We are still feeling POSITIVE despite the prevailing component shortages and labour issues, which could cap its performance in 4Q17. Note that the group is already close to securing alternative sources in filling these gaps; which should see solutions as soon as early FY18. We cut our FY17E earnings by 12% to account for lower sales in 4Q17 as we have been overly bullish previously, while leaving our FY18E earnings unchanged. The group’s undemanding valuation of 10.8x FY18E PER offers an attractive entry point. Maintain OP with an unchanged TP of RM2.87.

Further details on 3Q17 results. The group extended its strong sales momentum with the registration of third consecutive record high revenue in 3Q, thanks to the continuing orders loading (for both EMS activities as well as raw wire and cable products) from its existing customers. Note that this was against the backdrop of industry-wide components shortages as well as the limited labour resources, which caused some delays in the group’s orders delivery to customers. Meanwhile, 3Q headline NP appears to be exceptionally weak due to the one-off impairment of receivables (RM11.2m). This was caused by client’s technical glitches on new system adoption, which caused late payment, alongside the group’s stringent impairment policy. That said, we are not overly perturbed with this issue as we understand from management that the collection should be all done by year end which is very likely to be reversed back in 4Q17.

Components shortages and labour issues to be resolved in early FY18. From our latest meeting, we understand that its orders delivery is currently still being capped by both components shortages and labour issues. The group is already taking measures to source components from different channels. Meanwhile on the shortages of skilled labour, which have become more apparent in the 3Q, the group has already applied more labour quotas that should be able to last for at least the next 1-2 year (on the current orders visibility). All in, these shortfalls should be resolved as soon as early 2018. To be on the conservative side for 4Q17, we cut our sales assumptions by 11% in FY17E, which led to 13% reduction in our FY17E CNP, to account for opportunity costs on sales, arising from these two issues.

Brighter prospect from 1QFY18. Management noted that the orders visibility and hit rates getting better; with stronger orders loadings (for both EMS activities as well as raw wire and cable products) grabbed from other global competitors. On top of that, two (2) out of the four (4) new projects previously-mentioned will see contribution to the 3Q17 numbers. Recall that these two (2) projects, which are for the manufacturing of industrial electronics parts (OEM), were awarded by existing customers; with one (1) being an ODM project with a renowned MNC. While we have already factored the two projects earlier in our model, we see possibility of the group securing other voluminous orders given the group’s high hit rate and advanced manufacturing capabilities; considering its historical track records of always upping its ante after current orders are fulfilled. For now, we are more inclined to stick to the conservative side in FY18 with our previous assumptions unchanged.

Maintain OUTPERFORM with an unchanged TP of RM2.87 (based on a targeted PER of 15.0x). While we cut our FY17E CNP by 13%, we made no changes to our FY18E NP as our key assumptions for FY18E are still intact. At the valuation which is trading at 10.8x FY18E PER with a steep discount of 28% vs. its closest peers- SKPRES and VS, we see an attractive entry level premised on the group’s superior margins, advanced manufacturing capabilities as well as strong parentage support from Foxconn Technology Group.

Source: Kenanga Research - 9 Nov 2017