1QFY20 CNP of RM4.5m came in within expectations, accounting for 22%/24% of our/consensus’ estimates. Lower depreciation and raw material expense led to better margins. Looking ahead, we expect to see a gradual continuation of earnings recovery in the subsequent quarters on the back of improving car sales. We tweaked our FY20E CNP higher by 3.4% to RM21.2m on housekeeping. Maintain OUTPERFORM with a higher Target Price of RM9.30.

Within expectation. 1QFY19 registered CNP of RM4.5m (+98% QoQ; +72% YoY), accounted for 22%/24% of our/consensus’ estimates. The improvement mainly stemmed from better operating efficiencies. No dividend declared for the quarter.

Results’ highlight. YoY, 1QFY20 revenue dipped 17% due to lower demand for burn-in testing services. However, CNP grew 72% to RM4.5m thanks to: (i) lower depreciation with certain test equipment and machinery fully depreciated, (ii) decline in raw material expense as efforts to optimise its testing lines paid off, and (iii) lower staff cost following a reduction in headcount. QoQ, a similar positive picture was painted. 1QFY19 CNP almost doubled (+98% from a low base) albeit on a modest revenue growth of 2% to RM72.4m. EBIT margin (+5 ppt) and CNP margin (+3.2 ppt) also improved to 9.6% and 6.3%, respectively.

Gradual climb. We expect to see a gradual continuation of earnings recovery in subsequent quarter on the back of improving car sales. The EU market recorded back-to-back increase in passenger car sales for the month of October, advancing 9% YoY. This follows the 14.5% YoY jump in the previous month of September, where Germany was the best performer. We believe the growth will continue in tandem with the on-going strive for lower CO2 emission by regulators, pushing car manufacturers to get on board with electric vehicles in order to meet emission targets. This will in turn benefit KESM due to higher demand for automotive semiconductor in electric vehicles.

Tweaked FY20E CNP higher by 3.4% to RM21.2m on housekeeping, while maintaining a net profit margin of 6.1%. We maintain FY21E CNP of RM24.8m (+17% YoY) with a net profit margin 6.7% to account for better operational efficiencies and higher margin businesses from the automotive space.

Maintain OUTPERFORM with a higher Target Price of RM9.30 (previously RM8.70) based on 18.7x (from 18x) FY20E PER (in line with its 3-year average). We believe that KESM will continue to benefit from the rising semiconductor content per vehicle.

Risks to our call include: (i) later-than-expected recovery in vehicle sales, (ii) slower-than-expected adoption of new semiconductor modules in automobiles, and (iii) delay in the US-China trade truce which could potentially lengthen the industry recovery process.

Source: Kenanga Research - 21 Nov 2019