NATGATE’s FY23 results disappointed. Its FY23 core net profit declined 29% as the production ramp-up of a key client was held back by its relocation to Penang from China. The situation should normalise in FY24. We cut our FY24F net profit forecast by 5%, reduce our TP by 5% to RM1.62 (from RM1.70) but maintain our OUTPERFORM call.

Below expectations. NATGATE’s FY23 core net profit of RM60.8m (- 28.7% YoY) missed our forecast and the consensus estimate by 15% and 10%, respectively. The variance against our forecast came largely from the inability of a key client to ramp up its production,

YoY, NATGATE’s FY23 revenue declined by 32.5% due to a 50.8% plunge in the top line performance of its network and telco segment, which made up c.51% of the group’s revenue. This decline was largely attributed to a key customer that was in the process of relocating out from China to Penang, impacting the production ramp-up of new optical transceiver models. As such, there was poor absorption of cost relating to increased headcount and production lines assigned for these models prior to the mass production stage. This was partially cushioned by an uptick in orders at the data computing segment (+10.8%) as well a commendable increase in demand from the consumer segment (+424%), albeit from a very low base. Overall, its net profit fell 28.7%.

Tapping into AI servers. NATGATE is anticipating more orders to materialise in 2024 as its key networking customers transfer more products over from China to Penang. This will allow the group to ramp up its utilisation rate as there are various products that are still in the sample-built stage, awaiting ramp-up into mass production. 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 months. In addition, the group has started low volume production for a data centre customer, xFusion, with plans to initiate a gradual production ramp-up in 3QCY24, involving a higher value PCBA process.

Forecasts. We cut our FY24F earnings forecast by 5% and introduce FY25 numbers.

Valuations. Consequently, we lower our TP by 5% to RM1.62 (from 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 case. 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 - 1 Mar 2024