We came away from a management meeting with our POSITIVE conviction reaffirmed stemming from the group’s brighter prospect in FY17. FY16 was a transition year for the group with light finally emerging at the end of the tunnel as reflected in its latest 4Q16 results. Currently, orders are ramping up from all customers alongside improving operational efficiency as well as subsiding labour issues. Meanwhile, its mid-term prospect will be anchored by new pipeline of projects that will be sufficient to offset the STB sales shortfall, even at very conservative assumptions. Maintain OUTPERFORM with an unchanged TP of RM2.60.

Staging for a stronger FY2017. At a glance back on its FY16 results; while the group has been struck by a series of unfortunate events in 9M16 (with 1Q being hit badly by the adverse currency translation, followed by labour issues as well as orders volatility- absence of STB contracts in the 2Q and 3Q), the group had once again showcased its strength as an EMS provider that is always upping the ante, with a successful turnaround seen in 4Q16. Note that a strong 4Q16 CNP of RM24.9m was reported (+414% QoQ; -12% YoY), sending FY16 CNP to RM38.9m (-37%) which spearheaded our full-year estimate by 43%. These were all on the back of lower wastage and shorter- than-expected gestation period from new product ramping, as well as higher- than-expected operational efficiency (alongside more products output to counter fixed overhead costs). Besides, favourable forex translation also augmented the operationally strong numbers.

A better year ahead. Looking beyond FY16, we see more positive catalysts brewing that could drive the group way beyond the current level. From the latest meeting, we see lesser systematic risk to the group now as the labour issues have largely been resolved. Beside the newly allocated headcounts quota obtained by the group (with recruitment to start from 1Q17), the group is also playing it safe by relocating part of its orders to its Thailand plant, which comforted us further. Meanwhile at the top line, despite the murky economic outlook, we were POSITIVELY SURPRISED to gather that more orders are flowing in from the existing customers due to the growing confidence in the group’s capability. To us, these signs could be taken as a recognition to the group which could warrant higher chances of securing more contracts or new customers orders in the near to medium-term for other products, hence reaffirming our optimism on its short to medium-term prospect.

New project seeing lights. Beyond the organic growth mentioned above, we understand that four new projects are already on the negotiation stage with one close to be sealed. To recap, these projects are to be awarded by existing and new customers with one being an ODM project with a world- renowned MNC. Assuming that the ODM project goes well, this could be a door opening opportunity for the group to tap into voluminous orders going forward. We have conservatively assumed half of the value from the potential projects (that will commence in FY2017 on a gradual basis). Even so, this will be enough to offset the sales contribution from existing STB customers that was a main drag in FY16. We understand that no major capex will be incurred as the existing facilities are sufficient to take up the orders.

Maintain OUTPERFORM with an unchanged TP of RM2.60 (based on a targeted PER of 15.0x). While we made no changes to our FY17E NP for now as we had previously accounted for the abovementioned, we introduce our FY18E NP with a growth assumption of 11%; mainly stemming from the four new projects as well as organic growth assumption. The group’s superior margins, advanced manufacturing capabilities as well as strong parentage support from Foxconn Technology Group remains as key investment merits. Risk to our call; (i) slower-than-expected sales, (ii) loss of orders from its key customers, (iii) labour issues, and (iv) adverse currency translations.

Source: Kenanga Research - 06 Mar 2017