Building momentum

• 2QFY17 earnings were in-line; expect margin improvement to come in 3QFY17

• Single customer risk not alarming; secured contracts will run for another 4-5 years

• High-growth prospects on ample spare capacity and potential further high-value contract wins

• Reiterate BUY with TP of RM1.88

What’s New

• 2QFY17 net profit of RM23m (+23.3% y-o-y, +24.5% q-o-q) was in line with our/consensus expectations.

• The group registered revenue of RM456m (+74.7% yo-y, +42.4% q-o-q), supported by the increase in sales from its key customer. This is attributable to the growing popularity of a newly launched product, of which SKPRES is the sole manufacturer. Having said that, net margin dropped to 5% (2QFY16: 7.1%) due to labour issues that prevailed during the quarter.

• Taking these into account, we see improved visibility for the group’s net margin from 3QFY17 onwards, arising from; 1) the accretion of the recent hairdryer contract from its key customer, client D, 2) supported by improved operating margins from the high-value contract, and 3) resolution of the labour issues in Sept 2016.

• To recap, SKPRES has clinched a four-year contract worth RM2bn (RM500m p.a.) for manufacturing a newly launched product from its key customer. However, SKPRES would be foregoing the previous RM400m p.a. contract, for the manufacturing of a specific model of cordless vacuum cleaner. The move is to optimise and shift the existing limited labour resources to work on the higher-value product, following the government’s decision to freeze the hiring of foreign labour in Feb 2016. To ensure continued production, the group has resorted to hiring significantly higher-cost contract workers in the quarter.

• The contract awarded in Sep 2015 (contract value of RM600m/p.a. over five years) for the manufacturing of another model of cordless vacuum cleaner remains in production.

• The labour woes have been resolved with 1,000 new workers coming in batches from Sept 2016. With the labour issues being resolved recently, we see more certainty for the group’s mid-term prospects arising from the accretion of sizeable contracts.

Outlook

Single-customer concentration risk not a pressing issue. In FY16, c.55% of revenue is derived from client D. Looking forward, we forecast this key customer to contribute an even higher portion, 72% in FY17F. In the event that its key customer reduces or terminates contracts with SKPRES, the latter’s earnings could be materially and adversely affected. However, we are not overtly alarmed by this risk, as the contract wins are on a mid-term basis. SKPRES currently has two significant contracts from client D worth RM1.1bn p.a. which will run for another 4-5 years; contracts to manufacture cordless vacuum cleaners and hairdryers. Given its longstanding relationship with client D, we are positive about SKPRES’ long-term prospects as it has been able to continuously secure manufacturing contracts for client D’s latest flagship products.

New celebrated product. The recent product launch of the group’s key customer has the potential to be the next bestselling product, following glowing reviews from the Japan and UK launches. The recent US launch of the product (which is carried by large retailers) in Sept 2016 has been met with positive reviews. We are positive on the developments as SKPRES is currently the sole manufacturer for this product.

Vertically integrated manufacturer. SKPRES intends to go into the production of PCBA in the mid-term. This will complement its present tooling, plastic moulding and fullassembly operations. There will be a cost-saving opportunity as SKPRES will no longer need to purchase PCBA for the assembly of vacuum cleaners.

Well positioned for further contract awards. Only 25% of the capacity at SKPRES’ new plant in Senai, Johor has been utilised. With ample spare capacity, we believe the group is well prepared to take on more contracts. We forecast the utilisation rate to increase steadily with the addition of two assembly lines p.a. to cater for the expected increase in order volume.

Valuations

We maintain our BUY call on SKPRES with a TP of RM1.88. Our TP is pegged to FY18 PE of 13.5x, which is +1SD of its 5-year average forward PE. We believe that it deserves a premium valuation given its much stronger earnings growth than peers, especially post-resolution of its recent labour woes.

Source: Alliance Research - 29 Nov 2016