stencil division is expected to grow moderately due to capacity restriction. We expect the growth engine driven by volume in FY21F instead of hefty Average Selling Price (ASP) owing to the maturity of 5G chip R&D cycle. Meanwhile, we expect the R&D activity will be coming back in FY22F mainly because of huge capex investment in Internet of Things (IoT) after prevailing of 5G connectivity where people would demand more applications on the back of fast and low latency connections. We understand that Foundpac plays a critical role in supplying upstream and downstream players. Therefore, there will be a huge demand from mass productions of semiconductors and chips for testing purposes from downstream players such as ASE Technology, Amkor Technology, and JCET at the later stage amid slowing down in R&D activities. Besides, HighPerformance Computing (HPC), cloud server, automation manufacturing facilities, and data server would need more chips to materialize extraordinary computational power.
• Highly customised and less competition in the field. Foundpac is specialised in precision engineering, especially in customization. We understand that there is no direct competitor in the business circle mainly because buyers have been requesting for unique stiffeners and test sockets in most of the orders to conduct testing in R&D and mass production activities, whereby these products are selling at premium to ordinary products due to its exclusive usages. Hence, Foundpac is required to fulfill clients’ customize orders rather than standardize the product design. Moving forward, we believe the ASP of both products will be getting higher followed by smaller nodes (3nm & 5nm) as well as advance level of semiconductor chip packaging such as System in a package (SiP) & Antenna in package (AiP) in which more precise and complex engineering will be needed. Other than that, the Group has established a strong foothold in the developed market such as Europe and the US, stemming from lower lead time and advanced design capability. In short, the Group has advantage over regional players in the U.S, Germany, South Korea, and Japan amid their strategic locations.
• Venturing into automotive segment. Foundpac is ready to supply precision engineering parts to multiple business fields besides telecommunication which allows the Group to take advantage in any uptrend of the sector. In fact, the Group is penetrating into the automotive segment which is highly regulated by the developed country authority. Nevertheless, the Group is trying very hard to tap into the segment by complying with the international standard IATF 16949. We were told that the Group is approaching the end phase and started to fabricate the 1st sample order in May 2020, expecting to obtain the certification in mid-2021. The move is favourable as we believe autonomous car could be materialized in 2023 onwards which is backed by 5G seamless connections.
• Capacity expansion to ride the upcycle. The Group recently acquired a few CNC machines to expand the capacity (+15% est.) for stiffener and test sockets to cater to more demand from the technology boom cycle. These CNC machines are capable to execute more advanced and precise engineering tasks which is in line with the Group’s strategy to provide customised precise engineering parts to its clients. We believe these machines strengthen its foothold to penetrate into automotive field which is currently undergoing a stringent qualifying phase.
• Sturdy balance sheet. Foundpac registered RM51.1m cash pile (47.3% of total assets) as of June 2020. The Group’s net cash position serves as a good platform to capitalize on any form of business expansion opportunity during current turbulent time which enhances its leading position post-pandemic. We estimate the Group will continue to remain in a net cash position for the next 2 years on the back of disciplined balance sheet management. Meanwhile, Foundpac has a dividend policy of paying out at least 30% of net profit to reward its shareholders. We expect the Group to declare higher dividends for FY21-22F, estimated at 1.41-1.64% yield based on dividend payout of 40% as the Group used to declare 40-70% payout historically coupled with its anticipated stronger profits in coming years.
• Unlocking asset value. The Group plans to spin off its 75%-owned subsidiary Dynamic Stencil Sdn Bhd (DSSB). DSSB was acquired by Foundpac in 2017 mainly to manufacture and sales of laser stencils. We deem the listing could potentially raise fund for further expansion plan amid capacity restriction for laser stencils. In turn, Foundpac will be focusing on test sockets and stiffeners businesses as well as to target M&A opportunities to strengthen its exiting core business.

Valuation/Recommendation

• BUY with a target price (TP) of RM1.30 - Our TP is derived by ascribing a 35.4x PER to the Group’s FY2021F EPS, which is +1 SD of KL Technology Index’s 5-year mean PER on the back of accelerating 5G development post COVID-19. Our TP renders an upside of 25% from its closing price of RM1.04.

Source: JF Apex Securities Research - 5 Nov 2020