This article first appeared in The Edge Financial Daily on November 25, 2019 - December 1, 2019

QES Group Bhd
(Nov 22, 21.5 sen)
Downgrade to hold with a lower fair value (FV) of 21 sen: QES Group Bhd recorded RM800,000 core profit in the third quarter for financial year 2019 (3QFY19), bringing the cumulative nine months of FY19 (9MFY19) core profit to RM3 million. This is after excluding its net one-off loss of RM1.7 million mainly from impairment loss on trade receivables. The results fell below our expectations, accounting for only 30% of our full-year forecasts. The variation from our forecasts was due to the weaker-than-expected 3QFY19 results.

Its 9MFY19 core profit dove 71% despite revenue declining by 10% mainly due to worsening performance of its manufacturing division.

The distribution division comprises of product distribution and services, and supply of spare parts. Distribution revenue rose 6% mainly due to increased deliveries of engineering solutions. The division contributed 94% of the group’s revenue in 9MFY19 (versus 80% in 9MFY18).

Manufacturing division’s revenue plunged 74% due to fewer deliveries of its automated optical inspection (AOI) products and delayed deliveries of equipment at the customers’ request. Despite commanding higher margins than the distribution division, manufacturing contributed only 6% of the group’s revenue (versus 20% in 9MFY18).

On a quarter-on-quarter (q-o-q) basis, 3QFY19 revenue declined 2% as distribution revenue fell despite being partially offset by higher manufacturing revenue. However, 3QFY19 core profit rose 11% q-o-q as 2QFY19 had an RM1.8 million impairment loss on trade receivables.

Moving ahead, the manufacturing division would benefit from the inclusion of two new AOI products, that is to say its post-dicing inspection and post-proving inspection with beta testing targeted by March 2020. QES Group has a potential securement of new orders for a customised solution for 200 machines that could contribute approximately RM19 million to its revenue in 2020.

Although we like QES Group for its potential in its manufacturing division and the resilience of its distribution division’s recurring revenue, we are cautious given the equipment distribution segment, which contributes the bulk of its earnings, is facing headwinds from the trade war.

We downgrade QES to “hold” from “buy” with a lower FV of 21 sen a share (previously 28 sen a share), based on an FY20 forecast (FY20F) price-to-earnings (PE) of 12 times. We cut our FY19F-FY21F forecasts by 24-53% due to the slower-than-expected improvement in the semiconductor market as customers continue to delay orders amid US-China trade war jitters. — AmInvestment Bank, Nov 22