JEP Holdings - UOB Kay Hian 2020-10-26: Riding On UMS’ Coattails; Initiate Coverage With BUY

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JEP HOLDINGS LTD. (SGX:1J4)

JEP Holdings - Riding On UMS’ Coattails; Initiate Coverage With BUY

• The step-in by a semiconductor specialist to lead JEP in early-18 may have proven to be in good time, two years before the massive impact on the aerospace industry due to the COVID-19 pandemic. Diversifying away from aerospace, JEP has been filling orders from the structurally growing semiconductor industry, helped by controlling shareholder UMS Holdings.
• Initiate coverage on JEP Holdings (SGX:1J4) with a BUY and target price of S$0.20.

JEP Holdings - Company Background

• JEP Holdings (SGX:1J4) began operations in 1990 and has since built up a good track record as a reliable sub-contractor for the world’s leading aircraft manufacturers.
• Listed on the SGX in 2004 as Alantac Technology and after having carried out a major acquisition of JEP Precision Engineering in 2007, the combined entity was renamed to JEP Holdings.
• Today, JEP provides precision machining and engineering services primarily to the aerospace industry, as well as the semiconductor and O&G industries.
• JEP also owns a large format precision engineering firm, Dolphin Engineering, as well as a trading business, JEP Industrades (JEPI), which markets cutting tools used in manufacturing activities for various industries including aerospace, mould and die, and O&G.
• In the aerospace industry, JEP is the only large-scale manufacturer for aircraft engine casings in Singapore. The group's core specialisation is in providing the manufacturing service for engine casings. For instance, JEP manufactures the front case, rear case, forward case and turbofan case for the FM56 engine (used by Boeing 737-variants), produced by commercial airplanes' jet engine manufacturer CFM International. For Pratt and Whitney, JEP provides the engineering and manufacturing solutions to deliver aircraft engine rear and compressor cases, combustion chambers, engine front case high pressure compressors, intercompressors as well as engine front case and compressor front cases, just to name a few.
• For the semiconductor segment, JEP provides manufacturing services comprising precision machining and sub-assembly services to back-end semi-conductor equipment. Specifically, they provide manufacturing services for instruments and mechanical components in back-end equipment such as wire-bonders and chambers. The group covers small-to large-sized format components, automatic equipment-related parts, and also provides modular sub-assembly services for wire-bonders and chambers.
• Headquartered in Singapore, JEP operates out of four manufacturing facilities across the island. JEP's geographic segmentation for revenue in 2019 is as follows:
  • Singapore (30%),
  • China (26%),
  • the US (21%),
  • Canada (10%),
  • Malaysia (4%) and
  • others (9%).
• Aerospace has been a major revenue driver for JEP, accounting for > 49% of sales since 2007 (2019: 63%). That served well as the industry benefited from an overall expansion in market size due to the rise in air traffic demand, on the back of an expanding global economy.
• The last notable corporate action was in Jun 19, when SGX-listed UMS Holdings (SGX:558) launched a mandatory cash offer for JEP at S$0.15/share. Tenders on the offer were not well-received, in conjunction with the assessment that the offer price was not fair and reasonable by the deal’s independent financial adviser, Provenance Capital.
• Prior to that, the founder of UMS Holdings, Andy Luong, took helm as the executive chairman and acting CEO for JEP in Feb 18. Apart from streamlining business operations, Andy also helped diversify JEP’s revenue sources, tapping on his extensive network in the semiconductor industry.

JEP Holdings - Industry Outlook

WINGS OF AEROSPACE INDUSTRY CLIPPED

• The COVID-19 pandemic has resulted in a crippling of the aerospace industry. Following a decade of booming demand and record orderbooks, aircraft manufacturers are now witnessing order pushbacks and cancellations by the droves as global airlines struggling to survive amid the halt in international air travel.
• Aircraft manufacturers Boeing and Airbus have had a jerky first half in 2020, following order cancellations from customers that were mainly aircraft leasing companies. While global carriers have not cancelled their orders at this stage, they have not been placing new ones and are also not eager to take deliveries at this stage, as they seek to preserve cash.
• Aerospace component manufacturers such as Rolls-Royce, GE Aviation and Spirit AeroSystems have already announced significant job cuts, citing that the aerospace industry may not see a recovery until at least 2022.
• As a sub-contractor to the aerospace component manufacturing value chain, JEP is also expected to see new orders grind to a halt and a contraction in profit margins ahead.

