1H16 CNP of RM72.3m came in within expectations. A first interim net DPS of 3.5 sen was also declared as expected. While we believe its USD sales will improve sequentially on the back of several flagship smartphones launching, we expect 2H16 MYR sales to come in flat YoY given the high earnings base in 2H15. While we raise our TP to RM2.41 (from RM2.10) with a higher targeted PER being ascribed (in line with current industry’s average valuation), we downgrade our rating to UNDERPERFORM in view of the group’s less favourable riskreward ratio following its rich valuation.

Within expectations. The group recorded 2Q16 core net profit (NP) of RM37.6m (+8.4% QoQ, +32% YoY), bringing 1H16 CNP to RM72.3m (+32%) which made up 48%/47% of our/consensus’ full-year estimates. As expected, a first interim net DPS of 3.5 sen (representing 34% pay-out) was declared under the quarter reviewed. We are expecting the group to declare a total DPS of 11.0 sen for FY16.

YoY 1H16 revenue increased by 10% with stellar sales recorded in all segments. In particular, PC and Automotive rebounded from low base with both registering the steepest growth of 18% and 17%, respectively. Meanwhile, adjusted EBIT improved by a higher quantum of 25% on higher margin (+1.5ppts to 12.9%), driven by: (i) better product mixes with high utilisation rates in fat margin product such as Advanced packaging- wlCSP and testing as well as (ii) favourable currency translation (USD/MYR exchange rate improved by 13% from average RM3.64/USD in 1HCY15 to average RM4.10/USD in 1HCY16).

Meanwhile on QoQ basis, despite stronger seasonality, 2Q16 revenue inched up by only 1%, dragged by weaker USD vs. MYR (USD depreciated by 4% from average RM4.19/USD in 1QCY16 to average RM4.01/USD in 2QCY16). Note that 2Q16 sales in USD terms, in fact, improved by 5% to USD80.0m driven by Industrial segment. Despite the flat top line performance, the group adjusted EBIT grew by 8% helped by better product mixes as well as higher forex gains of RM3.6m (vs. forex gains of RM0.7m in 1Q16).

Outlook for 2H16. Management is guiding for a sequential improvement at its top line (of 0-5% in USD terms) on the back of higher demand for its advanced packaging (wlCSP and MIS packages) on Tier-2 Smartphone application which we think is achievable (vs. our assumption of +4.1%) amid the major launches of several flagship smartphone models. However, on a YoY basis, we are expecting 2H16 sales in MYR terms to be flat given the higher earnings base achieved in 2H15 as well as the lack of strong re-rating catalyst for the whole industry. Recall that the group’s robust earnings in 2H15 were predominantly driven by favourable forex translations (USD/MYR exchange rate was averaging at RM4.17/USD during 2H15) as well as the rising demand of Chinese smartphones. Coupled with the limited earnings visibility, we are maintaining our CONSERVATIVE stance on the OSAT players given their position as sub-con manufacturers in the back-end manufacturing process which are more vulnerable to sales weakness (high overhead costs with thin margins, thus with less tolerance for margin of errors). Note that we have already imputed conservative forecasts for FY16E and FY17E NPs with growth of -4% and -2%, respectively.

Downgrade to UNDERPERFORM following the recent strong share price run-up. Post-model updates (with no changes in our earnings drivers), our FY16E/FY17E CNPs were tweaked by -0.5%/+2.0%. While our TP is raised to RM2.42 (from RM2.10) with a higher targeted PER of 12.0x being ascribed (a valuation which is broadly in line with Malaysian OSAT players), we downgrade the rating to UNDERPERFORM in view of the less favourable risk-reward ratio following its rich valuation. Risks to our call include: (i) Higher-than-expected sales and margins. (ii) Favourable currency exchange to the group.

Source: Kenanga Research - 8 Aug 2016