LGMS’s 9MFY23 results disappointed. Its 9MFY23 core net profit fell 17% on increased headcount in preparation for future expansion. It is realigning its portfolio to optimise resources. We trim our FY23- 24F net profit forecasts by 28% and 13%, respectively, lower our TP by 12% to RM1.16 (from RM1.32) but maintain our OUTPERFORM call.

Below expectations. LGMS’s 9MFY23 earnings of RM7.5m (-16.7% YoY) came in below our expectations, accounting for only 53% of both our full-year forecast and the full-year consensus estimate. The variance against our forecast was mainly due to higher cost of sale which outpaced revenue growth.

Results’ highlights. YoY, LGMS’s 9MFY23 revenue was largely unchanged as it inched merely 1% lower. The weakness in the cyber risk management (-24%) segment and cyber threat response (-37%) segment was mostly offset by better showing from the cyber risk prevention (+12%), which makes up 76% of the group’s revenue. However, the group recorded higher cost of sales which consisted of employee benefit expense (+28%) and IT expenses (+23%) which explains the compressed margin. As a result, its net profit trended 16.7% lower.

Preparing for future growth. We understand that the group is currently in its growth phase, where the incurred costs (i.e., increased headcount and IT resources) are imperative for future readiness. Therefore, quarterly evaluations may sometimes fail to present a clear picture. For example, the tepid revenue growth in the immediate term is transient, as the group has embarked on a journey to realign its portfolio, optimising resource allocation to achieve better revenue recognition in the future. Additionally, LGMS has introduced "StarSentry" (code name: Project Mars), a plug-and-play device that seamlessly connects to users' networks, autonomously analysing all connected devices for vulnerabilities. Tailored for SMEs seeking costeffective and straightforward security solutions, this product is poised to contribute positively to the group, with a more meaningful impact in FY24. Consequently, we maintain a positive outlook on the company and the cybersecurity space it operates in.

Forecasts. We cut our FY23-24F net profit forecasts by 28% and 13%, respectively.

Consequently, we trim our TP by 12% to RM1.16 (from RM1.32) based on an unchanged 25x FY24F PER, in line with peers’ forward mean. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment thesis. We like LGMS for: (i) the high growth prospects of its core cybersecurity business given the under-penetrated local and regional cybersecurity markets, (ii) the deep moat around its business given the high barrier to entry created by the tough qualification process as a vendor, and (iii) new proprietary certification software which is expected to be the next earnings driver. Maintain OUTPERFORM.

Risks to our call include: (i) longer-than-expected gestation period for its regional expansions, (ii) economic downturn resulting in customer lowering budget allocated for cybersecurity, (iii) reluctance to spend on cybersecurity services due to the lack of knowledge and awareness in emerging countries, and (iv) failure to maintain the extensive list of accreditations due to potential loss of critical talent.

Source: Kenanga Research - 29 Nov 2023