INVESTMENT MERIT

Following its share price weakness which we believed is attributed to the weaker earnings in 4Q17, we see better opportunity to accumulate for earnings recovery in FY18, which will be anchored by new Bluetooth devices models. Meanwhile, FY19 could also see meaningful earnings stream from Neonode’s new touch technology, which could propel its earnings base to new high level. With the better riskreward ratio coupled with better earnings prospect, we advocate a Trading Buy recommendation with a TP of RM1.63.

Worst is over with recovery in sight in FY18. The group recently announced a FY17 NP of RM19.4m (-20% YoY) which only made up 88% of consensus’s forecast. Note that the weaker results were mainly due to the operational deleveraging whereby its flat top-line growth of +2% YoY (dragged by the delayed launching of new Bluetooth devices) was insufficient to offset the high overhead costs as well as the additional development costs for the new products. That said, we believe that the worst is over with recovery to be seen as soon as 1QFY18.

New models of Bluetooth devices to anchor growth in FY18. We understand that post the acquisition exercise of one of SALUTE’s major customers (with synergy centred largely around the growth of audio and music-listening products), the group is getting more models variations from this customer; with new ramp-up expected from 1Q18 on model A (introduced in 4Q17), as well as new model B which is a new wireless headset that will be competing in the premium segment. NP margins are expected to be decent, hovering at high single digits to low teens. In total, five models will be produced by SALUTE in FY18 and we expect group’s utilisation rate (UR) to be at c.75% for its four SMT lines with an expected maximum capacity of c.18m, vis-à-vis three models in 1HFY17 and four models in 2HFY17. Meanwhile for a model which is nearing its end of life cycle, we expect a refreshed model to be launched as soon as 1H18 which we believe will sustain demand.

New earnings stream from Neonode's new optical interactive sensing technology. Recall that in Oct 2016, Neonode- the Optical Interactive Sensing Technology company, noted that it has completed the relocation of its AirBar end-assembly process to its assembly partner- SALUTE in anticipation of high demand for AirBar- a gadget which brings displays to life by adding touch and gesture sensing to both new and existing PCs. At Salutica, each zForce AIR sensor module is assembled together with cosmetic parts into a final AirBar product, then packaged and shipped to Neonode’s global distribution partners. While the current airbar capacity is only limited to 30k-50k/month, we expect higher investment to expand its capacity, which will require more advanced SMT in FY19; on the assumption that the application will extend beyond PCs considering its cheaper alternative to the current touch screen technology as well as the wider adoption in other sectors such as Automobile and electronic gadgets.

Trading Buy with a new TP of RM1.63. We project the group to record a 2-year NP CAGR of 48%; with FY18E/FY19E NPs of RM31.6m/RM42.5m to be driven by an average 75% UR with four/five SMT lines (capacity: 19m/23m pieces of PCBs in FY18E/FY19E) on the back of the assumption of five/six Bluetooth models in FY18E/FY19E, new Neonode’s Airbar and USD assumption of RM4.30/USD. By ascribing a 15.0x FY19E PER which is at industry’s average forward PER, we derive our TP of RM1.63. Note that in terms of PEG, our ascribed PER of 15.0x implies a 0.3x FY18E PEG (on 48% 2-year NP CAGR in FY19E) which is at the low range of EMS players’ PEG which is ranging from 0.3x-0.5x. Coupled with our forecast net DPS of 5.3 sen in FY19 (implying a yield of 4.0%), our TP of RM1.63 suggests a total upside of 27% from here.

Source: Kenanga Research - 14 Sept 2017