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This article first appeared in The Edge Malaysia Weekly on April 30, 2018 - May 6, 2018

ARE companies involved in plastic injection moulding, printed circuit board assembly and box build assembly unwitting victims of the global tech meltdown? Although their earnings growth appears intact on the whole, companies in the electronics manufacturing services (EMS) sector appear to have been dragged down by the global rout of tech stocks.

Then again, perhaps investors are merely cashing out in reaction to a stronger ringgit following the sector’s solid run last year, largely attributable to a stronger US dollar.

Well-known EMS players such as SKP Resources Bhd and VS Industry Bhd have seen more than a quarter of their market value erased year to date, both losing a combined RM2.3 billion in market capitalisation.

VS Industry registered a net profit surge of 32% to RM91.27 million for the six months ended Jan 31, 2018, while SKP Resources reported a 38% jump in net profit to RM98.47 million for the nine months ended Dec 31, 2017. However, their quarterly growth has been flattish on the whole.

Even so, TA Securities chief investment officer Choo Swee Kee tells The Edge that the recent sell-off in EMS stocks was a tad overdone as the companies’ earnings appear intact.

“I would think the sell-off was a bit overdone considering the declines averaged over 30% year to date and, generally, I don’t think anyone is expecting a 30% drop in earnings for some of these counters.

But he adds, “One very important fact that you can’t ignore is that the EMS stocks have gone up quite a bit and some investors may have taken profit.”

Fortress Capital Asset Management director Geoffrey Ng concurs. “First, EMS players had a fantastic year last year, so a lot of investors are sitting on very handsome gains. And of course, with the strengthening of the ringgit, it gives them an impetus to sell because the ringgit’s strengthening eats away the profits they earn in US dollars.

“And with the [potential] US-China trade war, it leaves a very large overhang of uncertainty — in terms of how the trade war plays out and how it will impact their order books.”

However, there could be a silver lining if a trade war materialises. An industry source says brand owners could decide to diversify their supplier base beyond China as part of long-term risk management. “This certainly spells opportunities for EMS players in Malaysia,” the source says.

But as a subset of the technology sector, the performance of EMS stocks tend to be influenced by the performance of tech stocks, particularly semiconductor counters.

Tech stocks in Asia spiralled down after the recent projection of weaker sales by Taiwan Semiconductor Manufacturing Co Ltd (TSMC), considered the bellweather of semiconductor stocks.

“The fact that TSMC, the world’s largest contract chipmaker and a key partner of Apple Inc, has projected weaker sales amid weaker demand for smartphones was enough to trigger a tech stock sell-off, and naturally, EMS players were brought down by this,” says a bank-backed analyst.

As part of the small and mid-cap space, the EMS sector has also performed in line with counters in the sphere.

In an April 4 note to investors, UOB Kay Hian notes that the EMS sector had enjoyed a valuation rerating in the second half of 2017 with valuations breaking new highs.

“Hence, the recent sell-down in the small and mid-cap space, including that of the EMS players, in the past two months may be attributable to a paradigm shift for rates amid market volatility, bringing PE (price earnings) valuations closer to their historical mean,” the firm says.

 

A closer look at the sector

PublicInvest head of research Ching Weng Jin, who covers VS Industry and SKP Resources, opines that the sell-down in the two counters was overdone.

“Reports have emerged on a key customer of VS Industry and SKP Resources ceasing the development of a product in preference to a more technologically advanced version. VS and SKP are both running lines for the existing product, which would suggest eventual loss of revenue for each company. However, both companies are confident that they will get new orders for other products to mitigate this loss,” Ching tells The Edge. “In our view, these stocks have been oversold because the companies’ longer-term prospects are still bright.”

PublicInvest has an “outperform” call on both stocks with a target price of RM2.77 for VS Industry and RM2.22 for SKP Resources. Last Thursday, VS Industry was trading at RM2.21 and SKP Resources, RM1.40.

In an email response to The Edge, the management of VS Industry says the group’s operations in Malaysia will remain the key growth driver in the next financial year owing to an increase in sales orders from clients. “At the same time, we are also working to secure new clients to add to our stable. We will continue to focus on the consumer home appliances segment, which is our area of expertise.”

To put things in perspective, SKP Resources, VS Industry and Denko Industrial Corp Bhd are among five Malaysian contract manufacturers for a certain British customer that is famed for its household appliances. It is worth noting that the three companies transact with the key customer in ringgit and are therefore cushioned from foreign-exchange fluctuations.

If the movement in the ringgit was the main factor in the sell-down of EMS stocks, then recent developments could go in their favour. For instance, the US dollar has been moving higher as the benchmark US 10-year treasury yield breached 3% for the first time in four years on Monday. The ringgit weakened to 3.9115 to the US dollar on Wednesday, compared with 3.8620 on April 2.

On the other hand, EMS companies that have seen a recent decline in earnings may need to do even more to convince investors. Salutica Bhd, which develops Bluetooth headsets, saw its shares close at 54 sen on April 4, the lowest since its listing in May 2016. It was 33% lower than its initial public offering price of 80 sen and was about 62% down year to date.

Unlike VS Industry and SKP Resources, however, Salutica and Sungai Petani-based EG Industries Bhd’s latest results showed a drop in profitability.

Salutica’s net profit for the first half of its financial year ended Dec 31, 2017, fell 23% to RM12.47 million.

Nevertheless, AmInvestment Bank — the sole research firm covering the stock — maintains its “buy” call on the company with a fair value of 82 sen.

“We understand that the company has secured two new customers in the wearable and headset segments. The group is currently in the product development and prototyping stage with the new customers, and expects the commercial launch in the second quarter of its financial year ending June 30, 2019,” AmInvestment says in an April 23 client note.

“In addition, its existing key customer is expected to launch two new products in September or October. Till then, however, we do not expect any excitement as 3Q and 4Q are historically low seasons for the company.

“The group has been recruiting more engineers to facilitate research and development activities for the new products. Management expects this to eat into profit margins in the next one to two years,” AmInvestment says.

“Putting the headwinds aside, Salutica’s one-year forward PER of 13 times appears undemanding. Its peers, SKP Resources and VS Industry, are trading at 14 times and 15 times respectively,” the firm says.

EG Industries, which is involved in printed circuit board assembly and box-build segments, reported a 21% decline in net profit for the first half of its financial year ended Dec 31, 2017, to RM11.69 million. Its share price has declined by 23% year to date to 51 sen last Thursday.

CEO Alex Kang Pang Kiang says the main revenue generator for the group remains the printed circuit board assembly and box-build segments, but it is aiming to become a full-fledged and vertically integrated player.

“We will also be establishing our third business segment of distribution in FY2018. This is especially important as our knowledge of the Southeast Asia market allows us to help customers penetrate the 650 million population, while keeping our customers’ relationships even stronger.

“Currently, we are finalising the necessary channels and we are positive that it will start contributing more substantially to the group’s revenue in the near future,” he adds.

 

 

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