We came away from a meeting with its management feeling NEUTRAL as we reckon most of the near-term re-rating and de-rating catalysts have been priced in at this level. Albeit volume ramp-up from lower margins beauty products resetting the profitability to a lower level, the shortfall is being compensated by absolute volume, which should meet expectations barring unforeseen circumstances. Maintain MP with an unchanged TP of RM1.45.

Further details on its 3Q17 results. The group’s weaker-than- expected results were owing to the unfavourable product mixes; with lower margins beauty products dominating sales in 3Q17. To recap, beauty products contributed 29% vis-à-vis 15% in 2Q17 and nil in 3Q16; with higher components costs as well as greater complexity dragging down the profitability. Meanwhile, the labor issue has been resolved during the quarter.

Growth beyond current level. The group is seeing additional orders from its beauty product thanks to the overwhelming response from the foreign markets. To recap, the group is already running at few lines with full shifts as well as another new additional line (being setup recently) on one shift for the beauty products. With higher orders in sight, this required the group to run the second shift on the new additional line. Assuming all else being equal, our back-of-the- envelope calculations suggest that another RM6-7m could be added to the full-year bottom-line which we have already accounted in our FY18E earnings. Meanwhile, touching base on room of improvement for overall earnings, the group is looking at several alternatives; either by way of more contracts being secured from customers, better operational efficiency (with higher automation) or strengthening its position as a Vertical Integration EMS player for which we laud the strategy direction.

Striking a balance. While the group’s profitability continues to be suppressed by higher components costs as well as greater products complexity in the short-term, the shortfall is being compensated in terms of absolute volume, which should meet expectations barring unforeseen circumstances. Beyond that, we also do not discount the possibility of more contracts being awarded for revolutionary products in the long-term (which is 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 75%) to take in more contracts. All in, with sales contributions from existing and new products, potentially amounting up to RM1.4bn/year in FY18 from the UK customer alone), this should anchor the robust 2-year NP CAGR of 28%, even after registering 94% growth YoY in FY16.

Maintain MARKET PERFORM. Our FY17-18E CNP remain intact for now. With an unchanged PER of 13.5x being ascribed (which is being the group’s 3-year average forward PER), our TP is maintained at RM1.45. Maintain MARKET PERFORM. Risks to our call; (i) higher- than-expected orders from its key customers; (ii) lower input costs, and (iii) new orders secured from new customers.

Source: Kenanga Research - 15 Mar 2017