This article first appeared in The Edge Financial Daily on November 26, 2018

Scicom (MSC) Bhd
(Nov 23, RM1.61)
Downgrade to hold with a lower target price (TP) of RM1.80: Scicom (MSC) Bhd’s first financial quarter ended Sept 30, 2018 (1QFY19) core net profit slipped by 7% quarter-on-quarter (q-o-q) to RM5 million due to lower contributions from the Business Process Outsourcing (BPO) segment and higher overheads or upfront costs of the Cambodian tourism project, partly cushioned by higher earnings from the s-solution segment.

BPO revenue declined unexpectedly for 1QFY19 due to lower ad hoc projects and lower activities from a main client.

While the e-solution segment delivered higher profit driven by a higher number of applications processed (+38% q-o-q), the increase was not sufficient to offset the weakness elsewhere.

All in, the results were below market and our expectations. Its 1QFY19 core earnings only accounted for 11% of the street’s and our full-year earnings forecasts.

The earnings miss was due to weak BPO revenue and a low overall earnings before interest, taxes, depreciation and amortisation (Ebitda) margin.

Compared to 1QFY18, Scicom’s core net profit fell by a steep 55% year-on-year (y-o-y) due to lower revenue (-16% y-o-y), a weaker Ebitda margin (-8.8 percentage points to 20.6%) and normalisation of the tax rate to 24.6% (from 7.5%).

Notwithstanding the steep earnings decline, Scicom maintained its 1QFY19 dividend per share of two sen.

We understand that the Cambodian tourism management system is on schedule to be launched by end-2018. However, discussions on the utilisation of the tourist development fund are still ongoing.

As such, we believe that Scicom may only realise the full revenue potential starting financial year 2020.

We have cut our FY19 to FY21 earnings per share forecasts by 21% to 29% after incorporating: i) lower revenue or profit contributions from the BPO business as BPO business activities did not recover as fast as our earlier expectations; ii) a delay in the recognition of earnings from the Cambodian tourism project to the third quarter of calendar year 2019 (3QCY19) (from 4QCY18) on lower revenue or profit; and iii) weaker profit from the e-solution segment, taking the cue from the weak results and after updating our earnings model based on disclosures in Scicom’s FY18 annual report.

We have downgraded Scicom to “hold” (from “buy”), with a lower 12-month TP of RM1.80 (from RM2.76) based on a lower 17.5 times CY19 estimated price-earnings ratio (CY19E PER) from 20 times.

We have now pegged our target PER multiple at its five-year historical average (from +1 standard deviation).

At its current valuation of 16.5 times CY19E PER or 5.3% yield, Scicom’s valuation looks fair.

The soft immediate earnings outlook (a lacklustre BPO segment and timing uncertainty over the Cambodian project) is balanced by good long-term business prospects (expertise in the e-solution segment), and supported by its strong balance sheet (RM51 million net cash) and 5.3% yield.

Key upside risks include a robust recovery in BPO activities, strong contributions from the Cambodian project and the securing of major e-solution contracts.

Downside risks include further delays or renegotiation of the Cambodian tourism project and weaker-than-expected revenue from the BPO and e-solution segments. — Affin Hwang Capital, Nov 23