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Wednesday, December 26, 2018

Elsoft Research Berhad - Momentum Expected to Take a Breather in FY19

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We downgrade our recommendation on Elsoft from Hold to Sell with a lower TP of RM0.80/share (previously RM1.29/share). This is mainly upon lowering our assigned PE multiple from 25.0x to 18.0x (+0.5SD to 5-year average) as we expect sentiment on semiconductor equipment players to weaken further on concerns of lower spending on equipment by fabs in 2019. Alongside this, we have also conservatively cut our FY19/FY20 earnings estimates by 13.6%/2.6% and now forecast earnings to contract in FY19 (-18.6%) before resuming growth in FY20 (+19.5%). Notwithstanding, we remain sanguine on the group’s medium to long-term prospect premised on its R&D capability, which has proven to propel it to greater heights. A faster than expected pick-up in demand for the group’s new products will be a rerating catalyst for the stock.

FY18: Expected to be a Record Year

We maintain our expectations for Elsoft to achieve record high revenue and earnings in FY18. To recap, the group’s 9MFY18 revenue and core net profit increased 45.1% YoY and 69.8% YoY to RM65.1mn and RM33.1mn – in fact exceeding FY17’s. This was driven by higher demand for its smart devices LED flash tester, mainly catered to a major smartphone brand’s 2018 product line. As a result, the smart devices segment overtook the automotive segment as the group’s largest contributor, respectively accounting for 61% (+21pp YoY) and 27% (-14pp YoY) of its 9MFY18 revenue. As for the remainder of FY18, we forecast the group’s earnings to come in the range of RM1mn to RM5mn, underpinned by its latest order book of RM26mn which is expected to be realised across 4QFY18 to 1QFY19.

Earnings to Contract in FY19 Before Resuming Growth in FY20

Looking ahead to FY19, we opine that it will be challenging for the group to sustain FY18’s robust performance. While management expects the smart devices and automotive segments to remain the main contributors, we expect demand for existing equipment to moderate and that for newly developed equipment to only pick up in FY20 once the prototypes are qualified by customers. In the larger scheme of things, SEMI had recently reversed its projection for spending on equipment by fabs in 2019 from a 7% growth to an 8% decline. Altogether, this has prompted us to conservatively cut our FY19/FY20 earnings estimates by 13.6%/2.6% and correspondingly, we now forecast earnings to contract in FY19 (- 18.6%) before resuming growth in FY20 (+19.5%).

Bright Prospects from New Equipment

While the group’s newly developed equipment are not expected to contribute significantly in FY19 as they undergo qualification, we view bright prospects from them as they are geared towards diverse and relevant applications. Among others, this includes: 1) a next generation smart devices LED flash tester catered to a major smartphone brand’s upcoming product line, and 2) a new series of automotive headlamp tester, the first of its kind in the market, featuring more precise adaptation to obstructions on the road. Apart from equipment, management alluded that there will finally be traction from the group’s medical devices segment as it begins to deliver its maiden batch of embedded controllers for peritoneal dialysis machines in 1QFY19. While contributions from the segment are expected to be smallish, we believe that it will benefit further down the road from the proliferation of peritoneal dialysis as an alternative to haemodialysis for patients with chronic kidney disease.

Valuation and Recommendation

We downgrade our recommendation on Elsoft from Hold to Sell with a lower TP of RM0.80/share (previously RM1.29/share). This is upon: 1) lowering our assigned PE multiple from 25.0x to 18.0x (+0.5SD to 5-year average) as we expect sentiment on semiconductor equipment players to weaken further on concerns of lower spending on equipment by fabs in 2019, and 2) conservatively cutting our FY19 earnings estimate by 13.6%. A faster than expected pick-up in demand for the group’s new products will be a rerating catalyst for the stock.
Source: TA Research - 26 Dec 2018

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