3QFY20 CNL of RM3.0m resulted in lower 9MFY20 CNP of RM3.4m (-15% YoY), accounting for only 21%/24% of our/consensus’ estimates. Lockdown in China and the extended MCO in Malaysia led to 18% YoY decline in revenue to RM194.7m. New work-from-home practice and lacklustre consumer sentiment are delaying recovery of car sales in Europe and China. Downgrade to MARKET PERFORM from OUTPERFORM with a lower Target Price of RM7.40.

Below expectations. KESM reported 3QFY20 CNL of RM3.0m, resulting in a lower 9MFY20 CNP of RM3.4m (-15% YoY), accounting for merely 21%/24% of our/consensus’ estimates. The sharp decline was mainly due to the lockdown in China coupled with the movement control order (MCO) in Malaysia which has been extended over four phases.

Results’ highlight. YoY, 9MFY20 CNP shrank 15% to RM3.4m while revenue fell 18% to RM194.7m owing to the Covid-19 outbreak which led to lower loading volume for automotive burn-in testing services and electronic manufacturing services. Amid the challenging backdrop, the group still managed to register 1.6ppt improvement in EBIT margin thanks to lower depreciation expense and employee benefit expense. QoQ, 3QFY19 registered CNL of RM3.0m as the lockdown in China and the extended MCO in Malaysia led to lower utilisation rate. During the MCO period, the Malaysia plant was only operating at 20-30% capacity which was detrimental given its relatively high fix cost structure.

Stomping on the brakes. The lockdown in Europe saw car traffic in major cities (e.g. Berlin, London, Munich and Madrid) declining by 80-90% in the month of April. While restrictions are being eased gradually, the Covid-19 outbreak has created a new norm of working from home. This has weakened demand for automotive vehicles as new registration in Europe plummeted 55% YoY and 76% YoY in Mar and Apr, respectively. The dramatic decline overshadowed the fact that electric vehicles (EV) sale doubled in Q1CY20 compared to Q1CY19. While this is an encouraging sign, bear in mind that the EV market in Europe is still relatively small, representing 6.8% of total cars sold in 1QCY20.

China car sales on the other hand saw its decline narrowed to -2.6% YoY in April, an improvement from -48% YoY in March. Consumption-spurring policies such as the extension of subsidies and tax exceptions for EVs by another two years contributed to the pent-up demand. However, we believe that the momentum will be short lived and the immediate term remains challenging as the Covid-19 is slashing global auto demand.

Cut FY20E CNP and FY21E CNP by 68% and 21%, respectively, to account for lacklustre demand in the automotive market as the recovery is being pushed back further due to the disruption from Covid-19.

Downgrade to MARKET PERFORM from OUTPERFORM with a lower Target Price of RM7.40 (previously RM10.20) based on a lower FY21E PER of 17x (previously 18.7x), in line with its 5-year mean.

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

Source: Kenanga Research - 3 Jun 2020