1Q19 CNP missed expectations stemming from seasonality and higher-than-expected start-up costs for its maiden telecommunication device as well as operational deleveraging. While 2Q19 should continue to see weakness on lower efficiency and seasonality, we expect earnings in 2H19 to improve on seasonal ramp-up and efficiency improvements. Cut FY19/20E CNP by 17%/14%. Maintain OUTPERFORM with a lower Target Price of RM1.55.

Slight Hiccup. While we are cognizant of 1Q being the weakest quarter seasonally, PIE’s CNP of RM0.5m (-97% QoQ; -47% YoY) was deemed below expectations regardless, amounting to only 1% of our/consensus’ full-year estimates. We believe this was mainly attributed to: (i) higher than-expected start-up costs for its maiden telecommunication device, and (ii) lower-than-expected operational efficiency in the initial manufacturing stage for its new product due to steep learning curve (which resulted in higher usage of raw materials). No dividend was declared, as expected as the group typically declares dividend after its 4Q results.

Results Highlight. YoY, despite 4% increase in 1Q19 revenue, CNP came in 47% weaker at RM0.5m (low base effect). The decline mainly stemmed from higher start-up costs for its maiden telecommunication device. This, coupled with low operational efficiency and higher effective tax rate (21.3ppts) caused CNP margin to compress to 0.4% (-0.3ppt).

QoQ, CNP declined 97% attributed to weak seasonality (sales decreased by 24%) and operational deleveraging which saw EBIT margin compression by 10.5ppts to 1.0% (similar to 1Q18, -10.3ppt).

Seasonal ramp-up in 2H19. While 2Q19 should continue to see weakness on seasonality and lower efficiency for its new products, we believe 2H19 should see: (i) seasonal ramp-up alongside higher allocation from its Telecommunication customer, and (ii) mass production of its new products (industrial printing & production and medical segment) with full-year earnings contribution. The abovementioned should be able to comfortably support our estimated 2-year revenue/CNP CAGR of 8%/6%, post revision.

Trim FY19-20E earnings by 17-14% to RM43.0-48.5m. To be on the conservative side, we have reduced FY19/20E CNP margin (-0.9ppt; - 0.6ppt) to 5.9%/6.3% to account for the gestation period for its new product and slightly trimmed our bullish sales assumption by 5% for FY19/20E, resulting in a cut of FY19/20E CNP of 17%/14%.

Maintain OUTPERFORM with a lower Target Price of RM1.55 (from RM1.90) based on 14.0x FY19E PER. Even after our steep earnings revision, we think that there is good value proposition at current price level, following its 18% share price correction and with its Forward PER at only 12.6x vs. peers’ 3-year average of 14x. Note that this is all against the backdrop of its (i) relatively higher NP margin, (ii) decent dividend yield of 3.5%, and (iii) having strong parentage support from Foxconn Technology Group.

Risks to our call include: (i) slower-than-expected sales, (ii) loss of orders from its key customers, and (iii) adverse currency translations.

Source: Kenanga Research - 27 May 2019