FILLING IN SEMICONDUCTOR ORDERS

• There have been positive signs that the semiconductor industry is in a cyclical upturn. Capital spending for the largest upstream global foundries Samsung and TSMC are at records highs, due to demand arising from the mass adoption of 5G.
• The cyclical upturn is being driven by the rising demand for semiconductor chips, to support trends towards digitisation and digitalisation. This phenomenon has been going on over the recent years as common everyday items such as refrigerators, washing machines, watches and even water tumblers are able to collect data for analysis.
• Industry research firm Allied Market Research expects 5G to drive strong growth in the chipset market, estimating a 48.7% CAGR from US$2.12b in 2020 to US$22.93b by 2026.
• This is expected to spill over to benefit the entire semiconductor value chain, including JEP.

Investment Highlights

Diversifying away from aerospace orders and moving towards the semiconductor.

• Following the controlling stake taken over by UMS Holdings in mid-19, JEP could see a timely revenue shift from the waning aerospace industry and towards the expanding semiconductor industry. Currently fulfilling its backlog to aerospace clients that have not pushed back or cancelled their orders, JEP’s semiconductor division, Dolphin Engineering, is understood to be doing well as at Aug 20.

Semiconductor industry in cyclical upturn.

• Capital spending for the largest upstream global foundries - Samsung Electronics and Taiwan Semiconductor Manufacturing Company (TSMC) - are at records highs, due to demand arising from the mass adoption of 5G. The cyclical upturn is driven by the rising demand for semiconductor chips, to support trends towards digitisation and digitalisation.
• Industry research firm Allied Market Research expects 5G to drive strong growth in the chipset market, estimating a 48.7% CAGR from US$2.12b in 2020 to US$22.93b by 2026. This is expected to spill over to benefit the entire semiconductor value chain, including JEP.

Potential beneficiary of US-China trade war.

• Headquartered in Singapore, JEP operates out of four manufacturing facilities across the island. Together with its controlling shareholder, UMS Holdings, the duo has no manufacturing facilities in China and are not directly impacted by the on-going trade tensions between the US and China.
• With its strategic positioning in the region, JEP could benefit from new clients that are increasingly shifting away from the North Asia region.

Cost reduction underway.

• Since 4Q18, JEP started to streamline its operations by moving more labour-intensive works from Singapore to Malaysia, and also with a string of cost-cutting exercises. This resulted in a significant improvement in gross margin which expanded from 14.7% in 2018 to 17.6% in 2019. EBITDA improved as well, increasing from 12.4% in 2018 to 17.1% in 2019.
• Accordingly, JEP's net profit has improved from a close-to-breakeven region throughout 2014-17, to S$2.2m and S$6.5m in 2018 and 2019 respectively. We expect JEP's earnings to stay elevated in the S$4.2m-8.1m range in 2020-22, supported by improved profitability.

Positive FCFF to alleviate debt concerns.

• As at end-1H20, net debt for JEP stood at S$27.5m, implying an elevated net gearing ratio of 0.43x. This has fallen from S$35.6m (net gearing: 0.75x) in end-17 and we believe that one of management’s priorities is to lower its gearing ratio.
• Going forward, we expect JEP to be able to generate positive FCFF, supported by healthy net cash from operations. This should improve the group’s ability to pare down its debt.

JEP Holdings - Valuation

Initiate coverage on JEP with BUY and a target price of S$0.20.

• The P/B valuation is pegged to its historical 7-year average of 1.1x, backed by an 8.7% 2021F ROE, which also implies a forward PE of 13.1x. We believe the valuation is justified given that the cost reduction exercise will result in a sustainable increase in ROE ahead.
• Going forward, we are estimating JEP's ROE to be at 6.4%/8.7%/10.1% in 2020/21/22F, supported by improved profitability at both the gross and operating levels.
• Currently, JEP trades at 1.0x 2021F P/B and an implied 11.5x forward PE.
• See JEP Holdings Share Price; JEP Holdings Target Price; JEP Holdings Analyst Reports; JEP Holdings Dividend History; JEP Holdings Announcements; JEP Holdings Latest News. 
• See PDF report attached below for complete analysis on JEP Holdings (SGX:1J4).

Clement Ho UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-10-26

SGX Stock Analyst Report BUY INITIATE BUY 0.20 SAME 0.20