We recently visited three technology companies in Penang – IQ Group Holdings Berhad (IQGROUP), FoundPac Group Berhad (FPGROUP), and P.I.E. Industrial Berhad (PIE). On the trade war front, we gathered that EMS players are more likely the beneficiaries from the trade diversion. Among the technology companies we visited, while most of them have received enquiries from businesses looking to relocate out of U.S and China, only PIE (an EMS player) has seen those enquiries crystallizing into new orders. This is also the case for technology companies under our coverage.

Meanwhile, during our previous visit, the general view on 5G was that a more meaningful positive impact and clarity should only be seen in 4QCY19-1QCY20. As we enter into 3CY19, we are increasingly seeing signs of companies preparing for the adoption of 5G with the likes of FPGROUP observing higher demand for its products with specifications that could be used for 5G. We remain upbeat on the prospects for the sector as (i) developments for 5G picks up speed and (ii) enquiries (trade war-motivated) materialise into orders and new customers.

P.I.E. Industrial Berhad (MARKET PERFORM ↓; Target Price: RM1.25↓)

Still A Trade War Beneficiary

We met P.I.E. Industrial Berhad’s Managing Director, Alvin Mui in its manufacturing plant in Seberang Perai. P.I.E. Industrial Berhad (PIE) was incorporated in Malaysia on 21 March 1997, under the name of P.I.E Industrial Sdn Bhd and subsequently converted to a public limited company on 30 May 1997. The group started off with manufacturing and assembly of cable and wire. Since then, it has added on fabrication of moulds and dies, PCB assembly using precision SMT, plastic injection moulding and Class 10K and 100K clean room product assembly and testing of electronic products, which now enables the group to offer a complete integrated 'one-stop' CEM service to major multinational companies.

Re-focusing resources away from low-end telecommunication device. Recall that PIE had earlier secured a new product which is also a telecommunication device (low-end) and has started its first shipment of 33k units. Despite potential high volume (1.1m units in FY19, with potential to scale up to 5.8m units), PIE has decided to reduce order acceptances for this product. We believe management intends to phase out this product by 4Q19 due to its low margin and high labour intensity as they re-focus resources towards new potential customers.

Still benefiting from trade diversion but more time needed to see positive impact. As we understand, PIE is still receiving multiple enquiries from companies that are looking to shift their supply chain out of China. Among the enquiries, we gathered that a new customer has engaged the group to manufacture PCBA for its product on a consignment basis. While revenue potential should be minimal, gross margins could be higher (c.20%). Apart from this, we believe the management are in talks (preliminary discussions) with a potential new customer. We understand that the customer is keen on relocating from China and has made its first visit to PIE’s plant in July 2019. Our guesstimate is that the potential customer could contribute sales of c.RM30m (assuming full ramp-up).

Expecting earnings to recover in 2H19. While 1H19 is likely to be a weaker half on seasonality and higher start-up costs for its low-end telecommunication product, we expect to see some earnings recovery in 2H19, premised on: (i) seasonal ramp-up from its telecommunication and tooling customer, as well as (ii) steady growth from its existing key customers. As a gauge, in FY18, 2H18 accounted for 80% of its full-year earnings.

Reduce FY19-20E earnings. Following the phasing out of its new telecommunication product, we trim our FY19-20E sales assumptions by 4% and tweaked margins slightly lower (housekeeping) resulting in a reduction of FY19-20E earnings by 5- 6% to RM40.7-45.5m.

Downgrade to MARKET PERFORM (from OUTPERFORM) with a lower Target Price of RM1.25 (from RM1.55) based on FY19E PER of 12.0x. At current price (RM1.30), its Forward PER is 12.3x, in line with its closest EMS peers which is trading at 12.2x PER. Despite the minor setback in its low-end telecommunication device, based on (i) its position as a trade war beneficiary and (ii) possible growth from its potential new customer, we believe our ascribed PER of 12.0x is justifiable.

IQ Group Holdings Berhad (NOT RATED)

Losses Still Expected Next Quarter

We met up with senior management from IQ Group Holdings Berhad at their Head Office in Bayan Lepas. The group is involved in the design and manufacture of lighting, security and convenience products, serving some of the world’s major retail and professional brands. IQGROUP has over 25 years of experience and has built a reputation for design, innovation and quality, encompassing motion sensors, sensor lighting and wireless door entry products.

