Post conference call, we learnt that the subsequent quarter will remain weak due to low plant utilisation rate while labour cost remains unchanged. Uptick will only happen at end of CY20 when new products for ADAS and LiDAR kick in. Meanwhile, management will focus on asset realignment to gradually move away from the EMS segment that is weighing the group down. We expect near-term headwinds resulting from lower spending on car purchases as the work-from home practice may persist. Maintain MARKET PERFORM with an unchanged Target Price of RM7.40.

Outlook remains subdued. After our conference call with KESM, we are of the opinion that its outlook in subsequent quarter will likely remain weak due to lower plant utilisation rate. At present, both its China and Malaysia plant are running at 20% utilisation rate, compared to 30%-35% in the previous quarter. While the lock-down restrictions in China and Malaysia are easing, we do not expect any ramp-up in the near term as forecast by key automotive customers are being revised downwards. Not helping either is its electronic manufacturing service (EMS) segment which will continue to weigh down on its overall performance. While the EMS segment contributes less than 10% to group revenue, it takes up 20% of the total workforce, resulting in high operating cost. This means that labour cost remained unchanged even though revenue from the EMS segment halved in 3QFY20 compared with the previous corresponding quarter.

Cost optimisation. In the immediate term, cost optimisation will be the main focus of the group as it embarks on asset realignment to prioritise businesses on automotive semiconductor. This entails re-skilling operators and engineers to gradually switch over from the EMS segment to automotive burn-in and testing services. This process is expected to be carried out in the medium to long-term.

Uptick to happen towards end of 2020. The group is currently discussing with existing automotive customers on new product introduction and device modification. This includes burn-in and testing services for components that will be used for advanced driver-assistance systems (ADAS), Tyre Pressure Monitoring System (TPMS) and Light Detection and Ranging (LiDAR) systems. However, meaningful contribution from these new products will only be noticeable towards the end of CY20. For the immediate term, the company will still face headwinds from reduced spending on car purchases. While car sales in China has improved (from 43% decline in Mar slowing to 2.6% decline in Apr), we believe this will be short lived given that consumer spending on large ticket item will likely remain subdued. Meanwhile, Europe’s car sales have yet to show any clear indication of bottoming which recently recorded declines of 55% YoY and 76% YoY in Mar and Apr.

Maintain FY21E CNP but cut FY20E CNP by 23% to account for lacklustre demand in the automotive market as the recovery is being pushed back further due to the disruption from Covid-19.

Maintain MARKET PERFORM with an unchanged Target Price of RM7.40 based on unchanged FY21E PER of 17x, 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 - 10 Jun 2020