We came away from a meeting with the management maintaining our neutral outlook on KESM’s near-term prospects. The group is currently running at c.25% capacity (vs. 20% in 4QFY20), and is hopeful to breach the 30% mark in the upcoming quarter. While current momentum may translate into QoQ growth for 2Q21, management did caution on the seasonality factor and shorter working days in 3QFY21 owing to the Chinese New Year holidays. The group is working on new products but may only start to see meaningful contribution in mid-FY22. Maintain MARKET PERFORM with an unchanged TP of RM10.60.

On a recovery path. We came away from a meeting with KESM learning that the group is eyeing a gradual recovery ahead. In its latest reported quarter, it was operating around mid-20% utilisation rate and is currently nearing 30%. For the upcoming quarter, the group is hopeful to breach the 30% mark and expect marginal QoQ growth in 2QFY21. However, management did caution about the seasonality factor and long festive holidays in 3QFY21 as the group typically shuts down its plants during the Chinese New Year period

Material impact from new products to realise in FY22. The group’s focus for FY21 is still to increase utilisation rate. As such, the group will keep its maintenance capex but do not expect to incur significant spending on new equipment. We understand that the tides has begun to turn for KESM as key customers are starting to load the group with orders at an encouraging volume, along with new products which are in the midst of qualification, such as chips relating to advance driving assistance system (ADAS), tire-pressure measuring system (TMPS) and in-car infotainment system. However, the group does not expect to see significant impact from these new products in FY21 as the qualification process takes time, especially for the automotive sector which is more stringent than the smartphone sector. Also, new equipment lead time is now longer at 3-4 months as the Covid-19 poses logistical challenges. Upon qualifying for the new products, capex for new equipment may only be incurred between end-FY21 and early-FY22.

Macro outlook turning positive. Management believes the long-term growth prospects of the sector remains positive as semiconductor content in vehicles continues to rise going forward. We gather that China’s car sales remain strong, extending its growth streak to seven consecutive months. Europe has also shown encouraging rebound. While we are positive on the group’s recovery, we prefer the likes of D&O (OP; TP: RM2.00) and MPI (OP; TP: RM29.00) which are benefiting from the automotive recovery at a quicker rate, thanks to their niche in LEDs and silicon carbide (SiC) power module respectively.

Maintain FY21E and FY22E CNP at RM18.5m and RM24.8m respectively.

Maintain MARKET PERFORM with an unchanged Target Price of RM10.60 based on CY21E PER of 21x, in line with its 3-year mean.

Risks to our call include: (i) faster-than-expected recovery in order volume, (ii) quicker adoption of new semiconductor modules in automobiles, and (iii) easing of the US-China trade spat.

Source: Kenanga Research - 2 Dec 2020