Kenanga Research & Investment

Nationgate Holdings - Anchoring Position With Key Customer

Publish date: Tue, 31 Oct 2023, 09:14 AM

NATGATE is producing a broader range of products for its key customer (at the expense of the latter’s China-based contract manufacturers) as the customer relocates its base from China to Penang. Meanwhile, the pilot production line for xFusion is making steady progress, paving the way for mass production in 2QFY24. We keep our earnings forecasts, TP of RM1.70 and OUTPERFORM call.

We came away from an engagement with NATGATE recently feeling positive on its outlook. The key takeaways are as follows:

1. NATGATE is producing a broader range of products for its key customer specialising in optical transceivers as the customer relocates its base from China to Penang. This is at the expense of the customer’s China-based contract manufacturers. At present, the customer outsources 30% of its contract manufacturing to NATGATE, with the balance 70% to its China-based contract manufacturers. However, this is set to reverse over the next 18-24 months. This transition requires a complex learning and knowledge transfer process which explains a temporary earnings weakness in the immediate term which we have already factored in.

2. NATGATE will be leasing out its Plant 8 (c.248k sq ft) to the customer for its relocation from China to Penang. As such, NATGATE will need to secure additional land to accommodate order expansion from other clients. The data computing segment is currently showing signs of order recovery as the customers are focusing on finalising production of existing models before launching new models next year. Another potential growth area for NATGATE is the onboarding of a data centre customer, xFusion, which plans to initiate a gradual ramp-up in the second quarter of 2024, involving the PCBA process.

3. Overall, the group maintains a positive outlook for the future as it is currently paving the way for its customer's relocation which will eventually transform into a substantial order pipeline with NATGATE emerging as the primary contract manufacturer. Furthermore, the group's venture into data center equipment through xFusion presents promising opportunities, aligning with the increasing adoption of artificial intelligence (AI) technologies.

Forecasts. Maintained

We also keep our TP of RM1.70 based on an unchanged 25x FY24F PER. This represents a 30% premium to peers’ forward mean, 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 fastgrowing industrial and commercial products used in the networking and telecommunication sectors, (ii) 4IR-ready facilities that can 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 - 31 Oct 2023

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