1Q17 Net Profit (NP) of RM18.2m (-16% QoQ; +2% YoY) is deemed to be within expectation as we have in our last report indicated weaker earnings in this quarter due to short-term labour cost pressures. 2H17 should see substantial earnings improvement to make up for the shortfall; to be driven by ramp-up production capacity for new and existing products, alongside easing labour costs. No dividend as expected. No changes to our earnings forecast. Maintain OUTPERFORM with an unchanged TP of RM1.48.

Within expectations. The group reported 1Q17 net profit (NP) of RM18.2m (-16% QoQ; +2% YoY) which made up 14% of both our and the consensus’ full-year estimates. As expected, no dividend was declared for the quarter under review.

YoY, 1Q17 revenue recorded an impressive growth of 32% mainly driven by the contribution from first tranche of household electrical appliances (floor cleaning) contracts secured in May 2015 and partial contribution from the new revolutionary product (started in April). However, EBIT only inched up by 1% as margin (-2.3ppts to 7.6%) was corroded by the short-term cost pressures resulting from the hiring of higher cost contract workers to meet high orders (due to policy changes of foreign workers hiring) coupled with some teething problems during the kick-starting of the new contract.

QoQ, 1Q17 revenue soared by 38% on stronger seasonality as well as partial contribution from the new revolutionary products. However, PATAMI dropped by 16% owing to higher labour costs as well as a normalised effective tax rate of 24%. Recall that 4Q15 saw a lower effective tax rate of 14%; with c.RM2m of special reinvestment allowances being utilised under that quarter.

Earnings prospects still resilient. Looking beyond the temporary hiccup (short-term cost pressures) that will still partly affect SKPRES’s 2Q17 earnings, the group’s mid-term earnings prospect is still resilient anchored by the two long-term contracts awarded by its UK customer (sales contributions from existing and new products, amounting to RM1.1bn/year) which will eventually support the robust 2-year NP CAGR of 43%, even after registering 94% growth YoY in FY16. Beyond that, we also do not discount the possibility of more contracts being awarded for revolutionary products in the long-term (which are in line with its UK customer’s vision), given its solid reputation in the industry with world-class manufacturing capability. Note that the group still has ample free capacity (of 70%) to take in more contracts.

Post-results, we make no changes to our earnings estimates as we expect 2H17 earnings to make up for the shortfall. This will be driven by the ramp-up production from its new and existing products, alongside easing labour costs.

Maintain OUTPERFORM with an unchanged TP of RM1.48. This is based on a targeted 14.0x FY17E PER, a valuation which is 20% higher from its EMS industry peers. The premium valuation is justified, backed by its robust 2-year NP CAGR of 43% as well as the higher-than-industry (yet sustainable) margins backed by its cost pass-through mechanism.

Risks to our call include: (i) loss of orders from its customers, (ii) higher input costs, and (iii) weaker-than-expected consumer sentiment

Source: Kenanga Research - 30 Aug 2016