9M18 CNP missed expectations due to unfavourable product mix and material cost. However, a second interim net DPS of 19.0 sen is within expectation. While 4Q18 sales should come in stronger, we maintain our CAUTIOUS view in light of rising material costs, weakening USD/MYR as well as longer gestation period for product rationalisation exercise. We cut our FY18E/FY19E CNP by 11%/8%. Maintain UP with a lower TP of RM7.50 (10.0x FY19E PER). Below expectations. The group reported 3Q18 CNP of RM25.2m (- 42% QoQ, -45% YoY), bringing 9M18 CNP to RM105.6m (-26%) which made up 70% of both our/consensus full-year estimates. The negative deviations were due to unfavourable product mix, aggravated by higher-than-expected material costs. That said, a second interim net DPS of 19.0 sen is within expectation, bringing YTD net DPS to 29.0 sen for FY18.

YoY, 9M18 revenue marginally dropped by 1% with robust sales in Asia (+15%) negated by weakness in USA and Europe segments. While we have yet to obtain the detailed breakdown in terms of market segments, we believe the higher Asia sales that were predominantly driven by the Industrial’s copper clip packaging as well as higher volume of new sensors packaging from Automotive segment were offset by lower sales from legacy products, which was part of the group’s portfolio rationalising exercise. At the operating level, EBIT dropped by a higher quantum of 23% on lower gross profit (GP) margin of 16.0% on higher material costs (vs. 9M17 GP margin of 20.5%) and adverse currency translations. Note that a significant swing of forex impact was observed, with losses of RM1.6m (vs. forex gains of RM10.0m in 9M17). Coupled with a higher effective tax rate of 18.2% (+4.2ppt), core PATAMI dropped by 26%. QoQ, 3Q18 MYR revenue dropped 7% dragged by both softer USD (-6%) and weaker seasonality. With lower operational efficiency which resulted in softer GP margin of 16.0% (-1.9ppts), alongside higher effective tax rate of 20.5% (+2.6ppts), core PATAMI dropped by 42%.

Moderate industry growth. Though the overall industry continued to show improvement with the global semiconductor sales in March 2018 increasing by 20.0% YoY, marking the 20th consecutive YoY growth, we noticed the growth momentum is already moderating, mimicking the movement of the last up-cycle which lasted for 26 months back then from May 2013 to Jun 2015. From our last meeting with management last quarter, management noted that it sees challenges in the next 1-2 quarters at the top-line and bottom-line levels, a view shared by us. While its portfolio realigning has been on track thus far, management currently is adopting a more aggressive approach - by way of phasing out legacy/low margin products (or going for higher ASP) and taking up more sensors-related packaging business on the Automotive side, all by FY18. We are keeping our conservative stance, which only assumes 4%/5% growth in FY18/FY19 USD revenue (vs. management’s target of 5.5%/7.5%).

Maintain UNDERPERFORM with a lower TP of RM7.50 (from RM8.10). Post model updates, we cut our FY18E/FY19E earnings by 11%/8% to account for higher raw material prices. Maintain UP with a lower TP of RM7.50 (still based on 10.0x FY19E PER which is the group’s mid-cycle valuation)

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

Source: Kenanga Research - 18 May 2018