Unrelenting margin pressure
- 1Q22 slightly below expectations on weaker margins
- Expect higher costs to persist in the interim stage
- Guided for moderate increase in 1H22 revenue vs. 2H21; expectations toned down for some segments
- Cut earnings by c.20%; downgrade to HOLD with lower TP of S$1.36
Investment Thesis:
Cut to HOLD with lower TP of S$1.36 on weak margins. Gross margin declined to 15.4% in 1Q22 (from 17.3% in 1Q21), while net margin eased to 6.5% (from 8.1% in 1Q21), similar to 4Q21. This was due to continued supply chain disruptions, inflationary pressure, and investment for growth. We expect margin pressure to persist, at least in the near term. Hence, we cut our earnings projection for FY22F/23F by c.20%. With limited upside to our revised TP of S$1.36, we downgrade the stock to HOLD
Expect higher costs in interim stage as the group continues to invest for growth; working on NPIs in semiconductor space. Costs are expected to remain high as the group continues to create new pillars for growth with the recent acquisitions of Avimac and Penchem, expansion of facilities in Europe, Malaysia, and Singapore with large format machining and cleanroom assembly space, and the expansion of its workforce, paving the way for future growth. Meanwhile, Frencken is also working on new product initiatives (NPIs) in the semiconductor space, which could enable the group to penetrate a new segment of the semiconductor value chain.
Valuation:
Downgrade to HOLD with lower TP of S$1.36. We cut earnings by 20%/19% for FY22F/23F. TP is lowered to S$1.36 (previously S$2.09), pegged to a lower peers’ average of 11x (from the previous 13.5x, on further de-rating of tech stocks globally). Downgrade to HOLD.
Where we differ:
We are cautious on the margins front on the back of the still challenging supply chain environment and inflationary pressure.
Key Risks to Our View:
Dependence on global market conditions. Frencken has exposure to customers in the US, the EU, and Asia, so a global economic slowdown could impact demand and earnings.