Affin Hwang Capital
KESM was RM6.95
In the automotive sweet spot
KESM recorded a strong 2012-15 EPS CAGR of 32%. We believe the solid growth is sustainable, underpinned by focused growth in the automotive business and margin expansion from improved product mix and growth in the high-margin testing business. Hence, despite the 34% stock price outperformance ytd, we think valuations remain attractive and expect a continued PE re-rating.
Initiate coverage with a BUY and target price of RM11 based on 12x our calendarised 2017E EPS, for upside potential of 58%. Set to benefit from automotive structural growth story KESM provides a good proxy to the stable and growing automotive semiconductor segment, in our view. With strong growing demand for electronics for vehicles, from safety to infotainment and autonomous vehicles, we believe KESM is in the right segment to benefit from an automotive structural growth story.
2015-17E EPS CAGR of 35%
We forecast KESM to achieve a 3-year EPS CAGR of 35% on the expansion of its testing business in the automotive segment. Its recent investments, in our view, should gradually bear fruit in the coming years and drive revenue growth. We look for EBITDA margins to rise from 31.9% in 2015.
Further re-rating expected
We see several re-rating catalysts for the stock, including a strong earnings
upcycle and PE expansion, as awareness on the stock remains low and
institutional holdings are limited.
Initiate coverage with BUY and RM11 target price
We initiate coverage on KESM with a BUY rating, on: 1) solid growth prospects in the automotive space, a strong working relationship with customers and expansion into the testing business, which we expect to drive a 3-year-forward EPS CAGR of 35%; 2) a hands-on and forwardlooking management team; and 3) although valuation comparables are limited as competitors are mainly integrated device manufacturers (IDM), closest peer Trio-Tech (TRT US) trades at a 14x 2016E EPS. KESM also trades on average at a 56% discount to automotive-related IDMs’ 2016E PE of 20.7x. Thus, at a 2017E PER of 8x, valuation looks attractive. Our target price of RM11 (12x calendarised 2017E EPS) offers 58% upside.
KESM was RM6.69
Despite weaker performance in the global semiconductor industry, KESM’s earnings have continued to grow at a rapid clip. Between FY12 and FY15, net profits had grown by a stellar CAGR of 60%. KESM is now poised for the next growth stage following the recent acquisition of the remaining 34.6% equity interest in KESM Test as well as the successful development of proprietary process controls for Test-During-Burn-In (TDBI); both developments will enable the group to establish a stronger foothold in the resilient & high margin automotive segment. We project earnings to grow by 75.2%/13.6% in FY16E/FY17E, and recommend a TRADING BUY on KESM with a fair value of RM7.90 based on a targeted FY17E PER of 10x.
In a sweet spot.
KESM began as a company involved in burn-in services for the semiconductor industry. The company’s foray into the Testing Services industry over the years has begun to bear fruit and KESM now enjoys a market-leading position as the largest independent “Burn-in & Test” service company in Malaysia. Recently, KESM completed the acquisition of the remaining 34.6% equity interest in KESM Test (in May 2015) for RM35.0m. The automotive segment now accounts for 70-80% of revenue (UNISEM and MPI derive c.17% and 23% of revenue from the Automotive industry, respectively), with the balance coming from the commercial segment.
Betting big on the automotive segment.
KESM is well positioned to benefit from two salient trends; (1) rising global automotive sales (expected to exceed 100m units in 2017 from 91m in 2015), and (2) increased electronic chips content in cars. The value content of electronics in a car is expected to grow from USD284 to USD330 from 2014 to 2019. The automotive segment represents an area of high growth potential and has enabled the Group to diversify into a segment that offers longer product life cycle and higher margin.
FY16/17E Net Profit to grow 75.2%/13.6%. KESM’s EBIT margins have expanded from just 5.4% in FY12 to 9.5% in FY15, while its earnings have also increased at a 3-year CAGR of 60.0%. In addition to the above growth drivers, we see the trend of increasing chip content cascading down from luxury cars to mid/low range cars, anchoring top line growth for KESM’s Burn-in and Testing services over the medium-to-long term. At the same time, higher margins from the automotive IC segment as well as cost efficiency from KESM’s proprietary Test during Burn-in (TDBI) should pave the way for a 273bps/23bps improvement in EBIT margins for FY16E/FY17E.
Strong balance sheet with RM63.6m cash pile.
Despite the expansion drive these past few years, KESM was still able to maintain a net cash position (RM1.48/share). Looking ahead, we projected CAPEX to come in at RM50m/RM70m for FY16/FY17. While dividends are expected to maintain
at a modest 15% pay-out ratio (dividend yield of 1.9%), we see scope for a bonus issue, given the high retained earnings of RM219.5m and very low share capital of just RM43.0m.
Trading Buy with Fair Value of RM7.90.
We believe this under-researched
gem is due for a rerating given its unique position within a resilient segment, strong earnings delivery and cash rich position. KESM is currently trading at a mere 8.5x FY17E PER (6.6x ex-cash), compared to listed peers, which trade at an average Fwd. PER of 12.8x. We expect the valuation gap to narrow, and have derived a FV of RM7.90 based on 10x PER FY17E (+18.1% from yesterday’s close). The RM7.90 Fair Value is premised upon a 20% discount to the valuation of industry peers in view of its smaller market capitalization and tighter shares liquidity.
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