We are turning CAUTIOUS post-briefing in light of the rising material costs alongside longer gestation period for its product rationalisation exercise. Hence, we cut our FY18E/FY19E CNP by 14%/11%. The stock price has performed well, up by 72% since our conviction OP call on Jan 2017. With mounting pressure on margin coupled with potential setback from gestation period, we advocate a MP rating with a lower TP of RM14.70.

Further details on 1QFY18 results. 1Q18 USD-denominated revenue improved marginally (+1% QoQ and +3% YoY) as better sales momentum from Automotive electronics (+12% QoQ, +26% YoY) and Industrial segments (+9% QoQ, +13% YoY) were wiped out by weaker performance from Smartphone (-8% QoQ, +3% YoY) and PC/Notebook segments (-9% QoQ, -2% YoY). While MYR revenue grew by 8% YoY on stronger USD/MYR (RM4.26/USD vs RM4.05/USD), CNP, however, dropped by 7% YoY on higher commodity prices and higher effective tax rate, which undermined our expectations.

Realigning portfolios for sustainable growth. Management noted that the portfolio realignment with more capacity allocated towards Automotive sensor and Industrial copper clip packaging are within their blueprint. This will eventually lead to less earnings fluctuation and better margins compared to the legacy products. Management is working hard towards achieving its previously guided USD- denominated top-line growth of 5.5%-7.5% in FY18 (which will outpace the industry’s growth forecast of 2.7% in 2018). That said, we prefer to be conservative (by assuming only 3%-5% growth in FY18E/FY19E USD-denominated revenue) considering the gestation period which might take a few quarters to see meaningful growth. Meanwhile, another hurdle is the wafer constraints plaguing the industry. On the margins side, raw material costs are also on the uptrend which saw Copper as well as Gold prices higher by 26% and 5%, respectively (since 1QCY17 of which we believe accounted for 50% of raw material prices). As the group finds it difficult to pass on the cost hike to customers, we see cost pressure emerging, leading us to cut our FY18E-FY19E earnings by 11%-14%.

Other key notes. That said, not all is gloom and doom as the group’s net cash is still pilling up at RM542m in 1QFY18 vs. RM444m in 4QFY17. While this paves the way for higher dividend pay-out, we prefer to stick to the pay-out quantum for FY17 (which is 27.0 sen) considering the group’s expansionary mode to grow its Automotive segment. Recall that the group is conserving cash for additional capex for expansion and is finding ways to expand its portfolio offerings, not discounting the possibility of merger/acquisition.

Our take post meeting. Post-meeting, we are turning more conservative on its FY18 and FY19 prospects. This is premised on mounting material costs as well as the limited top-line growth in FY18/FY19 which will be capped by the wafer constraints as well as the ongoing portfolio rationalisation exercises. With our downwards earnings revision of 11%-14% for FY18/FY19, we reduce our TP to RM14.70 (from RM15.70), based on a rollover 15.0x FY19E PER (which is the industry 2-year forward average PER).

Risks to our call include: (i) Higher-than-expected sales and margins, and (ii) Favourable currency exchange to the group.

Source: Kenanga Research - 10 Nov 2017