INVESTMENT MERIT

SCICOM’s revenue streams are stable, riding on: (i) long-term contracts (avg. 2-3 years) for BPO, (ii) incremental growth from the EMGS segment, and (iii) minimal downside risk due to a welldiversified client base. As such, this cash-rich company’s dividend pay-outs are stable and on a quarterly basis while additional contract wins would serve as sweeteners. We are projecting RM46-54m earnings in FY17-18E. TRADING BUY with a TP of RM2.45 (18.6% total returns) on 16.2x FY18E PER, -0.5SD below 2-year forward PER.

Stable and scalable business model. Earnings are driven by the group’s outsourcing segment; (i) Business Process Outsourcing (BPO) c.67% of top line and, (ii) E-Government Service (EMGS) segment c.33% of top line, as both capture strong mid-teens to +20% net margins for FY13-15 and is expected to improve from the economies of scale on future projects. The BPO segment provides earnings stability due to the long-term nature of contracts (avg. 2-3 years). As for the EMGS segment, SCICOM is the only designated agency in Malaysia, appointed by the Ministry of Higher Education (MoHE) to process international student visa which will continue to grow as the government is committed to increase the number of international students in Malaysia as outlined in the Malaysian Education Blueprint, targeting 250k students by 2025 (from 135k in CY14, +16.5% YoY). For the BPO segment, there are no major client concentration risks as clients encompass a wide range of industries and geographies.

Additional contract flows to boost earnings. SCICOM has tendered for multiple international outsourcing contracts (i.e. for e-government services and BPO) which are expected to materialise by FY17-18E, and should provide an impetus for share price excitement, while the current weak Ringgit environment favours securing international contracts. We expect demand for SCICOM’s outsourcing business model to remain resilient as companies and government agencies globally constantly seek to minimise cost by outsourcing business processes to focus on improving efficiencies and earnings.

Renewed MSC tax status. Share price has weakened since Apr-16. The MSC tax incentive allowed the group tax incentives and thus, SCICOM has enjoyed 0% effective tax rate up to FY15. As the MSC status tax incentives ran out, effective tax rates rose in FY16 to 8% while we expect 8-18% in FY17-18E after taking into account higher taxable income going forward, while SCICOM’s wholly-owned subsidiary, Scicom E Solutions Sdn Bhd (SES), was recently granted a 10-year grant of MSC Status, which we believe could be the vehicle for new contract awards. We expect effective tax rates to down trend after FY18.

We are projecting RM45.9-53.7m in FY17-18E on the back of 14-13% top line growth, operating margin improvements from economies of scale and higher effective tax rates of 8-18% in FY17-18E which translates to 20-21% net margins in FY17-18E vs. 3-year historical average of 14-21% (refer overleaf).

Cash rich position allows for consistent dividend payments. SCICOM has maintained net cash position since FY06 due to low capital intensive outlay requirements and high margins, while dividend pay-outs are stable and on a quarterly basis since FY13. We project FY17-18E NDPS of 10.0-11.7 sen (75% pay-out ratio vs. 76-89% since FY14), translating to 4.6-5.4% net dividend yield.

TRADING BUY with a fair value of RM2.45 based on 16.2x FY18E PER, which is -0.5SD below the groups 2-yr average forward PER. Even so, we believe SCICOM is undervalued as earnings growth rate (12-17% in FY17- 18E) remains strong despite tax increments, commanding attractive 18.6% total returns. (refer overleaf)

Source: Kenanga Research - 1 Nov 2016