FRENCKEN GROUP LIMITED (SGX:E28)
Frencken Group 3Q20 Business Update - Semiconductor Segment Driving Positive Operating Leverage
- Frencken’s 3Q20 earnings of S$13.3m marked a beat, taking 9M20 net profit to 83% of our full-year estimate. The business update reflected earlier and stronger-than-expected operating leverage, buoyed mainly by a better sales mix and greater cost control efforts.
- We expect the semiconductor segment to continue driving growth going forward, driven by the accelerating development of 5G technology.
- We raise Frencken's 2020-21F earnings forecasts by 7.7% and 3.6% respectively. Maintain BUY with higher target price.
Frencken's 3Q20 net profit above expectations.
- In a business update provided by Frencken Group (SGX:E28), headline 3Q20 earnings of S$13.3m (+16.7% y-o-y) reflected positive operating leverage from gross margin expansion. This was despite a 2.8% y-o-y slip in revenue to S$165.5m, as a result of lower sales from the industrial automation (-32%), analytical (-4.8%) and automotive (-4.4%) segments.
- The relatively more profitable semiconductor (+49.5%) segment was the clear driver for Frencken, as well as tighter cost control measures, which resulted in a 1.7ppt y-o-y expansion in gross profit margin to a record 17.6%.
Demand for semiconductor components remains strong.
- The semiconductor segment is estimated to contribute 32% and 35% of overall sales for Frencken in 2020F and 2021F, respectively (2019: 18%). This will mainly be driven by the huge demand stemming from the accelerating development of 5G technology, reflected in the record capex spending by major foundries, the Taiwan Semiconductor Manufacturing Company and Samsung Electronics, in 2020-21.
- Pricing environment for the components manufactured by Frencken is understood to be healthy, and indicative demand from clients outstrips production capacity.
Improving operating margin.
- Frencken’s on-going improvement of operational efficiency has shown marked progress, and is expected to further bolster EBITDA margin going forward. Since implementing the Frencken Operations eXcellence and Frencken Production System programmes in 2017, operational efficiency has improved across Frencken’s worldwide manufacturing facilities.
- Frencken’s revenue rose at a 13.1% CAGR in 2018-19, while EBITDA saw a marked improvement of 32.1% CAGR, mainly bolstered by stronger operational efficiency. We expect 2020-22F EBITDA margins to normalise at above 11%, compared with the sub-9% region between 2014 and 2017.
- Additionally, management continues to make investments to upgrade equipment and facilities at its plants to elevate its competitive edge and enhance capabilities, which should help further uplift efficiency.
ROEs rising as company moves up value chain.
- Frencken is deepening its core competency to provide unique components, modules and designing of a whole product. The group has been moving away from the built-to-print model, ie contract manufacturing, which management believes does not add much value to its clients. For instance, Frencken is the sole global supplier of the reticle masking unit (REMA), a key module for the extreme ultraviolet lithography system developed by ASML Holding.
- Apart from mechanical design, assembly and testing, Frencken also manages the supply chain and provides life-cycle support for REMA.
Maintain BUY on Frencken with higher target price.
- We raise our Frencken's 2020-21 net profit forecasts to S$41.8m (+7.7%) and S$47.9m (+3.6%) respectively. Our forecasts incorporate higher gross profit margins to reflect the better-than-expected cost control efforts. Our 2020-21 revenue estimates remain unchanged.
- Maintain BUY on Frencken with higher target price pegged to 12.6x 2021F earnings or 1SD above its historical mean.
- See Frencken Group Share Price; Frencken Group Target Price; Frencken Group Analyst Reports; Frencken Group Dividend History; Frencken Group Announcements; Frencken Group Latest News.
- At current Frencken share price, the stock trades at 9.3x 2021F PE, a 21% discount to the peer average.
- Frencken share price catalysts:
- Higher-than-expected factory utilisation rates.
- Higher-than-anticipated capex spending by Seagate Technology for new hard disk drive manufacturing lines for the industrial automation segment.
- Better-than-expected cost management.
- Frencken is one of the UOBKH alpha picks for the month. See Singapore Stock Alpha Picks (Nov 2020) - Adding In Venture Corp & Ascendas REIT.
Clement Ho
UOB Kay Hian Research
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https://research.uobkayhian.com/
2020-11-17
SGX Stock
Analyst Report
1.42
UP
1.370
