KESM has planned another RM44m for capex in 1QFY23 for new equipment in anticipation of higher demand for burn-in and test services as it scales down its EMS segment. However, the transitioning phase will be hit by unabsorbed labour cost as well as lower utilisation rates due to ongoing lockdowns in China. We keep our forecast and MARKET PERFORM call but reduce our target price to RM6.65 on lower PBV multiple to reflect the immediate negative impact from the transition before the new capacity gradually ramps up in 2HFY23.

We came away from a meeting with KESM with the following key takeaways:

1. Despite the current dampened market sentiment, the group is still committed to its capex plans with another RM44m investment allocated for new equipment in 1QFY23, adding onto the RM100m spent in FY22. More than 90% of the capex will be catered for its Malaysian operation with the remaining going to its China plant in Tianjin. Commissioning of the new equipment will start in 2QFY23 with further ramp-up in 2HF23.

2. Scaling down of its EMS business segment is expected to be completed by 1QFY23 but there may still be unabsorbed labour cost (c.RM2m) before the burn-in and test business takes in these additional headcounts when commissioning of the new equipment starts in the subsequent quarter.

3. Operations in Tianjin, China continue to face adverse impact from the ongoing zero-Covid policy which could potentially lead to lower utilisation QoQ for 1QFY23. However, the group remains hopeful of a YoY improvement in FY23, albeit at a gradual pace.

Forecast. Maintained

Maintain MARKET PERFORM with a lower target price of RM6.65 (previously RM7.47) based on 0.8x (previously 0.9x) FY23F PBV to account for the slower performance in the immediate quarters before the commissioning of the new capacity. The average PBV of 2.5x of its peers may not serve as a good reference given that they are mostly highly profitable. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Risks to our call include: (i) expansion plans thwarted by a potential slowdown in automotive semiconductor demand, (ii) teething problems from retraining workers from its EMS segment to the burn-in segment and (iii) worsening lockdown in China that could prevent its Tianjin plant from breaking even.

Source: Kenanga Research - 12 Oct 2022