NATGATE is riding on a new wave of original design manufacturers (ODMs) seeking production diversification into Malaysia. Its recent marketing trips to China are promising potential new clients and orders by end-2023. Besides, pivoting to consignment-based on-boarding for future clients will yield higher margins and reduce inventory risks. It is expanding its total floor space by c.50% by adding 80k sq ft to Plant 5 (by Jul 2023) and an extra 248k sq ft to Plant 7 (by Dec 2023). We maintain our forecasts, TP of RM1.50 and OUTPERFORM call.

Tailwinds from China plus one policy. After our recent meeting with NATGATE, we left with a strong sense of optimism. The group’s reassurance of its bright prospects is supported by the growing number of ODMs looking to diversify their production beyond China and expressing interest in NATGATE’s capabilities. This follows the group’s multiple visits to China over the past few months, meeting various ODMs that manufacture products catered to industries such as data computing, networking, and automotive power transmission. While the group is still in talks with these prospective clients, we learnt that the discussions have been very positive with a good chance of crystallising into new opportunities by end-2023.

Strategising for margin expansion. Acknowledging the continued shortages of certain key components, the group has decided to on-board future customers on a consignment basis instead of the conventional turnkey basis. We view this development positively as it allows the group to: (i) yield higher margin with only manpower cost, (ii) mitigate raw material price fluctuation, and (iii) reduce the risk of inventory overstocking and expenses related to slow-moving goods. However, we have yet to factor in these potential catalysts pending further details.

Expansion on track. To accommodate new potential clients, the group is currently constructing a new capacity of c.80k sq ft at the third floor adding to its existing c.216k sq ft Plant 5, which is scheduled for completion by July 2023. Furthermore, the expansion of another 248k sq ft alongside its existing 227k sq ft Plant 7 is progressing as planned, with completion expected by December 2023. Overall, this will increase the group’s total floor space by c.50%.

Forecasts. Maintained as we believe our forecasts have adequately reflected its near-term growth potential.

We keep our TP of RM1.50 based on 23x FY24F PER, representing 30% premium to peers’ forward mean. We believe the higher valuation is justified by the group’s favourable exposure to the fast-growing networking product segment and its advanced capabilities which yield better margins as well as enhancing customer stickiness. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment thesis. We like NATGATE for its: (i) exposure to the fast growing industrial and commercial products used in the networking and telecommunication sectors, (ii) 4IR-ready facilities that is able to take on higher complexity jobs, and (iii) added-value services such as chip-on-board (COB) that enhance customer stickiness and yield better margins. Maintain OUTPERFORM.

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 - 15 May 2023