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Wednesday, March 29, 2017

Maintain BUY: Relatively stable margins seen for Prolexus for remainder of FY17

Author: damiantreez | Publish date: Wed, 29 Mar 2017, 12:58 PM

Prolexus Bhd
(March 28, RM1.36)
Maintain buy with a lower fair value of RM1.61: While we believe Prolexus Bhd deserves to trade at a premium to its three-year average price-earnings ratio (PER) of 8.2 times, we lower the PER peg to reflect Prolexus’ moderated growth outlook.

Valuations are rolled over to financial year 2018 forecast (FY18F), from FY17F, as we lower our PER peg to 10 times from 12 times.

Prolexus reported a second quarter of FY17 (2QFY17) net profit of RM7.7 million (quarter-on-quarter: 18.8%; year-on-year [y-o-y]: 9%), bringing first half of FY17 (1HFY17) net profit to RM14.1 million (y-o-y: -4.5%). Earnings came in below our earnings estimate at 44%. No dividend was declared for the quarter as expected.

The earnings shortfall was due to softer-than-expected top-line growth as cumulative sales contracted 4% against the corresponding period. This stemmed from both its apparel and advertising divisions. Nike’s top-line weakness appeared to have trickled down, impacting Prolexus. Advertising revenue weighed further on the overall top line, contracting 14% in tandem with the broader advertising industry.

Positively, its gross margin held relatively steady at 19.2% (19.5% in 1HFY16). This was in spite of the full effect of higher minimum wage impact. We expect relatively stable margins for the remainder of FY17, given the cost-pass-through nature of Prolexus’ contracts.

Meanwhile, Prolexus’ exciting double plant expansion remains on track to be completed in FY18. We anticipate its new Vietnam plant to commence operations in 1QFY18. It will initially enlarge existing output by 30%, with the potential to double existing capacity. Meanwhile, its Kluang fabric mill is scheduled to begin operations in 2QFY18. The fabric mill will enhance margins with cheaper knitted fabric input produced in-house.

However, for the interim, we expect initial start-up costs and underutilisation of capacity to initially weigh on margins. We take this opportunity to trim our aggressive margin assumptions. Apart from that, we lower our revenue projection given the new development with Nike amid heightened competition from other brands such as Adidas and Under Armour.

Factoring in changes to our assumptions, we cut our FY17F, FY18F and FY19F earnings by 15%, 17% and 8% respectively. Key risks to our forecasts include: i) higher-than-expected start-up costs related to its Vietnamese and Kluang expansions; and ii) further slowdown in Nike sales. — AmInvestment Bank Research, March 28

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