CIMB Research starts coverage of KESM with Add and target price of RM22

KUALA LUMPUR: CIMB Equities Research has initiated coverage of KESM Industries, which provides “burn-in”, testing and electronics manufacturing services to global semiconductor companies, with an Add and RM22.00 target.

It said on Thursday the RM22 target price was based on 13.5 times CY19F P/E, at a 10% discount to the Malaysian outsourcing semiconductor assembly and test (OSAT) providers' average of 15 times.
 
“We think the discount is justified as KESM is a smaller test service provider by market cap compared to Inari, MPI and Unisem. We see stronger earnings delivery and higher dividend payout as potential re-rating catalysts,” it said.

CIMB Research said the burn-in and testing process is crucial for semiconductor components going into automotive electronics, given the more stringent quality requirements versus components for consumer and industrial electronics applications.

KESM recorded an impressive earnings per share (EPS) compounded annual growth rate (CAGR) of 59% in FY14-17, driven by robust demand for testing from the automotive industry due to growing global vehicle sales volume and rising electronics content adoption in the automotive industry. 

KESM derives most of its revenue from the automotive segment (70%-80%), higher than its local peers such as MPI and Unisem, which on average have 25% revenue exposure to automotive.    
 
CIMB Research said McKinsey & Co projects automotive semiconductor demand to grow at 2015-20F CAGR of 6%, higher than overall industry CAGR of 3%-4%. It expects the growth to be driven by higher vehicle sales and rising electronics content in vehicles. 

IHS Markit forecasts the electronics content value to rise from US$312 per car in 2013 to US$460 in 2022F due to increasing safety, comfort and connectivity requirements. 

“We expect KESM to benefit from the growing demand for integrated circuit (IC) testing to support these new features.  KESM is also a beneficiary of the automotive industry's shift from internal combustion engines (ICE) to electric vehicles (EV),” it said. 

Member countries of the Electric Vehicle Initiative (EVI) target 30% market share for EVs in their respective markets by 2030F from less than 1% currently. 

McKinsey & Co estimates that a hybrid EV (HEV) contains about US$900 worth of semiconductors, while a standard EV has more than US$1,000 worth. 

“We expect KESM to record robust FY17-20F net profit CAGR of 20%, driven by strong automotive semiconductor IC testing demand. 

“Moreover, its capacity expansion will support earnings growth, in our view. KESM raised its capex from RM42mil in FY16 to RM110mil in FY17 to add new testing capacity. We estimate the new capacity expansion raised KESM’s testing capacity by 20% in FY17,” said the research house.