1H18 NP came in line, so was the absence of dividend. We increased our FY18E/FY19E earnings by 3%/14% to account for margins accretion from the commencement of in-house PCBA line in 2H18. The stock has performed well (+61%) since our OP call. As we believe the positives have been fairly priced in, we downgrade it to MP but with a higher TP of RM2.05. This is based on a higher targeted 15.0x FY19E PER, which is in line with closest peer - VS.

Within expectations. The group reported decent 2Q18 net profit (NP) of RM35.1m (+5% QoQ; +54% YoY), bringing 1H18 NP to RM68.4m (+67% YoY) which made up 52%/51% of both our/consensus’ full-year estimates. As expected, no dividend was declared for the quarter under review. Note that the group usually pays the final dividend at October; with pay-out of no less than 50% as per its dividend policy. We are expecting the group to pay DPS of 5.5 sen for FY18 based on a payout ratio of 51%.

YoY, 1H18 revenue soared by 44% driven by: (i) second tranche of household electrical appliances (floor cleaning) contracts, and (ii) full contribution from new revolutionary products (beauty tools). Meanwhile, EBIT margin improved by 1.0ppt to 8.0% alongside the subsiding cost pressures (on the absence of last minute hiring of higher cost contract workers in 1Q17 to meet high orders) coupled with the continuous yield improvement on lower wastage. With stable ETR of 24.0%, NP improved by 67% (with NPM of 6.1%). QoQ, 2Q18 revenue improved by 13% as a result of base normalisation from the low in 1Q18 (in which the quarter had shorter working months). That said, NP grew by a narrower quantum of 5% with NP margin dropping to 5.9% (-0.5ppts). We believe this was the result of different product mix (sales dominated by products with higher costing).

Orders remain resilient; with potential margin enhancement from vertical integration. The orders for main revenue drivers- the Beauty products and Household products are still intact. This will contribute at least RM1.7b/RM2.0b in FY18E/FY19E that will anchor a 2-year revenue CAGR of 16%. Meanwhile, further potential catalyst in the medium term would be from its potentially better profitability, which could be reaped from its new PCBA services. Note that currently, the group is sourcing the PCB parts from other EMS players. 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 long-term strategic plans to expand into PCBA and other EMS-related services. We understand that the PBCA set-up will be up and running in 1QCY18 and utilise 25% of space in the new plant. With more visibility in sight, we are now assuming further margins improvement from our current CNP margin assumption of 5.7%/5.6% in FY18E/FY19E to 5.9%/6.4%, looking at the record of other EMS players with in-house PCBA capability. It is also noteworthy that the more complete integrated one-stop EMS services will enhance the group’s position in winning more contracts from major customers.

Downgrade to MARKET PERFORM with a higher TP of RM2.05. Post margins adjustment, our FY18E/FY19E earnings have been increased by 3%/14%. Meanwhile, we made no changes to our key revenue drivers. In terms of valuation, we are now ascribing a higher targeted PER of 15.0x (from 13.5x), a valuation which is in line with its closest peer- VS. We believe that the valuation re-rating is justified given its enhanced manufacturing capability (in-house PCBA) which will help it to achieve vertical integration (VI) status, similar to VS. All in, our new TP is now at RM2.05 (from RM1.60). The stock has performed well (+61%) since our OP call. As we believe the positives have been fairly priced in, we downgrade it to MARKET PERFORM.

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 - 27 Nov 2017