Review

• N2N reported 2QFY19 core net profit of RM2.0mn (-54.6% QoQ, -72.2% YoY). This brought 1HFY19’s core net profit to RM6.5mn (-42.6%), which came below ours and consensus estimates at 29.6% and 29.3% respectively.

• The miss was due to weaker-than-expected margins on lower contributions from higher margin implementation fees (derived from new projects) as well as higher operating expenses and tax provisions.

• 1HFY19’s revenue and core net profit declined 2.9% and 42.6% to RM53.4mn and RM6.5mn. The steep fall in earnings was due to weaker margins on the back of the aforementioned reasons. As a result, core net profit margin compressed 8.4pp to 12.1%. Operating expenses increased due to the one-off incurrence of RM0.6mn for the full settlement of the lawsuit with SAKK Consulting and RM0.7mn for the harmonisation of products from Malaysia and Hong Kong. Meanwhile, tax rates widened 19.2pp QoQ to 24.2% due to the expiry of pioneer status for one of the group’s subsidiaries.

• Meanwhile, the group’s balance sheet remained strong with a net cash position (including marketable securities) of RM111.4mn or 19.9sen/share (- 5.6% QoQ, -10.6% QoQ).

Impact

• After lowering our margin and raising tax rate assumptions, we cut our FY19/FY20/FY21 earnings estimates by 36.6%/32.0%/24.9% to RM13.9mn/ RM17.3mn/RM21.9mn.

Outlook

• While we expect FY19 to be challenging, we expect earnings to recover in FY20 underpinned by opportunities from the replacement of brokerages ageing legacy back office settlement systems as well as market share gains within existing markets across Asia (i.e., Hong Kong, Malaysia, Singapore, Vietnam, Philippines, Macau, Indonesia and Thailand).

• Meanwhile, we do not expect the political unrest in Hong Kong (~50% of revenue) to weigh on the group’s financial performance as the business model there is based on a license and rental model whereby revenue is mainly fixed i.e., comprising of one-off software license fees and fees from the rental of terminals or in other words, is independent of trade volumes.

Valuation

• Following our earnings cut and pegging to a lower PE multiple of 25.0x (previously 28.0x), -1SD to the stock’s 3-year mean, against CY20 EPS, our TP for N2N is lowered to RM0.77/share (previously RM1.02/share). Downgrade to Hold. Key risks include poor demand for new system implementation.

Source: TA Research - 22 Aug 2019