NationGate, an EMS provider to be listed on the ACE Market today, is riding on high-growth industries with the networking and telecommunication segments making up c.70% of group revenue. The demand for optical transceivers is expected to rise as data centres upgrade to 400G and 800G transceivers to cope with higher bandwidth requirements. NationGate differentiates itself by incorporating smart manufacturing platforms and offering value-enhancing services such as chip-on-board processes, allowing it to enhance customer stickiness and realise higher margins. We project strong earnings growth in FY23 (+29%) and FY24 (+21%) as its various products move into the mass production stage. We initiate coverage on the stock with an OUTPERFORM call and a TP of RM0.85.

Prepared for take-off. Despite a slowdown in the tech space, primarily among consumer electronics, NationGate is expected to buck the trend to record strong earnings growth for FY23 (+29%) and FY24 (+21%) premised on various products moving into the mass production stage starting this year until 2024 after going through qualification for the past two years. With the capacity and headcount that have already been accounted for, the increase in revenue is expected to contribute significantly to its bottom line.

Riding on high-growth industries. The group is riding on high-growth industries such as networking, telecommunication, supercomputers, industrial instruments and automotive while consumer electronics only make up <1% of group revenue. With c.70% of its revenue coming from networking and telecommunication, the group is sanguine on higher orders backed by robust forecasts from key customers for optical transceivers as data centres are seeing the need to upgrade to 400G and 800G transceivers in order to cope with the higher bandwidth requirements. In addition, there will be a trickle-down effect for edge data centres to adopt 100G transceivers, bringing low-latency experiences closer to end-users.

Value enhancing services. To differentiate itself from the traditional EMS player, NationGate incorporated ViTrox’s V-ONE smart manufacturing platform to ensure its facilities are Industrial 4.0 ready. In addition, the group also offers added value services such chip-on-board (die attach, wire bonding and encapsulation) processes which is typically seen only among OSAT players. These initiatives have helped the group retain its customers and increase stickiness as well as realising higher margins of c.9% compared to typical EMS net margins of 4-5%.

Initiate with OUTPERFORM recommendation and target price of RM0.85. Our valuation is based on FY23F PER of 18x, representing a 25% premium to peers’ forward mean. We believe the higher valuation is justified by the group’s advanced capabilities which yield better margins. We like NationGate for its: (i) exposure into fast-growing industrial and commercial products catered for the networking and telecommunication sectors, (ii) 4IRready facilities that is able to take on higher complexity jobs, and (iii) added value services such as chip-on-board (COB) that is able to ensure customer stickiness and yield better margins. There is no adjustment to our target price based on ESG given a 3-star rating as appraised by us (see Page 13).

Risks to our call include: (i) heavy reliance on the networking segment which contributes c.70% of group revenue, (ii) competition from foreign EMS players that have presence in Malaysia, and (iii) adverse impact from component shortage which could delay delivery schedule.

Source: Kenanga Research - 12 Jan 2023