Downside risk seen for KESM Industries’ earnings


CGS-CIMB Research, which maintained its Reduce call on the counter, said it was more pessimistic about the prospects of an earnings recovery in the second half following a recent meeting with the company

PETALING JAYA: Further downside risk is seen for KESM Industries Bhd’s earnings if industry demand fails to pick up in the second half of this year.

CGS-CIMB Research, which maintained its Reduce call on the counter, said it was more pessimistic about the prospects of an earnings recovery in the second half following a recent meeting with the company’s management.

The research house had met with the management last week to discuss the group’s outlook following its earnings delivery in the first half of the financial year ended July 2019.

KESM’s revenue for the period had fallen by 10.7% year-on-year, mainly due to lower demand for burn-in and testing services.

It noted that the group’s utilisation fell below 45% during the second quarter, from 50% during the preceding quarter, mainly due to tight inventory control in the supply chain in light of the US-China trade war.

“For example, the group highlighted that a few end customers are not replenishing orders but instead, they are adopting book-to-order delivery to maintain lean inventory,” it said in a note yesterday.

Despite higher contract manufacturing projects completed under the electronics manufacturing service (EMS) segment during the first half, group core net profit fell by 82%.

The decline was attributed to changes in sales mix, given that the EMS segment offers a low single digit pre-tax margin compared to burn-in and test services, which offers mid to high-teens pre-tax margin.

“Moreover, the group highlighted that the EMS is not a core business for the group, but it helps to cover the overhead cost,” the research house added.

In addition to this, it said, the group was now less optimistic about a stronger demand recovery in 2H’FY19, given the ongoing inventory adjustments and uncertainty in the global economy, particularly owing to softening demand in China.

CGS-CIMB cut its FY19-21 earnings per share forcecast by 7-30% to reflect lower utilisation due to weak burn-in and testing demand, as well as higher operating expenditure related to EMS business expansion.

It also lowered its target price to RM7, based on 12.8 times CY20 price earnings ratio (P/E), a 20% discount to its target sector P/E of 16 times.

“Stronger-than-expected demand recovery in the automotive segment is a potential upside risk to our call.

“However, we see prolonged inventory adjustments due to the trade conflict as a potential de-rating catalyst for the stock,” it said.

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