NATGATE guided for recovery in production at its networking division following the completion of the customer’s relocation from China to Penang. Meanwhile, its data computing segment will be buoyed by the production ramp-up of its new AI-server and a pickup in the production of its crypto-related product as chip shortages ease. We keep our forecasts, TP of RM2.06 and our OUTPERFORM call.

We came away from NATGATE’s post-1QFY24 results briefing feeling reassured of its prospects. The key takeaway follows:

1. NATGATE is seeing recovery in its networking (optical transceivers) and telco (military communication device) divisions (1QFY24 +32% YoY), which contributes c.52% of the group's total revenue. This is as the migration of the production of the networking-related products of a major customer from China to Penang moves closer to full completion. The customer is now renting NATGATE's Plant 8 and the tenure will commence in Jul 2024. As such, NATGATE will handle increased volumes of optical transceivers (<100G modules) before transitioning to higher-end modules (200G-800G) as per the customer's allocation schedule. This transition is expected to enhance the plant's utilisation rate (currently at c.60%) and improve absorption of cost arising from the additional c.400-500 workforce hired in advance for this project.

2. We understand that the strong performance from its data computing division in 1QFY24 (+73% YoY) was primarily driven by its new server product which accounted for c.42% of the segment’s revenue. This means that the demand for its crypto-related product (making up the remaining c.58% of the segment’s revenue) remained flat as the customer was hit by chip shortages (chip sourcing rests with the customer as the job was awarded on a consignment basis). This issue was also reported by another local EMS peer producing the same product. Despite this, NATGATE remains optimistic about the overall growth of the data computing division, supported by the further production ramp-up at the server business and a gradual easing of the chip supply shortages for the crypto-related product.

3. NATGATE is in the midst of expanding its Plant 6 to 194k sq ft (from 74k sq ft) and Plant 9 to 194k sq ft (from 84k sq ft) with completion expected in end-2024. These expansions will add another 230k sq ft, making up for Plant 8 (c.248k sq ft) rented out to its networking customer. Post expansion (ex- Plant 8), the group will have a total floor space of c.1m sq ft that should adequately accommodate growth over the next two years.

Forecasts. Maintained

Valuations. We keep our TP of RM2.06 based on an unchanged 25x FY25F PER. This represents a 30% premium to peers’ forward mean, justified by the group’s favourable exposure to the fast-growing networking product segment, and its advanced capabilities which yield better margins as well as enhancing customer stickiness. 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 NATGATE for its: (i) exposure to the fast-growing industrial and commercial products used in the networking and telecommunication sectors, (ii) 4IR-ready facilities that can take on higher complexity jobs, and (iii) value-added services such as chip-on-board (COB) that enhance customer stickiness and yield better margins. Maintain OUTPERFORM.

Risks to our call include: (i) heavy reliance on the networking segment which contributes c.70% of group revenue, (ii) competition from foreign EMS players that have presence in Malaysia, and (iii) adverse impact from component shortage which could delay delivery schedule.

Source: Kenanga Research - 6 Jun 2024