Frencken Group - UOB Kay Hian 2021-03-09: 2H20 Positive Operating Leverage From Semiconductor To Continue

SGinvestors.io

FRENCKEN GROUP LIMITED (SGX:E28)

Frencken Group - 2H20 Positive Operating Leverage From Semiconductor To Continue

• Frencken's 2H20 results were in line with expectations, with earnings of S$23.8m (+5.2% y-o-y) taking full-year net profit to S$42.6m (+0.5%).
• The semiconductor sub-segment (+60.7%) drove positive operating leverage in 2020 on accelerating demand for lithography systems. We expect the growth to be sustained on the continued development of 5G technology and the global chip shortage.
• Reiterate BUY on Frencken with a higher target price of S$1.72 after raising our valuation peg.

Frencken's 2H20 net profit bolstered by positive operating leverage.

• Frencken Group (SGX:E28) reported a solid set of 2H20 results. See Frencken's announcements. Net profit of S$23.8m (+5.2% y-o-y) was led by gross margin expansion from a shift in product mix towards the more profitable semiconductor sub-segment.
• Despite a slip in revenue to S$328.1m (-2.3% y-o-y) due mainly to lower sales from the industrial automation (-38%) and medical (-8%) sub-segments, the semiconductor segment (+50.6%) drove the expansion in group gross margin to 18.3% (2H19: 17.4%).
• Frencken kept its first and final dividend of S$0.03 per share, maintaining its 30% payout ratio. See Frencken's dividend history.

1H21 to be sequentially better.

• A strong demand outlook was provided for 1H21, led by higher expected sales from the semiconductor, medical and analytical sub-segments. Revenue from the automobile sub-segment is indicatively flat h-o-h, but Frencken's management sees some scope for potential upside should there be a workaround on the chip shortage.

Demand for semiconductor components to remain strong.

• Capex at the upstream foundries are rising due to:
  • the ramp-up of 5G development, and
  • efforts to overcome the global chip shortage.
• Specifically for Frencken, channel checks suggest it is the sole supplier for one of the key components used in the deep ultraviolet (DUV) and extreme ultraviolet (EUV) lithography systems manufactured by ASML Holding (ASML NA). The Dutch company currently holds a monopoly for these photolithography systems, which is used in one of the three key steps in semiconductor chip manufacturing.

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.
• Over three years between 2017 and 2020, Frencken's EBITDA saw a marked improvement of 20.5% CAGR, on the back of a 6.4% revenue CAGR over the same period, due to better operational efficiency.
• We expect Frencken's 2021-23 EBITDA margins to normalise at the 12.5% range, compared with the sub-10% region for 2014-18. 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, i.e. contract manufacturing, which does not add much value to its clients.

Maintain BUY with increased target price of S$1.72.

• We raise our Frencken's 2021-22 net profit forecasts slightly to S$49.9m (+4.1%) and S$55.8m (+4.4%) respectively. Our forecasts incorporate the stronger-than-expected growth stemming from the semiconductor sub-segment in 2020.
• See Frencken Group Share Price; Frencken Group Target Price; Frencken Group Analyst Reports; Frencken Group Dividend History; Frencken Group Announcements; Frencken Group Latest News.
• We have raised our valuation peg from 12.6x to 14.7x, or 1.5 standard deviation above its historical mean. This is to account for the ramp-up of the cyclical upturn in the semiconductor sector, reflected in the rising capital spending by the global foundries. At the current Frencken Group's share price, the stock trades at 10.5x 2021F P/E.
• Frencken is also included as UOBKH's alpha picks in report: Singapore Stock Alpha Picks (Mar 2021) - UOB Kay Hian 2021-03-05: Add Frencken & China Sunsine; Remove BRC Asia & First Resources.
• Catalyst to Frencken Group Share Price:
  • Higher-than-expected factory utilisation rates.
  • Better-than-expected cost management.

Clement Ho UOB Kay Hian Research | https://research.uobkayhian.com/ 2021-03-09

SGX Stock Analyst Report BUY MAINTAIN BUY 1.720 UP 1.420