We spoke with KESM’s management recently and renewed our optimism on the company’s prospects. With the recent 9M17 report card demonstrating a marked acceleration on CAPEX of RM81.2m as compared to RM30m for the entire FY16, and coupled with a faster-than-expected ramp up of prior quarters’ new testing equipment, we now believe our prior estimates are overly conservative. Post increasing our CAPEX assumptions and factoring higher utilisation rate of existing machineries, we upgrade our FY17E/FY18E NP growth to 33.0%/16.4% from 26.5%/14.1% and introduce FY19 estimates. At the same time, we roll over our valuation base year FY18 to CY18 for a higher TP of RM17.60 based on 15x PER. Impressive set of 9M17 numbers. To recap, KESM delivered a strong set of 9M17 results with revenue growing 17.5% YoY to RM248.2m and NP jumping 35.1% YoY to RM30.6m. The strong top-line results were driven by capital investments in prior quarters which allowed the Group to capitalise on the higher demand for burn-in and testing services. Meanwhile, EBIT increased by a larger quantum of 26.6% with margins expanding 1.0ppt to 14.0%. Effective tax rate also came in lower by 3.1ppt at 12.7% resulting in higher net margins by 1.6ppt to 12.3%.
9th straight quarterly revenue growth. Of note, the shift in focus towards burn-in and testing of semiconductors for the automotive industry is paying back in droves. Automotive semiconductors account for 70-80% of revenue base and provide the Group with longer product life cycles and a recurring business (3-7 year life cycles compared to the commercial segments which averaged at the lower end of the 1-7 year life cycles and with more volatile demand). The smoothened quarterly delivery has been apparent, evidenced by the 3Q17 numbers providing a ninth-straight sequential improvement to quarterly revenue.
CAPEX plans to accelerate. After a slowdown in expansion plans in FY16 due to the delayed roll-outs from its clients, KESM is poised to achieve a record year on capital investment spend for FY17. The 9M17 quarterly statements reflected RM81.2m in CAPEX which is already more than double the entire FY16 CAPEX of RM30m and exceeds our full-year expectation of RM75m. We understand from management that the current pace in CAPEX is likely to continue into the immediate quarters ahead, with focus on the addition of testing equipment (~70%) for automotive semiconductors and the balance for upgrading and maintenance of existing machineries (~30%).
Increasing estimates! We adjust our CAPEX assumptions for FY17E/FY18E to RM120m/RM80m from RM75m/RM80m, taking into account the current trajectory of expansion within the testing business. We gather that commissioning of new testing equipment takes 3-6 months with ramp-ups in production progressing in synchrony with the planned roll-outs of KESM’s clients - leading us to assume a higher combined utilisation rate of 82%/84% (+2ppt). Consequently, we raise our revenue forecasts and hence FY17/FY18 net profits by +5.2%/+7.3% to RM40.8m/RM47.5m and introduce FY19E NP of RM54.6m.
Maintain OUTPERFORM with higher TP of RM17.60. Post model adjustments and rolling over our valuation base year from FY18E to CY18E, we derive a higher target price of RM17.60 from RM15.20 based on an unchanged target PE of 15x. We continue to like KESM and believe the company is uniquely positioned to benefit from two salient trends; (i) Rising car production by global automakers, and (ii) Increased chip content within vehicles. Risks to our call include: (i) lower-than expected sales and margins, and (ii) longer-than-expected gestation periods.
|KESM (9334) - KESM Industries Berhada - On a Strong Expansion Cycle!|
Source: Kenanga Research - 5 Jul 2017