CGS-CIMB Research starts coverage of EMS sector, Overweight rating

  • Analyst Reports
  • Monday, 04 Nov 2019

VS Industry Bhd plant in Senai inudstrial area, Johor. CGS-CIMB Research said VSI, SKP and ATA form part of the backbone of a well-entrenched supply chain in Malaysia for a large common customer,

KUALA LUMPUR: CGS-CIMB Equities Research has initiated coverage on the Malaysian electronic manufacturing services (EMS) sector with an Overweight rating.

It said on Monday it has an Add rating on all three of the largest Malaysian EMS companies which are VS Industry Bhd (VSI), ATA IMS Bhd (ATA) and SKP Resources Bhd (SKP).

“We see major earnings drivers coming from: i) strong sales growth of their key common customer (2015-2018 revenue CAGR of 36.2%), backed by strong end-demand and potential new product launches, ii) potential new customer wins as a result of manufacturing diversions from the ongoing US-China trade tensions and iii) potential margin expansion by pursuing higher value-added products, ” it said in its outlook report.

CGS-CIMB Research said VSI, SKP and ATA form part of the backbone of a well-entrenched supply chain in Malaysia for a large common customer, a renowned global company best known for its aspirational home care products, which accounted for more than 70% of VSI, SKP and ATA’s collective revenues in FY19.

“Our analysis shows that these EMS players have generated FY16-19 revenue and net profit CAGRs of 37.5% and 19.2% respectively driven predominantly by orders from its large common customer.

“The Malaysian EMS players are potential beneficiaries of US-China trade tension-related manufacturing diversions, supported by Malaysia’s well-developed supply chain and supportive government policies” it said.

In addition to diversifying its customer base to generate stronger earnings growth, we believe there is also margin expansion opportunities for the EMS players, through higher margin segments such as Internet-of-Things products, and vertical integration (forecasting EBITDA margin growth of c. 50 bps over FY20-22F).

“In our view, the sector also offers: (i) attractive valuations, (ii) superior operating margins as well as ROEs against regional peers and (iii) strong free cash flows, ” it said.

CGS-CIMB Research said the sector currently trades at 12.8 times CY20F P/E, a discount to its three-year mean price-to-earnings of 13.7 times. On aggregate, the research house projects a 9.4% net profit CAGR over FY19-22F for ATA, VSI and SKP.

“Our top pick for the sector is SKP as it offers i) the cheapest P/E valuations (CY20F P/E: 12.0 times), ii) sector-leading ROEs (FY20-22F: 18.4-19.3% vs 9.0-18.1% for its peers) and iii) the highest dividend yields (FY20-22F: 3.6-4.8%) among its peers.

“Downside risks: slowdown in orders from key customers and sharp increases in operational costs, ” it said.

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