This article first appeared in The Edge Financial Daily, on April 27, 2016.
Tek Seng Holdings Bhd
(April 26, RM1.25)
Upgrade to buy with a target price (TP) of RM1.48: Tek Seng Holdings Bhd’s solar segment, which achieved a significant turnaround in the third financial quarter ended Sept 30, 2015 (3QFY15) after a production ramp-up, is expected to achieve better economies of scale in FY16 and lead the company’s earnings growth. Tek Seng’s bottom line is estimated to grow 110% year-on-year, with 66% of its net profit (after minority interest) to be contributed by the solar segment.
Tek Seng’s construction of a new plant has been completed recently. To recap, this three-storey new plant has a gross floor area of close to five acres (2ha) and can house 10 solar cell production lines. The floor space of the existing plant is fully occupied by four production lines, out of which one was installed in 4QFY15.
Tek Seng will be installing three new production lines in June 2016. All the capacities of these three new production lines (fifth to seventh line) and the fourth line will be fully taken up by a customer on a 5+5 tenure. We note that these four lines (total capacity: 350mw per annum) would have much lower margins (low single-digit profit after tax margin) than its other lines, but their profitability (estimated RM5 million to RM6 million per annum) after excluding minority interest is certain. Tek Seng can pass on any cost fluctuation (including labour) to its client since the latter has committed to a minimum take-up volume.
To recap, Tek Seng, in its recent placement, has allocated RM7 million to RM12 million for the acquisition of two solar cell manufacturing lines with a combined capacity of 140mw per annum. We understand that Tek Seng is currently in advanced negotiations with one of its existing clients to activate these two new production lines and the terms are expected to be finalised by early-3QFY16. Management expects these two production lines (eighth and ninth line) to be installed by end-FY16. All in, Tek Seng’s capacity is expected to reach 700mw per annum (from the current 300mw per annum) with nine production lines slated to come on stream by early-FY17.
Post the new capacity expansion discussed above, Tek Seng’s new plant would still have space for an additional five production lines. We understand that Tek Seng is exploring business opportunities to activate five new lines (10th to 14th line) with a US-headquartered client, that is a contract manufacturer for solar modules assembly and with plant facilities in Malaysia. We have not factored in any earnings from this potential expansion for now without a better clarity on the terms and timing.
Management guided that Tek Seng’s 1QFY16 solar cell average selling price stays firm at 38 US cents (RM1.50) per watt and will be sustainable through May. However, the selling price could soften to 36 US cents to 37 US cents per watt in June due to weaker wafer prices.
We are expecting a net profit compound annual growth rate of 40% between FY15 and FY18, with the solar segment being the key earnings growth driver. We estimate the solar segment would contribute 66%, 74% and 75% of Tek Seng’s net profit in FY15, FY16 and FY17 respectively.
The EU’s Feb 16 investigation outcome revealed that Tek Seng and its joint venture (JV) partner, Solartech Energy Corp, were not involved in the transhipment of China manufactured solar products from Malaysia and Taiwan to the EU, and hence, are exempted from the EU’s anti-dumping and anti-subsidy duties. Based on the investigation results, we see minimal risk of a dramatic drop in demand due to anti-dumping related issues in the US.
We upgrade Tek Seng to “buy” with higher TP of RM1.48 (previously RM1.20), following our earnings upward adjustment and pegged to a higher 10 times fully diluted FY17 price-earnings ratio (previously nine times). — UOB Kay Hian, April 26