CIMB Research downgrades KESM to Hold, lower target price

KUALA LUMPUR: CIMB Equities Research has downgraded KESM Industries from Add to Hold with a lower RM19.60 target price from RM22. 

It said on Wednesday that the prolonged wafer supply shortage was a downside risk, while potential accelerating recovery in wafers supply was an upside risk to our call. Wafer substrate is a key raw material for the fabrication of integrated circuit (IC) chips.  

“KESM is still facing wafer supply constraints as its customers face assembly and production yield issues, but it expects the situation to improve in 4QFY18F. We cut FY7/18-20F EPS by 9-15% to account for lower utilisation rate,” it said.

CIMB Research said KESM’s revenue rose 11.6% on-year in 1HFY18, driven by higher demand for burn-in and testing services, and capacity expansion. 

As a result of higher operating leverage, EBITDA margin expanded 2.7% pts on-year to 34.7% in 1HFY18. 

However, depreciation expenses rose 27% on-year following the addition of machinery and test equipment to support the group’s capacity expansion, while effective tax rate increased to 14.8% (vs. 12.2% in 1HFY17). Overall, 1HFY18 net profit increased 12.8% on-year to RM22.6m.  

The research house expects KESM’s utilisation rate to fall from 80% in 2QFY18 to 70% in 3QFY18F due to lower wafer supply. 

Nevertheless, it expects the group’s supply constraint issue to improve in 4QFY18F as its customers gradually improve their production yield. 

“We expect KESM to deliver steady EBITDA margin expansion in FY18-20F, with a shift in product mix towards more advanced IC chip testing and better economies of scale. 

“KESM expects to incur lower capex of RM70m in FY18F vs. RM109m in FY17.  We had earlier expected KESM to deliver higher earnings in 2HFY18F in view of resilient demand in the automotive segment. 

“However, we are now turning cautious on its near-term earnings outlook due to the wafer supply constraints at its customers. Hence, we cut FY18-20F EPS by 9%-15% to account for lower utilisation rate assumptions. 

“Meanwhile, we do not expect the appreciation in the ringgit against the US$ to have material earnings impact on KESM, given that the majority of its transactions are denominated in ringgit,” said CIMB Research.