This article first appeared in The Edge Financial Daily on May 31, 2017 - June 6, 2017

SKP Resources Bhd 
(May 30, RM1.30)
Reiterate buy with a target price of RM1.60: We cut our financial year 2018 (FY18) to FY19 earnings forecasts by 1% and 1% respectively due to higher operating expenses during the years. Margins did not recover as expected, following the resolution of labour issues faced in the first half of FY17. 

The net margin came in at 5.4% versus the forecast 5.5%. As such, we lower our net margin estimate to 5.8% in FY18 from 6%. We believe margins will stay compressed and gradually improve at a slower pace due to the complexity of manufacturing new products. 

While earnings grew at 27% year-on-year in FY17, we do note SKP Resources Bhd is a high-growth company with its revenue growing at 85% y-o-y. We are still positive on SKP’s prospects and believe the stock will be rerated once the company improves its cost management and secures new contracts. 

In FY17, about 72% of revenue was derived from client D. Looking forward, we forecast this key customer to contribute an even higher portion, about 76% in the FY18 forecast. In the event its key customer reduces or terminates contracts with SKP, the latter’s earnings could be materially and adversely affected. 

However, we are not overtly alarmed by this risk, as the contract wins are on a mid-term basis. SKP currently has two significant contracts from client D worth about RM1.1 billion per annum which will run for another four to five years.

Given its long-standing relationship with client D, we are positive on SKP’s long-term prospects as it has been able to continuously secure manufacturing contracts for client D’s latest flagship products.

Key risks to our view include slower-than-expected margin recovery. SKP’s net margin dropped to 5.4% in FY17 (versus 7.8% in FY16) due to operation shifts and labour issues. While this is resolved, it will take time for SKP to gradually achieve optimal efficiency levels. 

Thus, we conservatively forecast a net margin of 5.8% for FY18. — AllianceDBS Research, May 30