Weak consumer spending, MCO seen to affect EMS

This article first appeared in The Edge Financial Daily, on March 27, 2020.
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Electronics manufacturing services sector
Maintain underweight:
The Malaysian government has extended the mandatory control order (MCO) to April 14, from March 31 previously, in view of rising new Covid-19 cases prompting the government to believe this trend may continue for some time before it reverses. 

Players in the electronics manufacturing services (EMS) sector under our coverage have halted production since the MCO implementation on March 18. 

While the government is allowing companies that are part of the supply chain of essential goods to continue production during the MCO period and has expanded the essential list to include certain products and services, for instance, electrical and electronics (E&E), EMS players are still awaiting the international trade and industry ministry's clarification and approval as it is unclear which part of E&E is allowed to operate.

A full 28-day factory closure is likely to negatively impact EMS players' earnings as they would still incur fixed costs such as rental and staff despite a temporary production halt. 

Even if they are allowed to resume production, they must operate at a minimal workforce capped at 50%, according to the National Security Council, resulting in lower production and adversely impacting their earnings.

Our year-end FBM KLCI target was lowered to 1,200 on March 16 as our gross domestic product forecast was cut to 3.3% for the year in our strategy report “A financial tsunami”. In the note, we also downgraded the EMS sector to “underweight”, from “overweight”, as our earnings forecasts were lowered 16% to 36% as well as the target price-earnings ratio (PER) multiples. 

We believe weak consumer sentiments and the global economic slowdown are likely to dampen discretionary spending, and EMS players are unlikely spared as they are mainly involved in manufacturing consumer products such as household appliances, coffee machines and pool cleaners.

In view of accelerating Covid-19 cases globally, deteriorating consumer sentiments and the MCO extension, our earnings forecasts are cut another 9% to 22%, expecting a steep 36% decline in the sector's core net profit for 2020. 

In addition to the cuts in earnings forecasts, our target 2020 PER multiple for ATA IMS Bhd and VS Industry Bhd are also lowered to 10 times, at the sector's 13-year mean PER since 2007. Our “sell” call on ATA and VS is maintained with lower target prices (TPs) of 55 sen from 90 sen and 60 sen from 85 sen respectively. 

For MTAG Group Bhd, our target 2020 PER multiple is maintained at seven times — about a 30% discount to the target PER that we apply to larger-cap EMS players under our coverage, but downgraded the rating to “sell” from “hold” with a lower TP of 20 sen, from 28 sen, as a result of the cuts in earnings forecasts. — Affin Hwang Capital, March 26