9M17 NP came in below expectations due to weaker-than- expected margins from new revolutionary products. Absence of dividend was expected. That said, it is not all gloom and doom as the group is seeing additional orders on new revolutionary products, though the net positive impact is still insufficient to supersede the shortfall at this juncture. All in, our FY17E/FY18E NPs have been reduced by 7%/2%. Downgrade to MARKET PERFORM with a lower TP of RM1.45 (from RM1.48).

Missed expectations. The group reported 3Q17 net profit (NP) of RM30.4m (+34% QoQ; +26% YoY), bringing 9M17 NP to RM71.4m (18% YoY) which made up 63%/62% of both our and the consensus? full-year estimates. Negative deviation was due to the lower-than- expected EBIT margins owing to higher components costs as well as greater products complexity from new revolutionary products. As expected, no dividend was declared for the quarter under review.

YoY, 9M17 revenue recorded an impressive growth of 66% mainly driven by the contribution from second tranche of household electrical appliances (floor cleaning) contracts and the new revolutionary products (beauty tools). However, EBIT recorded a smaller growth quantum of 17% as margin (-2.9ppts to 7.0%) 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) in 6M17 coupled with lower profitability from the new revolutionary products. Note that the foreign labour issues have now been resolved.

QoQ, 2Q17 revenue jumped by 27% mainly on the back of higher ramp-up of the new revolutionary products accompanied by the second tranche of household electrical appliances. While revenue shown a stellar growth, EBIT improved by a higher magnitude of 33.5% with margin improved marginally by 0.3ppts alongside the foreign labour issues being resolved. However, note that the group?s NP margin is still hovering at the 5% mark instead of the previous 7% mark due to the unfavourable product mixes as well as higher component costs.

Not all gloom and doom. While the group?s profitability continues to be suppressed by higher components costs as well as greater products complexity, it is not all gloom and doom as the group is seeing additional orders on new revolutionary products from its main customer to cushion for the shortfall. Note that one additional line has been set up (on top of the existing two lines) which is running one shift currently. Assuming all else being equal, our back-of-the-envelope calculation suggests that at least RM7m will be added to the bottom- line on full-year basis. Meanwhile, its mid-term earnings prospect will continue to be driven by the two existing long-term contracts awarded by its UK customer (sales contributions from existing and new products, amounting to RM1.1bn/year). All in, this should anchor the robust 2-year NP CAGR of 28%, even after registering 94% growth YoY in FY16. Beyond that, positive catalysts could be coming from more contracts being awarded for revolutionary products in the long- term (which are in line with its UK customer?s vision).

Downgrade to MARKET PERFORM. With lower margins being imputed for higher component costs from the new revolutionary products as well as additional sales assumption from new line (on one shift), the net impacts to our FY17E/FY18E earnings are -7%/-2%. All in, with an unchanged PER of 13.5x being ascribed, our TP is reduced from RM1.48 to RM1.45. Downgrade to MARKET PERFORM as we view that the positives have already been priced in. Risks to our call include: (i) higher-than-expected orders from its customers, (ii) lower input costs, and (iii) new orders from new customers.

Source: Kenanga Research - 01 Mar 2017