• Maintain NEUTRAL, new SGD0.80 TP from SGD1.14, 4% downside with c.4% FY23F yield. We maintain our NEUTRAL call, as Frencken’s 1Q23 update indicated weak demand and higher operating costs amid on- going excess inventory in the chip sector. We see low utilisation rates from expanded capacities straining near-term margins, as the semiconductor market waits for inventory levels undergo a correction. We slash earnings estimates by 31%, in view of weaker-than-expected sales and a dimmer margin outlook. Our TP is pegged to 10x FY23-24F P/E.

• 1Q23 net profit was below our estimate, at SGD5.2m (-60% YoY). This was booked on a lower revenue of SGD173m, marking a 13% YoY decline from 1Q22’s SGD198m. Revenue from the mechatronics division shrank 14% YoY (SGD149m), led by industrial automation (-40% YoY, to SGD19m) and Asia’s semiconductor (-24% YoY, to SGD58m) segments. Turnover from the medical and analytical & life sciences units grew 31% and 3% YoY to SGD30m and SGD40m, due to an increase in orders from Europe and Asia. Meanwhile, revenue for the integrated manufacturing services division dropped by 10% YoY, as sales at both the automotive & consumer and industrial electronics segments declined. FRKN’s GPM narrowed to 12.3% (-3.1ppts YoY). Net profit plunged by 60% YoY to SGD5.2m as a result of lower margins and higher costs.

• Excess chip inventory continues to dominate sector trends. Taiwan Semiconductor Manufacturing Co (TSMC) (2330 TT, NR) – FRKN’s major client ASML’s (ASML NA, NR) key customer – remains impacted by customers’ excess inventory levels, and is awaiting adjustments. For now, TSMC’s 2023 revenue outlook points to a decline by at least a low single- digit percentage YoY.

• Margin drag at play – due to higher installed capacity, low utilisation. FRKN now anticipates a drag in its margins, with the current sales decline expected to pull down its utilisation rate on a higher installed base. Note that its production capacity had been expanded ahead of an anticipated ramp-up in the utilisation rate. But, with the decline in semiconductor outlook and sales to customers, the higher depreciation costs and costs for the new capacities will drag on profitability. As 1Q23 net profit missed estimates, we cut FY23-25F earnings by 31% each year, to SGD33m, SGD35m, and SGD37m to reflect a weak 1Q23 and soft margins.

• Key downside risks to our forecasts include a later-than-expected recovery in semiconductor demand.

• ESG. As FRKN’S ESG score is 3 out of 4 – on par with our country median – we apply a 0% discount/premium to its intrinsic value to derive our new TP. As there is now greater focus on the E pillar due to critical climate change issues, we have tweaked our ESG weightage. Henceforth, we assign a weightage of 50% to the E pillar, followed by 25% each to the S and G pillars. Further details are in our 2 May thematic research note titled Envisioning a Better Future.

Source: RHB Research - 24 May 2023