Easing labour shortage issue. To recap, in 4Q19, IQGROUP registered Net Loss (NL) of RM2.2m caused mainly by a delay in products shipment due to labour shortage issues at its plant in Dongguan, China. The group has addressed this issue by shifting most of its manufacturing to its new Wuning plant. We understand that there is lesser competition in Wuning, China, thus providing a more stable labour force.

Seeing increase in enquiries. We understand that the group has seen increasing enquiries (for its Malaysia manufacturing plant) since 2018 due to the trade diversion. However, we note that there has not been any indication of these enquiries translating into new orders yet. As such, we do not see IQGROUP as a beneficiary of the trade war in the immediate term. Interestingly, we gathered that c.20% of IQGROUP’s manufacturing is still in Malaysia as management hopes to ramp up its home brand industrial sensor lighting, Lumiqs (pioneer status).

1Q20 likely to remain in the red. We believe for 1Q20, IQGROUP is likely to remain in losses given the transition period for its manufacturing in China (temporary lower efficiency due to the relocation to its Wuning plant), with impact potentially spilling over to 2Q20 as well.

FY20 internal growth target of 20%. Overall, management has set FY20 internal growth target at 20%, but we believe this may be a challenge given our view of a muted 1H20.

Fair value of RM1.03-RM1.11. Assuming narrowing losses to c.RM1m in FY20E, based on Fwd PBV of 0.65-0.70x (1-year average), IQGROUP could command a fair value of RM1.03-RM1.11.

FoundPac Group Berhad (NOT RATED)

5G - A Growth Driver

We met with the senior management of FoundPac Group Berhad in Bayan Lepas. FPGROUP was incorporated on 16 November 2015 as a private limited company and was converted into public limited company on 11 March 2016. The group is principally involved in the design, development, manufacture, marketing and sale of precision engineering parts namely stiffeners, test sockets, hand lids and related accessories, as well as the manufacture and sale of laser stencils. The groups’ customers are primarily large multinational semiconductor manufacturers, outsourced semiconductor assembly and test companies (OSATs) and printed circuit board (PCB) design houses.

Qualified for two additional orders with verbal confirmation for another two. In Apr 2019, the group received three blanket purchase orders (POs) for metal parts (manufactured by its 75%-owned Dynamic Stencil) with contribution of RM300k/month. Now, we gathered that the group has been qualified for two additional orders and received verbal confirmation for another two more, which could increase metal parts contribution to RM600k/month (vs. RM300k/month). All in-all, management is targeting RM16-18m revenue contribution from Dynamic Stencil in FY20.

Possible margin expansion. As we understand, management intends to increase contributions from its higher-margin metal parts to 80% (vs. current: Stencils: 80%; Metal parts: 20%) over the years. No timeline was given as to when management hopes to achieve the said composition. From our back of the envelope calculation (based on RM16-18m from Dynamic Stencil) FY20 could see contributions from metal parts increase to c.33%, which could offer upside to margins.

Potential entry into more lucrative spaces. We note that the group had placed orders for new 7-axis and 5-axis machines with expected arrival by July 2019 and Sept 2019, respectively. The said machines are expected to improve efficiency (in terms of productivity) by 60% and could pave the way for FPGROUP’s entry into the automotive, medical and aerospace segments. We believe this is possible, given that the group has already secured license from Malaysian Investment Development Authority (MIDA) for the automotive and medical spaces (likely to manufacture jigs and fixtures).

5G rather than trade diversion. On the trade war front, while there have been enquiries, management sees growth mainly coming from repeat orders as companies gear up for the upcoming adoption of 5G. On the ground, the group has already started working with customers towards the adoption of 5G.

4Q19 to remain strong. We believe 4Q19 could replicate the strength seen in 3Q19 driven by strong demand for both its products from the precision engineering segment and Dynamic Stencil (driven by preparation for 5G). As such, we estimate FY19 revenue could come within the range of RM44.5-45.0m.

Targets 15-20% growth for FY20. Overall, management targets 15-20% top-line growth for FY20, driven by repeat orders from its precision engineering (stiffeners & test sockets) segment as well as laser stencils and metal parts from Dynamic Stencil. We reckon the strong orders could continue into FY21 as development in 5G gains momentum.

Fair Value of RM0.380. Based on our back of the envelope calculation, assuming FY20E revenue growth of 15% (from FY19E revenue of RM44.5m) and net margin expansion to 30% (from c.27%) on better product mix, this translates into a Forward PER of 12.0x at its current price of RM0.340. Based on FY20E PER of 14.0x (vs. 2-year average of 16x), FPGROUP could command a Fair Value of RM0.380.

Source: Kenanga Research - 19 Jul 2019