3QFY19 CNP of RM18.6m (-46.9% YoY, +30.7% QoQ) brought 9MFY19 CNP to only RM38.7m (-46.1% YoY), which is markedly below consensus at 60% and our forecast at 55%. A second interim dividend of 2.0 sen was recommended, in line with expectations. Cut FY19-20E CNP by 17-10% to RM58.7-83.7m. Downgrade to UNDERPERFORM with a lower TP of RM2.15 given: (i) results disappointment, (ii) 4QFY19 to be another soft quarter, and (ii) after 34% share price appreciation.

Missed expectations. 3QFY19 registered core net profit (CNP) of RM18.6m (-46.9% YoY, +30.7% QoQ), after stripping off severance expense (RM22.4m) arising from the planned closure of its Batam plant, bringing 9MFY19 CNP to only RM38.7m (-46.1% YoY), which is markedly below consensus at 60% and our forecast at 55%. We believe the disappointment stemmed from the lacklustre automotive industry, especially in China which was still registered declining passenger car sales. This resulted in lower-than-expected GP margin of 8% (vs. expected 10%). A second interim dividend of 2.0 sen was recommended during the quarter, in line with our expectations of 2.0 sen for the quarter and 6.0 sen for the full year.

YoY, 9MFY19 CNP fell 46.1% as revenue declined 8.6% (USD terms: - 11.8%), stemming from weakness in the automotive and communications segments, exacerbated by higher effective tax rate of 54.7% (vs. 13.1% for 9MFY18) due to: (i) deferred tax recognized, and (ii) non-deductible losses of a subsidiary company. On the other hand,

QoQ, 3QFY19 CNP recovered 30.7% alongside revenue improvement of 1.4% (USD terms: +1.0%), from higher demand of radio frequency (RF)/communications components that go into Chinese mobile phones as well as 5G network infrastructure. Additionally, 3QY19 recorded higher foreign exchange gains of RM4.4m (vs. foreign exchange gains of RM3.5m in 2QFY19) on the back of slightly more favourable exchange rate (USD/MYR: +0.4%).

Another soft quarter ahead. Management is guiding flat to a slight dip in 4QFY19 revenue. Alongside an expected final severance payout for the closure of Batam plant, this should lead to another soft quarter in 4QFY19. In the notes to the accounts, it was pointed out that the Batam plant operations (PT Unisem) will be extended to March 2020 to service some final orders. Moving forward, the production of micro electromechanical systems (MEMS) microphones is starting to ramp up, with more enquiries from new customers and is expected to contribute an additional c.4% to revenue in FY20. However, this should be offset by the closure of the Batam facility (<10% revenue contribution) in 2020.

Cut FY19-20E CNP by 17-10% to RM58.7-83.7m after reducing FY19- 20E revenue assumptions by 2% each and GP margin by 1.0-0.5ppt to 9.0-11.0%.

Downgrade to UNDERPERFORM (from MARKET PERFORM) with a lower TP of RM2.15 (from RM2.40) based on unchanged Fwd. PER of 18.0x (in line with the group’s mid-cycle PER) applied to FY20E EPS of 11.7 sen. Given this set of disappointing results, expectations of another soft quarter ahead, and 34% share price appreciation since Sep 2019, we believe risks outweigh rewards at this juncture.

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

Source: Kenanga Research - 29 Oct 2019