Target Price : RM7.06 ↔ KESM’s 1HFY24 results met expectations, recording a third consecutive quarterly profit. Its revenue improved 15% on better showing from the automotive segment. However, we remain cautious of continued drag from its non-automotive division. We maintain our forecasts, TP of RM7.06 and MARKET PERFORM call.

KESM’s 1HFY24 core net profit of RM1.1m (vs. net loss of RM3.8m in 1HFY23) made up 41% of both our full-year forecast and the full-year consensus estimate. We consider the results to be within expectations as we expect further improvement in 2HFY24.

YoY, KESM’s 1HFY24 revenue increased 15.2% on a better showing from its burn-in and test services which process automotive chips. This followed a portfolio realignment and capacity restructuring a couple of quarters ago to gradually migrate into newer chips while ramping down the production of legacy products. Inevitably, the major replacement of new equipment led to a 24% increase in depreciation as additional machinery and test equipment were commissioned for use in the production. There was also a 12% increase in other expenses due to higher utility cost. However, the group still managed to remain profitable with core net profit at RM1.1m in 1HFY24 compared to a RM3.8m net loss in 1HFY23.

QoQ, its 2QFY24 revenue inched down by 2.8% but net profit declined by a sharper 84.9% due to the absence of realised forex gains, coupled with increased depreciation on the commissioning of a higher number of new equipment.

Outlook. Despite the encouraging earnings continuity, we maintain our cautious stance due to the group's less-than-stellar track record.

Meanwhile, the group has completed the qualification for most of its new equipment to be certified for mass volume production. The new equipment enables the group to take on more advanced chips from the automotive sector as adoption of electric vehicles continues to grow. On the other hand, the demand in the non-automotive sector remains soft and hence the new capacity catered for this business segment will still likely weigh on the group, albeit marginally.

Forecasts. Maintained Valuations. We also keep our TP of RM7.06 based on an unchanged FY24F PBV of 0.85x, in line with companies in the technology-related space that are loss-making or barely breaking even, i.e. JCY, ATAIMS and JHM (MP; TP: RM0.70) to reflect its earnings volatility. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment case. We like KESM for: (i) its presence in the promising automotive semiconductor space, (ii) being one of the largest independent burn-in and test service providers in Malaysia potentially benefiting from MNC expansion here, and (iii) its physical presence in China riding on the Chinese government’s ambitious plans for its semiconductor industry. However, we remain cautious over the immediate term as the group still faces potential risk of sub-optimal loading volume during the transitionary period. Maintain MARKET PERFORM.

Risks to our call include: (i) slower-than-expected ramp-up in the production volume under burn-in and test services, (ii) slower-than- expected adoption of new semiconductor modules in automobiles, and (iii) a sharp decline in customer forecasts.

Source: Kenanga Research - 8 Mar 2024