UOB Kay Hian Research retains overweight on EMS players


  • Analyst Reports
  • Wednesday, 25 Mar 2020

VS Industry Bhd plant in Senai inudstrial area, Johor. UOB Kay Hian Malaysia Research said: “We prefer VS Industry as its current valuation has been overly conservative in assuming negative equities for its China operations while ignoring its valuable assets. Maintain overweight."

KUALA LUMPUR: UOB Kay Hian Malaysia Research is retaining its overweight stance on electronics manufacturing services (EMS) players has value has emerged after being battered following the Covid-19 outbreak.

In its research note issued on Wednesday, it said EMS players’ valuations have been smashed close to a minus two standard deviation (-2SD) below three-year forward mean price-to-earnings (PE) amid the aggravating Covid-19 outbreak.

“While decelerating global demand is inhibiting earnings growth (hence our earnings revisions), value has emerged in most names after the heavy sell-down.

“We prefer VS Industry as its current valuation has been overly conservative in assuming negative equities for its China operations while ignoring its valuable assets. Maintain overweight, ” it said.

UOB Kay Hian Research said the rapid spread of Covid-19 resulted in: a) minor supply chain disruption; b) slower demand on end customer’s products; and c) operational disruption from movement control order (MCO).

This has raised concerns on the sustainability of bright prospects (key beneficiary of trade diversion) and earnings risks for EMS players.

“Rounds of heavy sell-down in ATA IMS (-59% ytd), SKP Resources (-49%) and VS (-45%) sent valuations close to -2SD below their three-year mean PE. Potential earnings downside more from demand side.

“On the supply side, our channel checks revealed only minor supply chain disruption (for components) with the production shutdown in China back in mid-Feb 20. The saving grace is the ample inventory that can last for four weeks.

“Since then, EMS players have replenished the depleted inventory following the gradual resumption in China operations, ” it said.

In terms of product demand, while the EMS players have yet to see any significant orders revision from its major customers, progress in new projects has been delayed by one to two quarters due to movement restriction globally, it said.

UOB Kay Hian Research said judging from the global lockdown, we reckons that demand for electrical appliances could dwindle at least in the near term, given the products’ long lifecycle and demand elasticity.

“Note that ATAIMS, SKPRES and VS (the trio) have stopped their operations since 17 March and are still appealing for the resumption of operations. Although they are not liable for the losses (compensation to end customers) due to the case of force majeure, the companies are still bearing the brunt of operational halts which will see ineffective charge out of overheads cost.

“Our analysis shows that every 5% sales delay to EMS players’ FY20 revenue (with operation halted until March 30) will reduce their FY20 earnings by 7-8%. We also understand that margin compression will be the trend at least for 1H20, alongside higher labour costs to incentivise productivity, ” it said.

The research house while the aggravating Covid-19 outbreak is leading to business paralysis, we still like the sector for its long-term structural growth, stemming from trade diversion and continuous job wins from renowned multi-national corporation (MNC) customers.

“To err on the conservative side, we have factored in a burned down scenario based on: a) a hair-cut on sales assumptions by 2% to 14% across the trio for FY20-22, with earnings revision; and b) burned-down valuations close to -two SD below their three-year mean PE.

“Note that this is based on a U-shaped scenario whereby we assume some loss of output rather than pent-up orders. Even so, risk-reward profiles are appealing which show ample upside following the burned-down valuations.

“Our top BUY is VS (Target: RM1.03) as it remains as the prime beneficiary of the US-China trade diversion. Moreover, its current valuation has been overly conservative in assuming negative equity for its China operations, while ignoring its valuable assets, ” it said.

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