This article first appeared in The Edge Malaysia Weekly on June 25, 2018 - July 1, 2018
IN the red a mere two years ago, Denko Industrial Corp Bhd is looking to chart record-breaking top- and bottom-line figures for the financial year ending March 31, 2019 (FY2019), on a surge of box-built orders from existing customers.
Acquiring Integrated Manufacturing Solutions Sdn Bhd (IMS) — a company co-owned by Denko’s executive chairman Datuk Seri James Foo and CEO Datuk Fong Chiu Wan — provided the electronic manufacturing service (EMS) player a swift boost in earnings as it was able to tap the former’s key customer.
This makes it the largest contract manufacturer out of five local suppliers. The key customer, which Denko did not wish to name, contributes about four-fifths of its revenue.
Prior to the completion of the acquisition in February this year, Denko had posted a net loss of RM11.34 million in FY2017 on the back of RM101.6 million in revenue. For the full FY2018, Denko’s net profit grew 16.91% year on year to RM92.51 million while revenue increased 27.2% to RM2.31 billion.
Notwithstanding the record FY2018 earnings, Foo tells The Edge in an interview, “We expect the momentum to continue and to see double-digit, top- and bottom-line growth in FY2019.”
Moreover, Denko expects an improvement on last year’s gross profit margin of 7% as the company has renegotiated pricing terms with its customers. In addition, following the improved earnings, Denko is aiming to declare a maiden dividend in FY2019 and to pay out at least 35% of its profit.
Sustaining growth momentum
But with too many eggs in one basket, Denko is seeking to be less dependent on its single largest customer. In addition to expanding its customer base, it also wants to diversify into other industries. And in an attempt to reduce costs, it plans to add more manufacturing activities to its in-house facilities rather than sourcing externally.
To improve efficiency and quality through automation, it will allocate RM75 million to RM100 million in capital investment annually for machinery and equipment, to be funded through a combination of internal funds and bank borrowings.
“For FY2019, the growth momentum is still there, but at the same time we have to look for something in FY2020. We are looking at other business opportunities to grow our revenue in case of any negative sentiment in the market,” says Foo.
Ramping-up production capacity
As orders are expected to build up, Denko has been ramping-up its production capacity to keep up with demand. Currently, at 90% plant utilisation, Denko’s total production capacity is worth RM2.8 billion to RM3.1 billion.
With three additional facilities planned for FY2019, Foo says Denko’s production space is expected to increase 49% to 1.15 million
sq ft by end-July, and its warehouse space by 55% to 327,630 sq ft by August this year.
But its expansion plans are far from complete. In FY2020, Denko intends to further enlarge its production capacity by injecting about RM60 million for plants and machinery in an attempt to achieve revenue of RM3.5 billion.
Staying focused on Malaysia
In spite of offers to branch out overseas, Denko prefers to remain focused on the local market as it believes its abundant growth potential remains largely untapped.
“There are customers that have invited us to invest overseas, but the way we [want to] manage our business is to be very, very focused here, instead of focusing on too many other areas,” Foo says.
Given the company’s earnings, it is not surprising that there have also been proposals for mergers and acquisitions from local and overseas firms.
AmInvestment Bank Bhd forecasts that Denko will see net profit of RM131 million and RM161.6 million in FY2019 and FY2020 respectively, on revenue of RM2.81 billion and RM3.49 billion.
UOB Kay Hian analyst Fong Kah Yan’s projections are similar — earnings of RM128 million and RM163 million in FY2019 and FY2020 and revenue of RM2.86 billion and RM3.38 billion.
Foo says the company is not short of proposals and opportunities and that the right business model can add value for the shareholders. “But at the end of the day I have to ensure the return on investment is there.”
Expensive compared with peers
Denko had been a penny stock trading below 50 sen apiece since the end of 2004. Currently, it is trading at about RM1.50, a threefold gain over the past 1½ years. Its share price saw a sudden surge at end-January last year after Foo launched a conditional voluntary takeover offer via his wholly-owned Oregon Technology Sdn Bhd.
Foo is also the founder and CEO of ATA Industrial (M) Sdn Bhd. (At an extraordinary general meeting on July 12, shareholders will be asked to approve Denko’s name change to ATA IMS Bhd.)
Foo describes Denko’s share price performance as “very reflective”.
“Compared with our peers, I think we are still in good shape. We are comfortable with our current share price,” he says.
An analyst at a local research house says Denko is “more expensive” than SKP Resources Bhd and VS Industry Bhd. According to Bloomberg, Denko is trading at 13.5 times forward price-earnings ratio (PER) against 11.1 times for SKP and 13.1 times for VS Industry.
Also, Denko’s shares are more illiquid as nearly three-quarters are held by management, with Foo holding an indirect 50.1% stake. Malaysian funds own 12.3%, foreign funds 5.2%, and retailers the balance.
Only two research houses cover Denko. AmInvestment has maintained its “buy” call with an unchanged fair value of RM1.76 per share based on a CY2019 PER of 13 times, while UOB’s Fong initiated coverage in April with a “buy” call and target price of RM1.75 based on 13 times 2019 earnings per share.
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