KESM’s lacklustre performance despite strong global demand for automotive chips can be attributable to its legacy product portfolio of which the group aims to discontinue over the next 2-3 quarters. Meanwhile, KESM will gradually work on new product introductions and has committed an aggressive capex of RM106m. We remain cautious on the plans given as its existing facilities remain under-utilised. Also, the lockdown resumption in China may continue to impact its Tianjin operation. Maintain MARKET PERFORM with a lower Target Price of RM7.50.

Challenges to continue. KESM has been in a slump since the beginning of the pandemic and is still struggling operationally despite a large part of the world entering the endemic phase. While having >90% of its revenue exposed to the automotive semiconductor space, KESM has not been able to capitalise on the strong demand compared to peers due to having a legacy product portfolio for its burn-in and test services. In a time of chip shortage, especially for automotive components that are manufactured based on matured nodes (where yield rates are already well optimised), customers are likely to cut down on burn-in processes in favour of quicker time to market. Not helping either is the fact that customers also have in-house burn-in facility which further puts KESM in an unfavourable spot when overall burn-in demand is low.

Cutting down on legacy products. Cognizant that its growth hinges on new products, KESM has started discontinuing legacy products. This will take place over the next 2-3 quarters as it gradually ramps down affected production. In addition, the group will also scale down its electronic manufacturing services (EMS) business which currently contributes less than 10% to the group’s revenue due to unfavourable margins from rising component prices.

Expanding for new products. KESM has indicated an aggressive capex plan of c.RM106m for new equipment over the next two quarters to cater for new products relating to advance driving assistance system (ADAS), tire-pressure measuring system (TMPS), power management and networking chips. However, the group does not expect to see significant impact from these new products as the qualification process takes time, especially for the automotive sector which is more stringent than the smartphone sector.

Overall, we remain cautious on the group’s aggressive capex commitment given existing facilities still running below optimal levels. Also, the latest headline on lockdown resumption in China does not bode well for its facility in Tianjin which contributes c.30% of group revenue.

Maintain FY22E CNP but reduce FY23E CNP by 28% to RM1.8m and RM7.2m respectively.

Maintain MARKET PERFORM with a lower Target Price of RM7.50 (previously RM8.30) based on 0.9x (previously 1x) FY23E PBV compared to peers’ average of 3.2x due to earnings volatility.

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 - 15 Jun 2022