Given FRONTKN’s increasingly higher exposure to the semiconductor sector, we see the stock as a proxy to the industry current up-cycle. Meanwhile, growth and margin expansions will be mainly driven by increasing stake in its Taiwan subsidiary, which is undergoing capacity expansion as well as its Malaysia operations alongside better semiconductor industry’s prospect. Trading Buy with a TP of RM0.43 based on 14.2x FY18E PER.

Better portfolio exposure. Frontken Corporation is a leading service provider of surface engineering, which utilises numerous spray coating methods and mechanical repair and services know-how to improve the operational efficiency of various industries. In the span of three years, the group has switched from its focus from heavy Oil & Gas related services to higher margin semiconductor services, which contributed 70% revenue to the group as of FY16. Consequently, the group had achieved its highest CNP margin of 7.8% over the past five years.

Decent start in FY17. On its latest financial performance, FRONTKN continued to report strong 1Q17 CNP of RM5.0m (-53% QoQ, >100% YoY) which was a huge reversal from losses a year ago. This was on the back of stronger revenue (+14%) predominantly driven by higher margin services from the semiconductor customers. While the headline CNP dropped by 53% QoQ bogged down by the forex losses of RM1.7m, the 1Q17 CNP would have been better by c.9% QoQ, notwithstanding the forex impact.

Growth and margin expansions premised on the Semiconductor upcycle. According to the SIA data, April sales recorded the highest YoY growth of +21.1% since October 2010, marking the ninth consecutive YoY growth. Consequently, WSTS has once again revised its 2017/2018 growth forecasts up from 6.5%/2.3% to 11.5%/2.7%; with higher growth forecasts mainly from Sensors and ICs. Based on our correlation study on the group’s YoY growth of semiconductor business as well as the global semiconductor sales growth, the correlation is as high as 85.5% over the span of last five years with multiplier between 2.8x to as high as 12.8x. As the group’s customers are mainly from the Front-End semiconductor value chain that are now focusing on leading edge foundry technology, we believe the group will continue to enjoy better sales and high margins amid the booming semiconductor sector.

Widening its exposure to the industry supercycle. The group has recently increased its stake (from 73.2% to 84.6%) in Ares Green Technology- its Taiwan subsidiary, which provides surface treatment and advanced precision cleaning for the TFT – LCD and semiconductor industries (Foundries). Note that the group has also invested RM28m in 2016 for additional lines (which we forecast to be an additional 40% capacity) to take up additional high margin services from its key customers. On the other hand, while we are cognisant of the exposure in O&G (20% to-date) that might continue to be a drag to the group’s profitability, we understand that the group has reduced its activity to the respective sector which should limit its downside.

Trading Buy with a TP of RM0.43. Another plus point is its sturdy net cash position of RM65.7m or 6.3 sen/share as of 1Q17. We expect the group’s net cash to continue growing with the absence of major capex going forward; with a likelihood of the group to conserve the cash for earnings accretive business investment. Our TP is based on a targeted 14.2x FY18E PER which is the group’s 3-year forward PER.

Risks to call include: (i) weaker-than-expected sales from semiconductor services, (ii) continuous drag from the Oil & Gas services, and (iii) adverse currency translations.

Source: Kenanga Research - 20 Jul 2017