· A roller coaster ride. Recall that K1’s share price once hit our previous TP of RM0.63 and recorded an all time high of RM0.67 then, before it dived to hover at the range of between the YTD low of RM0.19 to RM0.345, three months ago. We reckon that the weaker sentiment, particularly in the small cap stocks and the disappointing 1Q15 results were the culprits sending the share price sinking. Taking a glance back on its 1Q15 results (which was published back then on May 2015), the group reported a breakeven NP of RM0.520m (-84% QoQ and YoY). This only made up a mere 2.4% of management’s previously guided and our FY15E earnings projection. The negative deviations were: (i) lower-than-expected revenue dragged by weak demand from network cameras, (ii) margins compression arising from the lower sales prices for various product lines approaching end-of-life stage, and (iii) higher R&D costs for numerous prototypes and samples to pitch for new businesses.

· Still weak 1H15 results despite the 2Q15 earnings improvement. The group has recently announced its 2Q15 NP of RM2.5m (>100% QoQ; 14% YoY), bringing 1H15 NP to RM3.0m (-44% YoY). YoY, 2Q15 revenue came in flat with a marginal growth of 2% as the better sales from consumer electronics segment was negated by loss of network camera business in which its customer switched their production base away from Malaysia for corporate reasons. Despite the flat top-line growth, EBIT climbed by 5% with margins mainly gaining traction from the prudent costs management. Meanwhile QoQ, the group’s revenue increased by 16% from low base mainly driven by surging demand from the new electronic headlamps. Positively, EBIT tripled to RM2.5m from low base helped by better product mix as well as a reduction in prototype/sample development costs. Despite earnings improvement seen in the 2Q15 results, 1H revenue and PATAMI still decreased by 15% and 44%, respectively, as growth in other segments (Consumer Technology, Automotive and Industrial) during 2Q15 were not sufficient to offset the weakness in 1Q15 results.

· Outlook for 2H2015. While the shrinking network camera business is a concern, we are also cognisant of the dwindling sales and profitability in the Mobile Phone accessories segment (used to contribute 30% to the revenue) which is seeing its Japanese customer stepping up in the pricing war to defend its turf against the rising mobile phone OEMs from China. We understand that the relatively high single-digit NP margins that the group used to enjoy could be hard to maintain in view of the stiff competition. While the two major segments mentioned are currently seeing headwinds, we gather that the group is pursuing more business opportunities particularly in the healthcare segment with an US customer. We understand that the group is currently applying for an ISO certification to pitch for new businesses. No numbers were guided from the management yet.

· Fairly valued. Post-results, we have reduced our bullish FY15E earnings projection of RM21.6m to RM7.8m to account mainly for: (i) lower sales from the Mobile Phone and Computer Peripherals segments, (ii) lower GP margin assumptions of 11.5% (-3.0ppts), and (iii) corporate tax rate of 9% as its pioneer status has expired. We have also introduced our FY16E earnings with key assumption being: (i) 5% organic growth across all segments, (ii) additional sales contribution from the Healthcare segment, and (iii) GP margin assumptions of 12.0%. To align with the overall broad market derating, we have also ascribed a lower targeted PER of 8.5x (from 10.0x previously), a valuation which is broadly in line with FBMSC’s forward PER. As a result, our new TP is RM0.19 (from RM0.63). We may revisit the stock again should the group secured new orders with lucrative earnings.

Source: Kenanga Research - 1 Sep 2015