Our POSITIVE conviction is reaffirmed after a clarification from management regarding the unwarranted shares sell-down dragged by the concerns of profitability compression and its key customer’s R&D refocusing plans. While we still expect a 2- year CNP of 27%, better profitability is lining up with the commencement of PCBA line in Sept 2018, alongside better strike rate for new contracts. Reaffirm our OP rating with an unchanged TP of RM2.05 (15.0x FY19E PER).

Share price dragged down by uneventful news. SKPRES’ share price retraced by 12% over the past two weeks which we believe is owing to: (i) growing concerns on exporters’ profitability on weaker USD and higher raw material prices, and (ii) its key customers’ new R&D plans perceived as potentially impacting its earnings. While we observe that the negative sentiment has also affected other EMS players, we are unperturbed by the news and believe that the sell-down in SKPRES is unjustified, premised on the key-takes below.

Stable margins helped by cost pass-through mechanism. From our latest meeting, we were reassured that its core net margin should maintain at the 5%-6% mark, supported by cost pass-through mechanism. Recall that over the past five years, the group’s core NP margins hovered at a relatively high and stable 5-8% range, compared to its closest peers in the EMS space (which averaged at mid-single-digit, with some in negative territory). Note that this is all against the backdrop of the USD/MYR swing and mounting raw material costs. We understand that SKPRES is still maintaining back-to- back arrangements with its customers and vendors on the negotiation of resin purchase price, packaging and component parts on a monthly basis. Meanwhile, the group’s exposure to USD is also minimal at <3%; hence is insensitive to the strengthening of MYR compared to other players.

Totally embracing products revolution. It is widely reported that its key customer is looking to rejig its R&D spending towards new portable household products, which have sparked rounds of sell-down across the EMS players that have exposure to older products. While these products would contribute 9% in our FY18E/FY19E sales, we are unperturbed as we understand that the gradual product migration is part and parcel of its customers’ practice. While this product line could still contribute >5% in FY19, management is well ready for new orders for revolutionary products, with only slight modification on the existing line.

Potential margin enhancement from new PCBA line. While top line growth remains decent with a 2-year revenue CAGR of 16%, the key potential catalyst is better profitability from new PCBA services. Note that the group is still sourcing PCB parts externally. To enhance its profitability and consolidating its Vertical Integration status, the group has started its PCBA and Battery Pack lines, which will see meaningful contribution from Sept 2018 onwards. While we have yet to factor in the potential margins enhancement, our conservative CNP margin assumption of 5.9-6.4% could see some upside, judging from the trend of other EMS players with in-house PCBA capability. Furthermore, the more complete integrated one-stop EMS services will enhance the group’s striking rate of winning more new contracts from its major customers.

Maintain OP with an unchanged TP of RM2.05. Post model updates, we trimmed our FY18E CNP by 2% for house-keeping while maintaining our FY19E earnings. SKPRES is trading at an undemanding 2-year Fwd. PER of 12.3x vis-a-vis peers’ 13-15x with PCBA capability, which we believe is unjustified given the overblown issues as well as its new in-house PCBA capability. Besides the decent total upside of 21%; (i) the solid 2-year CNP of 27%, (ii) stable earnings visibility, (iii) decent dividend yield of 4.1%, and (iv) cost pass-through mechanism are the stabilizing and appealing factors to investors in the tech space.

Source: Kenanga Research - 22 Mar 2018