We came away from a recent plant visit feeling more POSITIVE on SKPRES’ medium-term prospect. Several strategic measures have been initiated to strengthen the group’s manufacturing capabilities which could drive revenue growth momentum further with enhanced profitability. Although we have yet to account for the positives, the riskreward ratio is appealing at this level, even with our conservative forecasts. Upgrade to OUTPERFORM with a higher roll-over TP of RM1.60.

Staging for a stronger come back. Recall that SKPRES has been struck by a series of unfortunate events in FY17, i.e. short-term cost pressures resulting from the hiring of higher-cost contract workers as a result of policy changes as well teething issue of new products ramp-up. While all these unforeseen events have reset the group’s profitability to a new low in 9M17 (at c.5%), the group managed to strike back with a swift improvement with the last quarterly results coming in well within our, and the consensus, forecasts, alongside margin improvement (at 5.6%). With the labour issues being resolved coupled with better operational efficiency, we believe the group’s profitability could get back to the >6% mark.

Orders remain resilient; with potential margin enhancement coming from vertical integration. We gather that orders for its main revenue drivers- the box-built products which will contribute at least RM1.7bRM2.0b in FY18-FY19, are still intact. While top-line growth remains decent with a 2-year revenue CAGR of 16% (mainly from the base case assumption of the total announced RM1.1b contracts), we believe the key potential catalyst in the medium term is potentially better profitability (beyond the current level) which could be reaped from its new PCBA services. Note that currently, the group is sourcing the PCB parts from the other suppliers. To further improve its profitability as well as its capability as a complete integrated ‘one-stop’ EMS service provider, the group had on April 2017 announced its long-term strategic plans to expand into PCBA and other EMS related services. During our recent visit, we were delighted to gather that the PBCA set-up will be up and running in 4QCY17, which will utilise 25% space in its new plant. While we have yet to account the margins accretion from the PCBA services given the scarcity of details, we see potential margins improvement from our current conservative CNP margin assumption of 5.6%-5.7%, judging from the trend of other EMS players with in-house PCBA capability. On top of the margins accretion, it is also noteworthy that with more complete integrated one-stop EMS services, this will enhance the group’s possibility of winning more contracts from major customers.

Trading at laggard even with better manufacturing capability now. Among the major EMS players in Malaysia, SKPRES has been trading as a laggard with 2-year forward PER (consensus) of only 10.4x as opposed to other EMS players trading at 2-year forward PER (consensus) of 12-13x with PCBA capability. Even at our very conservative FY19E earnings which is 8% below the consensus (with only 2-year NP CAGR of 19% with CNP margin assumption of 5.7%), it is only trading at 11.1x which is still lagging compared to its peers. We reckon that the premium for its peers stems from the more complete manufacturing capabilities. Now, with the group’s in-house PCBA capability coming in place coupled with the resolution of previous problems, we see better risk-reward ratio from here.

Upgrade to OUTPERFORM with a higher TP of RM1.60. While we made no changes to our FY18E/FY19E earnings, we roll over our valuation base year to FY19E. All in, with an unchanged PER of 13.5x (which is the average 3-year forward PER) being ascribed to FY19E EPS, our TP is increased from RM1.40 to RM1.60. Upgrade to OUTPERFORM. Risks to our call include: (i) lower-than-expected orders from its customers, (ii) higher input costs, and (iii) single customer concentration risk.

Source: Kenanga Research - 20 Jul 2017