We revise our call on Prolexus Bhd (PRLEXUS) to NOT RATED (from Trading Buy) with lower FD Fair Value (FV) of RM1.68 (from ex-rights FV of RM2.10). We are positive on its expansion plans in Malaysia and China coupled with the foray into Vietnam. However, fading odds of TPPA materialising could weaken the case for its Vietnam expansion and potentially hurt long-term US demand growth. Nevertheless, we expect an FY19 earnings jump if the expansion plans play out well.

Expansions across the board. With the completion of its 1-for-2 rights issue in June 2016, PRLEXUS has embarked on the construction of a new garment factory in Vietnam as well as a fabric mill at its Kluang facilities. We estimate the rights issue to fund c.70% of the expansion capex, with the balance funded via cash and borrowings. We expect Phase 1 of the new Vietnam plant to be completed in FY18, with an expected production capacity of 4.5m pieces of garments/year. Meanwhile the fabric mill, slated to begin operations in mid-FY18, has a Phase 1 capacity of c.40m pieces/year; sufficient for the company’s local usage. Furthermore, the completion of a new block in its China facility in recent months is expected to double worker capacity by c.600 workers. We are positive on the series of expansions in all its production sites which should lead to solid FY17-18E revenue growth of 9-22% to RM438- 537m. The upcoming garment factory is also expected to improve margins over the long run; we expect to see 1-2% net margin improvement in FY19E as the fabric mill streamlines cost structure.

Modest advertising prospects. PRLEXUS operates 14 outdoor advertising screens across Malaysia under the PowerScreen brand. Its latest screens will target locations outside of Klang Valley, such as Kota Kinabalu and Kuching. Sales on the advertising businesses should remain stable, with consistent margins of c.35%, as seen in the last two years.

However, fading hope on TPPA. Among the reasons for PRLEXUS’ new Vietnam expansion is to capitalize on the potential benefits of the TPPA, particularly in the elimination of tariffs and duties on textiles-related products. However, we believe the likelihood of TPPA materializing has faded significantly after the election in the United States. We understand that c.90% of its sales are to major customers such as Nike and Under Armour. Although we expect sales volumes to remain stable, we think a failure of the TPPA could lead to slower demand growth over the long run, especially by US-based companies that may be pressured to increase their portion of goods manufactured in the US.

Fairly valued, for now. We revise our call on PRLEXUS to NOT RATED (from Trading Buy) with a lower Fully Diluted FV of RM1.68 (previously was RM3.15 or post-rights RM2.10). Our Fair Value of RM1.68 is based on a Fwd. PER of 9.0x applied to CY17E FD EPS of 18.7 sen. Our Fwd. PER of 9.0x implies a 10% discount to PRLEXUS’ average peers’ Fwd. PER of 10.0x. We think the discount is fair – despite PRLEXUS’ solid FY17-18E revenue growth of 9-24% (against peers’ average 9-13% and net cash position; we observe that PRLEXUS generated below-average net margins (7-6%, against peers’ average 9%), dividend yield (2%, against peers’ 4%) and market cap (RM275m, against peers’ RM932m). However, if the current expansions are carried out successfully, we believe PRLEXUS should see double-digit bottom line growth in FY19, arising from both top line growth and margin expansion. Hence, we recommend investors to put the stock on the backburner for now, but revisit towards mid-2017 as the fabric mill and Vietnam plant approaches completion.

Source: Kenanga Research - 22 Nov 2016