This article first appeared in The Edge Financial Daily on November 22, 2019

KESM Indutries Bhd
(Nov 21, RM8.61)
Maintain hold with a higher target price (TP) of RM8.21: KESM Industries Bhd’s headline net profit for the first quarter of financial year 2020 (1QFY20) of RM4.5 million showed a 98% quarter-on-quarter (q-o-q) and 72% year-on-year (y-o-y) improvement, which looks rather impressive. Nevertheless, there was a significant gain on the disposal of personal protective equipment (PPE) amounting to RM1.6 million. After excluding this and other one-off gains, its core profit of RM2.7 million was down 37% q-o-q and 10% y-o-y, reflective of the still-weak environment that KESM is operating in.

On a more positive note, we are comforted that its revenue and margins have held up steadily despite the weak environment. Its 1QFY20 earnings before interest, taxes, depreciation and amortisation (Ebitda) margin was lower by 1.1 percentage points q-o-q likely due to an unfavourable product mix but held up relatively well at the 27-29% level, as the management contained operating costs. Depreciation for the quarter also declined by 15% y-o-y, and hence put KESM in a better position once demand picks up.

We raise our calendar year 2020 target price-earnings (PE) multiple by two points to 14 times, which is above its long-term mean PE of 12 times as risk appetite for the sector improves. Our TP is raised to RM8.21 but we maintain our “hold” rating as the results did not give any sense of a sustainable recovery.

However, we still like KESM as a proxy for the semiconductor automotive space, which we believe should provide better growth prospects once global growth improves. Key downside risks include a loss of customers and a reduction in outsourcing opportunities, while upside risks include a gain of customers and a gain in outsourcing opportunities. — Affin Hwang Capital, Nov 21