This article first appeared in The Edge Financial Daily on August 28, 2019
QES Group Bhd
(Aug 27, 17.5 sen)
Downgrade to hold with a lower fair value (FV) of 21 sen: We downgrade our recommendation on QES Group Bhd to “hold” from “buy” with a lower FV of 21 sen per share (previously 30 sen per share). We reduce our financial year 2019 (FY19)-FY21 earnings forecasts by 14%-31% to account for lower equipment manufacturing revenue. Our valuation is based on a forecast FY19 price-earnings ratio of 15 times.
Its first half (1H) of FY19 core net profit of RM300,000 (-95% year-on-year [y-o-y]) came in below expectations, accounting for only 2.1% of our full-year forecast and consensus estimate.
The sharp drop in earnings was mainly due to declining sales of the equipment manufacturing division. Customers held back on orders given the uncertainty over the US-China trade dispute. The equipment manufacturing segment, which typically yields a higher gross profit margin compared with the distribution segment, only contributed 5% of revenue (versus 24% for 1HFY18).
Lower sales of the equipment manufacturing division were partially cushioned by better sales of the distribution segment (+21% y-o-y) and servicing fees (+9.8% y-o-y). Overall, revenue only dipped marginally to RM80 million (-4.5% y-o-y). The distribution segment contributed 80% of total group revenue (versus 63% for 1HFY18).
For the second quarter of FY19, QES sank into the red, suffering a core net loss of RM1.5 million. On top of a 30% quarter-on-quarter (q-o-q) fall in equipment manufacturing orders, the company also recorded an RM1.8 million impairment on trade receivables. However, revenue for the quarter under review rose 1.6% q-o-q on higher sales of the distribution segment.
Operationally, the company took a hit as its earnings before interest, taxes, depreciation and amortisation margin dropped 8.1 percentage points (ppts), while its pre-tax margin fell 8.7ppts. The precipitous revenue drop for the equipment manufacturing division led to severe margin compression.
We still like QES for its: i) manufacturing segment, which may lead to margin expansion with fully automated machines commanding average selling prices of four times higher than semi-automatic ones’; and ii) recurring revenue from its distribution and servicing business that remains defensive amid the US-China trade war.
However, we turn cautious given that the growth of the company relies significantly on the equipment distribution segment, which is facing headwinds from the trade war. — AmInvestment Bank, Aug 27