Memtech International (MTEC) - UOB Kay Hian 2018-10-12: Continued Drag From High Raw Material Costs

MEMTECH INTERNATIONAL LTD (SGX:BOL) | SGinvestors.io MEMTECH INTERNATIONAL LTD (SGX:BOL)

Memtech International (MTEC SP) - Continued Drag From High Raw Material Costs

  • Key takeaways from our recent Asian Gems Investor Conference:
    1. high raw material costs could continue to drag gross margin;
    2. tighter environmental and labour regulations in China could lift operating costs; and
    3. expect a better 2019 on more new projects, but near-term outlook could remain soft.
  • We cut our 2018-20 net profit forecasts by 4.6-5.0%, and our target price by 12.0% to S$0.95, based on peers’ average 2018F PE of 9.8x (from 10.7x). 
  • Maintain HOLD. Entry price: S$0.75.



WHAT’S NEW 


Softer gross margin due to high raw material costs.

  • Memtech International’s (Memtech) gross margin was weaker than expected in 2Q18 due to higher costs of raw materials - silicone rubber and plastic resin. Margins could stay weak as raw material prices remain elevated due to supply shortages from a factory shutdown and higher oil prices. Memtech has little room to pass on the increase in raw material prices, aside for negotiating for a lower cost-down.
  • On the other hand, Memtech could quote for higher prices for new contracts to incorporate the higher raw material costs.

Higher operating costs due to tighter regulations.

  • Tighter regulations from the Chinese authorities in enforcing social insurance payment and more stringent environmental rules could increase future operating costs of Memtech. Labour costs could continue to rise and regulatory compliance cost could also be higher than expected.
  • On the bright side, this could weed out the weaker manufacturers and incumbent players could end up with more market share.

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Expect a better 2019 from automobile and consumer electronics.

  • Although 2018 is likely to be a soft year due to weaker consumer sentiment, operations could improve from 2019, driven by more new projects and mass production in the automobile and consumer electronics segments. Memtech expects more new projects from a major US MNC client as it targets to produce more products gradually. It is also exploring new projects with customers in the healthcare and other segments.


STOCK IMPACT 


Seasonally stronger 2H18 but gross margin could remain weak.

  • Memtech’s business in 2H18 could get a lift from:
    1. better seasonality as most customers in the automotive and consumer electronics segment ramp up production going into the year-end holiday season; and
    2. more new projects, especially for a major US MNC client in the consumer electronics segment.
  • On the flip side, gross margin weakness could persist as Memtech could not pass on the higher raw material costs to customers.


EARNINGS REVISION/RISK

  • We cut our 2018-20 net profit forecasts by 4.6-5.0% due to weaker gross margins from high raw material prices and higher regulatory costs.
  • Risks include higher-than-expected raw material costs, unfavourable forex rates, further pricing pressure from customers and lower-than-expected utilisation.


VALUATION/RECOMMENDATION

  • Maintain HOLD but we cut target price by 12.0% to S$0.95, pegged to peers’ average 2018F PE of 9.8x (from 10.7x) following the sector’s de-rating. Entry price is S$0.75.


SHARE PRICE CATALYST

  • Lower raw material prices.
  • Faster-than-expected ramp-up at a new US MNC customer.
  • Potential privatisation.





Nicholas Leow UOB Kay Hian | http://research.uobkayhian.com/ 2018-10-12
SGX Stock Analyst Report HOLD Maintain HOLD 0.95 Down 1.320



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