2Q19 CNP of RM14.2m (-53.7% YoY; +143.2% QoQ) brought 1H19 CNP to only RM20.1m (-45.3%), which is markedly below consensus at 22% and our forecast at 20%. An interim dividend of 2.0 sen was recommended, also below expectations. Trim FY19-20E CNP by 28-27% to RM70.9- 93.2m and dividend from 9.0-11.0 sen to 6.0-7.5 sen. Upgrade to MARKET PERFORM with a lower TP of RM2.05.

A substantial miss. Unisem registered 2Q19 core net profit (CNP) of RM14.2m (-53.7% YoY, +143.2% QoQ), bringing 1H19 CNP to only RM20.1m (-45.3% YoY), which is markedly below consensus at 22% and our forecast at 20%. The disappointment came as Chinese customers turned to local suppliers post-Huawei ban in May 2019, leading to weaker sales in the communications segment. The automotive industry also remained sluggish, particularly in China, as buyers held back purchases ahead of the imposition of VI emission standards in July. An interim dividend of 2.0 sen was recommended during the quarter, below our expectations of 3.0 sen for the quarter and 9.0 sen for the fiscal year.

YoY, 1H19 CNP tumbled 45.3% on a revenue decline of 7.5% (USD terms: -11.6%), again, caused by weakness in the automotive and communications segments. This was exacerbated by a higher effective tax rate of 28.0% (vs. 14.2% in 2Q18) due to non-deductible losses of a subsidiary company. However, QoQ, 2Q19 CNP recovered 143.2% on a revenue improvement of 2.9% (USD terms: +1.6%), driven by higher demand for radio frequency (RF)/communications components that go into Chinese mobile phones as well as 5G network infrastructure. In addition, the quarter recorded foreign exchange gains of RM3.5m vs. foreign exchange losses of RM2.4m in 1Q19 on the back of favourable exchange rate (USD/MYR: +1.3%).

Uncertainty extends into 2H19. Management guided flat 3Q19 and 2H19 revenue sequentially, as the closure of Batam facility (<10% revenue contribution) offset a production ramp-up of micro electromechanical systems (MEMS) microphones. Notwithstanding a potentially flattish top-line, we remain sanguine that Unisem’s earnings will recover appreciably in 2H19, backed by the discontinuation of loss making Batam facility and the expansion of the group's wafer bumping capacity in its Ipoh and Chengdu facilities. The group is in the midst of finalising qualifications to set up a 12-inch wafer bumping facility, with production expected to commence in 4Q19.

Trim FY19-20E CNP by 28-27% to RM70.9-93.2m after cutting revenue forecasts by 8-13% to account for the closure of Batam facility and slow resumption of demand for communications products as trade disputes intensify. We have also lowered our FY19-20E dividend forecasts from 9.0-11.0 sen to 6.0-7.5 sen.

Upgrade to MARKET PERFORM with a lower TP of RM2.05 (from RM2.15) based on unchanged Fwd. PER of 16.0x applied to FY20E EPS of 12.8 sen (rolled forward from FY19E). The Fwd. PER is in line with Unisem’s mid-cycle PER. Despite the uncertain environment, we believe most negatives have been priced in with a 35% share price correction YTD.

Risks to our call include: (i) weaker/stronger-than-expected USD/MYR, (ii) slower/faster-than-expected adoption of 5G, and (iii) an escalation/resolution of the trade war.

Source: Kenanga Research - 7 Aug 2019