SKPRES is scheduled to release its 1Q20 results in the last week of August. With minimal new developments, we expect earnings to come in flattish sequentially, around RM20m. Although we expect earnings to pick up from 2Q20, recovery could be slightly softer than anticipated due to initial lower efficiency from newer products. Reduce FY20-21E earnings by 7%/4%. Downgrade to MARKET PERFORM with a lower Target Price of RM1.20.

Expecting 1Q20 to come in flattish sequentially. SKPRES is scheduled to release its 1Q20 results towards end of August. With minimal new developments, we expect flattish sequential earnings of around RM20m (vs. RM20.1m in 4Q19), making up 16% of our initial full-year estimate of RM126.5m due to seasonality. Nevertheless, we expect to see earnings picking up from 2Q20 onwards with (i) seasonal production ramp-up ahead of festive seasons, (ii) contributions from its new model variant for one of its conventional electrical appliances (production started in July 2019), and (iii) new lifestyle product (starting in November-2019) from its key customer.

Initial lower efficiency. While we expect to see earnings picking up from 2Q20 onwards, we believe the recovery may not be as strong as anticipated earlier owing to: (i) start-up costs for the two new products, and (ii) initial lower efficiency due to production learning curve. From our channel checks, we gathered that one of its closest peers have had such experience during the production of a similar product. However, we reckon the impact should be less severe to SKPRES. The peer, on top of initial lower efficiency (due to learning curve), also incurred additional expenses to perfect its new product and to ramp up production to be on time.

PCBA line and new model variant have commenced. The group’s first PCBA line has commenced in April, while the new model variant started last month. The PCBA line is expected to enhance net margins by up to 0.5ppt, although the effect is more likely to be felt in FY21 due to initial inefficiency. Having said that, the commencement of the group’s PCBA line could pave the way for more contracts given the key customer’s emphasis for its contract manufacturers to be vertically integrated. In anticipation of new products, SKPRES has already identified a 2.2-acre land and placed orders for new plastic injection machines. Additionally, with its Johor plant having c.50% floor space availability, the group also has ample capacity to cater for new contracts.

Reduce FY20-21E earnings by 7%/4% to RM117.8m-RM137.8m as we trim our slightly bullish FY20-21E sales assumption by 7%/4%.

Downgrade to MARKET PERFORM (from OUTPERFORM) with a lower Target Price of RM1.20 (previously RM1.40) based on a lower FY20 PER of 13.0x (vs. peers’ average of 13x). Note that among its closest peers, SKPRES pays the highest quantum of dividend (50% payout) translating into decent FY20-21E dividend yield of 4.1-4.8%.

Risks to our call include: (i) less aggressive expansion from its key customer which translates to lower-than-expected orders, (ii) higher/lower than-expect start-up costs, (iii) higher/lower-than-expected input costs, and (iv) single customer concentration risk.

Source: Kenanga Research - 16 Aug 2019