This article first appeared in The Edge Financial Daily on September 21, 2017 - September 27, 2017

KESM Industries Bhd
(Sept 20, RM15.98)
Maintain buy with a target price of RM21.80: KESM Industries Bhd’s revenue and pre-tax profit for the financial year ended July 31, 2017 (FY17) were 2% and 3% above our expectations, respectively. FY17 earnings before interest, taxes, depreciation and amortisation (Ebitda) margin came in at 33.6%, slightly above our forecast of 33%, probably due to a higher degree of testing work undertaken.

At the core profit level, FY17 earnings were 12% above our forecasts. This was however due to a negative tax charge in the fourth quarter ended July 31, 2017 (4QFY17) and hence a lower-than-expected FY17 effective tax rate of 8% versus 15.3% in FY16. We suspect this could be due to investment tax allowance following KESM’s aggressive capital expenditure (capex) plan (RM107 million in FY17, which was nearly equivalent to its Ebitda for the financial year). The dividend per share (DPS) for the quarter amounted to six sen, bringing FY17 DPS to 12.5 sen (FY16: 7.5 sen), which was above our expectation of 8.5 sen.

Sequentially, 4QFY17 revenue rose 6% but core earnings jumped 28% due to the negative tax charge. Importantly, revenue momentum remained on an uptrend (11th consecutive quarter of sequential revenue growth), underpinned by KESM’s strong capex expansion into the automotive burn-in and test segment. Also aiding the margin expansion was the lower amount of electronic manufacturing service work undertaken. This was reflected in the lower raw materials and consumables used, which declined one percentage point year-on-year to 10% as a percentage of FY17 revenue.

We leave our forecasts relatively unchanged. Slight changes to the forecasts after taking into account minor adjustments post the results. We keep our “buy” rating on KESM for its exciting growth prospects underpinned by the strong structural growth in the automotive segment. TP is unchanged at RM21.80 (based on 17 times calendar year 2018 earnings per share). The key downside risks include a loss of customers and a reduction in the outsourcing opportunities as customers increase their in-house burn-in and test functions. — Affin Hwang Capital, Sept 20