We are turning more SANGUINE post briefing, premised on a cleaner slate in FY19 (with the ending of product rationalisation exercise in 4Q18) alongside better portfolio profile. Although we only expect meaningful margins expansion in the later part of FY19, we believe the worst is over, following the 40% share price correction since our first downgrade, which presents better risk-reward profile. Upgrade to MP with a higher TP of RM8.15 (from RM7.50).

Further details on 3Q18 results. Post-briefing (which was attended by a crowd of c.40 analysts and fund managers), we are turning more SANGUINE post briefing, premised on a cleaner slate in FY19 (with the ending of product rationalisation exercise in 4Q18) alongside better portfolio profile. Though seasonally weaker 3Q18 was observed, its USD-denominated revenue showed improvement YoY (+4.5%) with the group’s product transformation programme gaining traction without major setback. Recall that this roadmap is to skew capacity towards Automotive sensor and Industrial (servers) copper clip packaging, which carry higher margins. In terms of products breakdown YoY, improvement continued to be seen in Automotive electronics (+10%) and Industrial segments (+4%), offsetting the much weaker performance in Smartphone (-21%), Features phones (-70%) and PC (-13%). That said, net margin increment from the transformation programme was insufficient to offset the weakening USD/MYR (-6% QoQ, -12% YoY to RM3.92/USD) and mounting costs from higher commodity prices (Gold/Copper +4%/+2% QoQ); with CNP at RM25.2m (-42% QoQ, -45% YoY).

Rocky road in FY18; with light at the end of the tunnel in FY19. Note that 2Q18 and 3Q18 were the transition periods for the group; with its results having disappointed consensus. Adverse currency translations, higher material costs, wafer constraints were the culprits to blame. While the portfolio rationalisation exercises were also ongoing (by way of phasing out legacy/low margin products or negotiating for higher ASP) which have initially caused some glitches in terms of operational deleveraging, the silver linings were seen in gradual pick-up in sensors-related packaging business on the Automotive side. The exercise is expected to continue till the end of 4Q18, with a cleaner slate by 1Q19. Ultimately, management’s ideal contribution of Automotive segment is 50% (vs. current 29%) in two to three years. In terms of 4Q18 outlook, management is confident of achieving a better sequential top-line (USD terms), which should lead to a 5% YoY top-line growth in FY18 (in line with our +4.6% assumption). While there is no strong earnings visibility for now, we believe the worst is over, with new high-margins products, i.e. MEMS, Copper clips and Flipchips (for application in Automotive sensors and Industrial segments) to start contributing meaningfully in 2H19. Having altered our previous overly conservative USD sales/ CNP margins assumption of +5%/9%, to 6%/10%, our FY19E CNP has been increased by 9% with no changes to our FY18E CNP.

Risk-to-reward ratio balanced out. Since our downgrade in Nov17, its share price has corrected by 40%, with its 2-year Fwd PER/PBV trading at 10.1x/1.66x which is at its 5-year mean level. On the other hand, despite the weaker earnings in 9M18, the group’s net cash has piled up to RM554m (or RM2.92/share), with 29.0 sen DPS payout- the highest over the past nine years. Though management is eyeing an earnings accretive acquisition to complement its Automotive business, we still see potentially higher dividend payout of 31.0 sen, even after considering its FY19E capex of RM120m, similar to FY16-FY18.

Upgrade to MP. All in, we increase our TP to RM8.15 (from RM7.50), still based on a targeted 10.0x FY19E PER (which is the group’s 5- year average forward PER).

Source: Kenanga Research - 21 May 2018