SKP Resources Bhd (SKPRES), an Electronics Manufacturing Services (EMS) provider with clientele base comprising the world’s largest electrical appliance players, is principally involved in the manufacturing of plastic components, precision mould making, advance secondary processes, sub-assembly of electronics equipment and full turn-key contract manufacturer. The group has remained profitable for the last ten financial years and achieved a 10-year NP CAGR of 12.6%, overcoming the ups and down of a few challenging economic cycles. We like SKPRES for its (i) solid reputation in the industry with world-class manufacturing capability, which warrants higher chances of it winning other contracts in the near to medium term, (ii) resilient earnings prospect (at a 2-year NP CAGR of 93%) backed by its on-hand long term contracts from the top-notch home appliance maker, Dyson, (iii) earnings accretion from the acquisition of Tecnic, and (iv) strong Balance Sheet and healthy Operating Cash Flow which will support its generous Dividend Payout Policy of no less than 50% from its PATAMI (translating into decent dividend yield of 2.7%-4.7%). We initiate coverage on SKPRES with an OUTPERFORM call at a target price (TP) of RM1.76. This is based on a targeted 14.0x FY17E PER, a multiple which is 20% higher from its EMS industry peers. The premium valuation is justified, backed by its robust 2-year NP CAGR of 93% as well as the higher-than-industry (yet sustainable) margins backed by its cost pass through mechanism.

Reputable EMS player that has remained profitable for more than a decade enduring different economic cycle. SKPRES was established in 1994 in Johor and has since grown to become one of Malaysia’s largest and fastest growing integrated contract manufacturers. Today, it provides one stop solution/full turnkey project management to its clientele in various industries. Its sound track record in execution has won itself a solid reputation with the world’s biggest names such as Dyson, Pioneer, Hewlett Packard, SONY, Panasonic, Fujitsu, Flextronics, Fisher & Paykel and others. Notably, the group has remained profitable for the last ten financial years and achieved a 10-year NP CAGR of 12.6%, riding out different economic cycles. Besides securing contracts from various customers, the group’s profitability was also partly backed by the cost pass through mechanism which has helped to stabilise its operating margins. Today, SKPRES still maintains back-to-back arrangements with its customers and appointed vendors to negotiate the purchase price of resin, packaging and component parts on a monthly basis.

Long-term contracts to anchor robust 2-year NP CAGR of 93%. We are sanguine on the group’s long term prospects, having learnt that its expansionary plan is on track. Recall that the group had acquired a 2h.a. land in Senai Johor and allocated a total capex of RM34.0m for an additional capacity expansion of 90% in FY17. Since then, two major contracts have been secured from its major customer Dyson, with the first one being announced on May 2015 (contract value of RM400m/year over the next five years for the first model of cordless vacuum cleaners) and another 5-year contract worth RM3.0b (or RM600m/year over the next five years for the second model of cordless vacuum cleaners) which was announced in September. We are also comforted by these new contract announcements as it signals Dyson’s confidence in SKPRES’s capability, which would boost its chances of securing other contracts in the near to medium term for other products. Beyond that, we also understand that the group has already involved in the development phase of new products that should take up another 20-30% capacity in the medium term, if all goes well.

Realising synergistic benefits from the acquisition of Tecnic. Note that Tecnic’s financials have already been consolidated into the group’s earnings from 1Q16. In terms of synergistic benefits, we understand that SKPRES is not only able to leverage on the additional production capacity of Tecnic (for its plastic injection business), but also on the its wider clientele base which is well-spread over a diverse range of industries. Additionally, Tecnic’s capability as one of the largest and leading precision, mould design and fabrication company would also complement SKPRES’s plastic injection moulding business which allows SKPRES to offer wider range of value added services and better mould customisation to its customers. Meanwhile, higher operational efficiency could also be achieved through enlarged networks of customers, consolidation of operations, and elimination of duplicate resources within the enlarged group as well as potential increase in efficiency and effectiveness of its marketing and distribution channels.

Earnings estimation. We are estimating the group to register NP of RM89.8m (+112% YoY) in FY16E, followed by a robust NP of RM157.3m (+75%), with key earnings assumptions being a 2-year revenue CAGR of 93% on the back of (i) the recent two major contracts secured (translating into RM200m for FY16E revenue and RM1b for FY17E revenue, (ii) Tecnic’s full revenue contribution from FY16 onwards with an organic growth of 8% annually, and (iii) 5% YoY organic growth assumptions for its existing businesses with other customers, as well as a NP margins assumptions of 7.6%-7.7% in FY16EFY17E. Note that we have yet to factor in the potential contracts (on new products) that SKPRES might secure in the short to medium term. All in, our FY16E/17E FD EPS (assuming full conversion of warrants totalling to 180m) are at 7.2sen/12.6sen.

Source: Kenanga Research - 10 Dec 2015