• Memtech International's FY18 core PATMI of US$8.9m (-27.3% y-o-y) was below our/consensus’ expectations mainly on higher-than-expected tax expenses.
• We see continued ramp-up of projects across its major segments, but also rising headwinds from slowing auto sales and trade tensions.
• With limited upside and catalysts, we downgrade Memtech International from Add to HOLD, with a slightly lower Target Price of S$1.08, and a 4-5% forecast dividend yield.

FY18 Core PATMI Down on Weaker Gross Margins, Miss on Taxes

• Despite a 5.1% y-o-y topline growth in a seasonally-stronger quarter, MEMTECH INTERNATIONAL LTD (SGX:BOL) was unable to offset the weaker gross margins (4Q18: 17.7%, 4Q17: 18.8%) and higher operating costs, resulting in a 21% y-o-y decline in 4Q18 core earnings to US$3.2m.
• Higher than expected tax expenses were also a drag on its FY18 core PATMI of US$8.9m, which accounted for 90%/89% of our/consensus’ full-year forecasts.
• Memtech International also declared an FY18 DPS of 3.0Scts (FY17: 5.5Scts), implying a 2.9% dividend yield and based on a 32% payout ratio.

Auto Losing Steam, Consumer Electronics Could Fill the Gap

• Memtech International saw its FY18 revenue grow 13.2% y-o-y to US$192.5m, thanks to robust growth in automotive (+18.9% y-o-y), consumer electronics (CE, +16.5% y-o-y) and industrial & medical (+15.0% y-o-y), mitigating the sales weakness in telco (-20.2% y-o-y).
• Going forward, we think the global slowdown in car sales and limited order visibility from its major MNC customer could weigh on its auto and CE segments, respectively, in the near-term. But we remain positive on the stronger ramp-up of industrial & medical projects, and higher demand from its acoustic customers.

Gross Margin Contraction Was the Key Culprit

• While Memtech International’s sales mix has tilted in favour of greater auto contribution (FY18: 68%, FY17: 47%), gross margin fell 2.0%pt y-o-y in FY18. This is attributed to
  1. rising labour costs,
  2. higher raw material prices and product packaging costs,
  3. increased depreciation costs for new equipment,
  4. additional costs to meet new environmental standards and
  5. lower manufacturing yield for some new projects.
• We expect a gradual improvement in FY19F as these projects enter the ramp-up phase, boosting core earnings by 26%.

Downgrade From Add to HOLD, With 4-5% Dividend Yield

• As we turn more conservative on the macro outlook and Memtech International’s project wins, we lower our FY19-20F EPS by 8.2-9.4%.
• Our target price falls marginally to S$1.08 (pegged to 8.5x FY20F P/E, at 20% discount to industry average).
• Given that Memtech International's share price has risen 37% since our last note, we downgrade the stock from Add to HOLD, with its 4-5% dividend yield as near-term support.
• Upside/downside risks to our call could stem from trade tensions and project pipelines.

Source: CGS-CIMB Research - 27 Feb 2019