This article first appeared in The Edge Financial Daily on April 16, 2018

SKP Resources Bhd
(April 13, RM1.63)
Reiterate buy with a lower target price (TP) of RM2: Management guided that post third quarter financial year 2018 (3QFY18), business has been as usual for SKP Resources Bhd (SKP) with orders from its main customers intact. Also easing concerns on the strengthening of the ringgit against the dollar which we opine to have somewhat affected investor sentiment on export-oriented stocks, management reiterated that the group remains largely sheltered from foreign exchange fluctuations. This is considering that the group’s cost pass through agreement with its main customers whereby any cost increases or savings are fully passed through, albeit with a time lag of about one month. In fact, with about 97% of sales in ringgit and about 50% of costs in dollar, the group is expected to benefit transitorily from the ringgit’s strength on lower procurement costs.

We remain hopeful that the group will sustain its double-digit earnings growth momentum into financial year 2019 (FY19) and FY20 (26.0% and 36.3%), underpinned by prospects of further contract awards from Customer X, its main customer. That said, as the group has yet to secure sizeable contracts of late, we expect near-term earnings to be flattish quarter-on-quarter (q-o-q) and FY19’s earnings growth to be backend loaded. For this reason, we have toned down our new contract assumption for FY19 by about RM330 million and cut our earnings estimate by 11.6% to RM163.5 million.

We believe that it is only a matter of time before the group secures further contract awards from Customer X. Recall that Customer X has a track record of robust growth owing to its innovatively designed electronic consumer products. And with more products in the pipeline, we continue to view the group as a potential beneficiary of its growth via the provision of box-build assembly services given their long and established business relationship. Furthermore, the group is in a favourable position to capture business opportunities with ample space at its latest plant in Senai, Johor (JB Site 2). To date, the plant which has the potential to enlarge the group’s capacity by 90% is only about 50% occupied.

Meanwhile, the group continues to make progress with the development of its printed circuit board assembly (PCBA) solution. Its first surface mount technology (SMT) line which is housed in JB Site 2 and designated to Customer X is currently pending qualification and expected to be commissioned in 2QFY19, a slight delay from previous target to be in 1QFY19. Then, SKP will have enhanced its capabilities as a one-stop electronics manufacturing services provider. The reduced reliance on outsourcing PCBA will not only enable the group to price more competitively but also enjoy margin expansion, albeit estimated to be marginal by about 0.5 percentage points (pp). Facilitating further business opportunities from Customer X as well as other customers, in FY19, RM10 million in capital expenditure (capex) has been earmarked to facilitate further expansion of PCBA solution.

While lowering our TP for SKP to RM2.00 per share (RM2.20 per share previously) based on an unchanged price earnings (PE) of 16 times and lower calendar year 2018 (CY18) earnings per share (EPS), we are reiterating our buy recommendation on the stock. The stock has declined by 30.7% year to date (YTD) and 32.8% from its peak of RM2.35 per share on Jan, 8 2018 and in our view, this has been overdone on uncertainties surrounding recent global trade tensions. Fellow electronic manufacturing services (EMS) peers have suffered the same fate. That aside, we continue to like the group for its earnings growth prospects of more than 20% across FY18 to FY20. The absence of new contract awards is a key risk. — TA Securities, April 13