Frencken Group - DBS Research 2019-08-13: Industrial Automation Bolsters Earnings


Frencken Group - Industrial Automation Bolsters Earnings

  • FRENCKEN GROUP LIMITED (SGX:E28)'s 2Q19 net earnings above expectations, boosted by Mechatronics Division.
  • Moderate 3Q19 revenue growth expected on medical and industrial automation.
  • Tweak FY19F and FY20F earnings up by 3%.
  • Maintain BUY with higher Target Price of S$0.80.

Strong 1H19 despite global headwinds; medical and industrial automation to drive 3Q19 growth.

  • Frencken Group’s 1H19 earnings jumped 43.5% y-o-y despite a challenging macroeconomic backdrop. We expect the company’s medical and industrial automation segment to continue to drive growth in 3Q19. Frencken Group’s strong presence in a wide variety of industries and business segments - Automotive, Analytical & Life Science, Medical, Semiconductor and Industrial & Industrial Automation provides greater resilience and stability.
  • At 7.6x FY19F and 7x FY20F earnings, Frencken Group is trading at about 30% discount to its peers’ average of c.11x price-to-earnings (PE). In our view, this discount is too steep. See Frencken Group's share price.
  • Frencken Group is supported by a dividend yield of about 4%, based on a 30% payout ratio. See Frencken Group's dividend history.

Where we differ:

  • We use a lower PE multiple of 8.5x, which is at a 20% discount to its peers’ average given the Frencken Group’s smaller scale.

Potential Catalysts:

  • Positive outcome from US-China trade negotiations;
  • Better operational efficiency to improve margins;
  • Turnaround in the semiconductor industry in which Frencken Group has c. 20% revenue exposure.

WHAT’S NEW - Lifted by industrial automation

2Q19 boosted by Mechatronics Division.

  • Frencken Group’s 2Q19 revenue increased (+11.5% y-o-y) to S$164.3m due to higher sales at the Mechatronics Division which compensated for softer sales at the Integrated Manufacturing Services (IMS) Division. The Mechatronics Division posted revenue growth (+16.7% y-o-y) of S$133m mainly due to strong sales by the industrial automation segment. The Medical and Analytical segment posted a modest increase in sales but the Semiconductor segment was weak (-22.7% y-o-y) due to the industry’s cyclical downturn.
  • The IMS Division registered a marginal sales decline (- 5.0% y-o-y) to S$31.7m in 2Q19 mainly due to reduced sales in the Consumer & Industrial Electronics and Tooling segments. The Automotive segment recorded stable sales (y-o-y).
  • Frencken Group’s 2Q19 net profit of S$11.1m (+58.7% y-o-y, +29.2% q-o-q) accounted for 31% of our forecast while revenue accounted for 24% of estimates. In 1H19, revenue / net profit accounted for 48%/55% of our full year estimates and exceeded expectations on the earnings front.

Higher GP margin due to improved product mix.

  • 2Q19 gross profit (GP) margin improved to 17.0% from 16.4% in 2Q18 mainly due to higher margin contribution from the Mechatronics Division.

Business diversity to neutralise challenging outlook.

  • The macroeconomic backdrop is expected to remain challenging in the second half of FY2019 due to continued uncertainties over the global trade environment and extent of the cyclical downturn in the semiconductor industry. Frencken Group’s business diversity should provide greater resilience and stability to the group.

Outlook for 3Q19:

Moderate revenue growth (y-o-y) for medical and industrial automation segment; semiconductor flat; analytical and automotive weaker.

  • The medical segment is expected to show moderate revenue growth (y-o-y) in 3Q19 due to increased sales to customers in Europe and Asia. Revenue of the industrial automation segment, which is typically lumpy, is expected improve marginally (y-o-y). On a q-o-q basis however, sales in this segment should be softer compared to 2Q19.
  • The semiconductor segment is anticipated to post stable revenue in 3Q19 compared to 3Q18. Revenue from the analytical segment is expected to ease (y-o-y) mainly due to slower orders from customers in Europe. The automotive segment is expected to post softer revenue compared to 3Q18.

Tweak FY19F and FY20F earnings up by 3% on higher margin assumption. Maintain BUY with higher Target Price of S$0.80.

  • We have tweaked our revenue forecasts lower by 4%, mainly to account for the moderate/negative growth for the semiconductor, analytical and automotive segment, partly offset by stronger growth for the industrial automation and medical division. Net profit is adjusted higher by 3% for FY19F and FY20F, as we raised net margin to 5.7% from 5.3% previously. Frencken Group continues to implement multiple initiatives to drive productivity and improve operational efficiency.
  • Our Target Price is raised accordingly to S$0.80 on the company’s higher earnings, still pegged to 8.5x PE which is a 20% discount to its peers’ average PE given Frencken Group’s smaller scale, and also rolling over to FY20F earnings.
  • Maintain BUY.

Lee Keng LING DBS Group Research | https://www.dbsvickers.com/ 2019-08-13
SGX Stock Analyst Report BUY MAINTAIN BUY 0.80 UP 0.750