We came away from a management meeting with our POSITIVE conviction reaffirmed, its prospect for FY18 which to be driven by the mass production of new engineered products as well as stack-up orders for Automotive EBS components. FY17 is the year of investment for the group with fruition expected from 1Q18 onwards. Post meeting, we made no changes to our FY17E/FY18E earnings. Maintain OP with an unchanged TP of RM1.55.

More details on the 3Q17 results. The weaker 3Q17 results were mainly dragged down by setting up costs (relocation, upgrading and maintenance of CNC machines coupled with the new plant refurbishment totaling c.RM2m) for the new Engineered products as well as the seasonally slower HDD business from Thailand. Coupled with the high overhead costs, operational deleveraging was particularly apparent with core NP down by -37% QoQ. However, we believe 4Q17 earnings should see a normalisation with the absence of high settingup costs alongside improving sales volume from HDD business, which should replicate the sales momentum seen in 1Q17 and 2Q17.

Hold on tight for the blossoming of earnings in FY18. We understand that the stack-up orders of Automotive EBS components from a new customer- being the key driver for the Automotive segment, is still intact. All in for Automotive segment, the total volume growth for this component could at least see a 2-year CAGR of 30% with at least another 20 CNC machines to be invested next year. For the HDD segment, management is expecting orders from third party machining as well as adoption of helium drive (for nearline enterprise) to supersede the slow industry growth. On the new segment - Engineered products - the low-margin portfolio, which is dominated by Camera segment, will be rejigged towards the new fatter margins products with mass production from 1Q18 (3QCY17) on a gradual basis. For one of the new Consumer Electronics products, although there are delays for the mass production; which we have already accounted into our FY18E earnings, we see the stringent qualification as a must for orders stickiness going forward.

Sturdy balance sheet with healthy free cash flow to pave way for better dividends. On the cash flow side which is more reflective of the merits of this asset-heavy company, operating cash flow was much stronger than a year ago, at RM40.9m in 9M17 vs RM16.5m in 9M16 with the absence of adverse currency hedging, resulting in a net cash position of RM85.1m or 26.0 sen per share. Going forward, assuming capex of RM30m in FY18 mainly for the PPE investment, we are projecting FCF of RM28.7m which is more than sufficient for the dividends payment of RM13.2m or 4.0 sen FY18E DPS which implies a pay-out ratio of 39%.

Maintain OUTPERFORM with an unchanged TP of RM1.55. Post meeting, we made no changes to our FY17E/FY18E earnings. FY17 is the year of investment for the group with fruition to be reaped from 1Q18 onwards. Hence, with an unchanged forward PER of 15.5x being ascribed (representing the group’s up-cycle valuation of +1SD), our new TP is maintained at RM1.55. Maintain OUTPERFORM.

Risks to our call include: (i) slower-than-expected sales thus lower operational efficiency, (ii) losses from the new settlement of hedging contracts, if any, (iii) implications of trade wars arising from Trump’s policy, and (iv) adverse currency fluctuations.

Source: Kenanga Research - 22 Aug 2017