• Initiate coverage on Frencken with BUY and 25% potential upside to S$0.75 Target Price.
• Diversification of business segments, manufacturing facilities and customer base brings resilience and stability.
• Benefitting from technological advancement and rising transformation trend.
• Attractive valuations - trading at steep discount to peers PE and offers 4% dividend yield.

Diversification Brings Resilience and Stability

• FRENCKEN GROUP LIMITED (SGX:E28) has a strong presence in a wide variety of industries and business segments, with a global customer base. It operates 5 key segments - Automotive, Analytical & Life Science, Medical, Semiconductor and Industrial & Industrial Automation.
• Design and manufacturing sites are located close to customers and span across three regions – USA, Europe and Asia, in 16 locations.

Beneficiary of Technological Advancement

• The accelerating scope of technological changes, like data analytics and Internet of Things (IoT), as well as the transformation of the Automotive industry and advances in the Analytical and Medical segments are some of the key drivers for Frencken’s business.

Investment Summary

Initiate with BUY, Target Price: S$0.75 for 25% potential upside.

• We initiate coverage on Frencken Group (SGX:E28) with a BUY call and target price of S$0.75, which implies potential upside of 25% from current Frencken share price.
• We like Frencken for its diversification in terms of business segments, location of manufacturing facilities and customer base.
• We believe that current PE valuation of 7.1x FY19F and 6.5x FY20F earnings, standing at about 40% discount to peers’ average of 12x, is too steep. Furthermore, the stock is supported by a dividend yield of about 4% to 5%, based on a 30% payout ratio.

Diversification brings resilience and stability.

• Frencken is present in a wide variety of markets and business segments, with a global customer base.
• Frencken has two key business divisions - Mechatronics and Integrated Manufacturing Services (IMS) - which can be further classified under five key business segments –
  • Automotive,
  • Analytical & Life Science,
  • Medical,
  • Semiconductor and
  • Industrial & Industrial Automation.
• The diversification helps to buffer Frencken from adverse impact from a cyclical downturn of a particular industry and in turn brings resilience and stability to the Group.
• Frencken’s design and manufacturing sites span across three regions – USA, Europe and Asia, in 16 locations. For now, there is no urgent need for Frencken to diversify out of China as China only accounts for five (excluding the Chuzhou plant expected to be ready in mid 2019) out of the 16 locations.

Attractive valuation with 4% yield.

• At current PE valuation of 7.1x FY19F and 6.5x FY20F earnings, Frencken is trading at about 40% discount to peers’ average of 12x, which is too steep, in our view.
• Furthermore, the stock is supported by a dividend yield of about 4% to 5%, based on a 30% payout ratio.

Diversified blue chip customer base; largest customer accounts for 20% of total revenue.

• Frencken’s customers are mainly market leaders in their respective sectors. In the automotive segment, its customers are tier #1 and OEM automotive companies. In the semiconductor space, its customers are market leaders for wafer fabrication, diagnostics and backend integrated circuit process equipment.
• In FY18, the top four major customers accounted for 48% of the trade receivables. These four customers are involved in different spectrum of industries and are exposed to a variety of end markets to which they sell. The largest customer, which is from the Mechatronics division, accounts for 25.6% of the revenue for this division, and 20% of total revenue.
• Frencken’s customers are also located globally, with about 51% from Asia (13% from China), 42% from Europe, 5% from USA and the balance 2% from other regions, based on FY18 revenue. A diversified customer base would help to minimise any negative impact from the ongoing US-China trade war.

Offers full suite of services.

• One of Frencken’s competitive edge is that it is a one-stop global integrated technology solutions provider.
• Frencken offers end-to-end solutions across the entire customer value chain - from product conceptualisation, integrated design, prototyping and new product introductions, to supply chain design and management, state-of-the-art value and volume manufacturing and logistics services.

Valuation & Peers Comparison

Trading at steep discount to peers, which is unwarranted.

• At current PE of 7.1x FY19F and 6.5x FY20F earnings, Frencken is trading at about 40% discount to peers’ average PE of 11.8x FY19F and 10.6x FY20F earnings, and also to SGX-listed peer, Venture Corporation (SGX:V03). The discount is too steep, in our view. Refer to the attached PDF report for Frencken’s peer comparison table.
• Furthermore, the stock is supported by a dividend yield of about 4% to 5% based on a 30% payout ratio.

Expect PE to move back to 8.5x, at +1SD of mean.

• Frencken’s PE has been hovering within 4.5x (-1SD of its mean valuation) and 8.5x (+1SD of mean) in the last three to four years. With the continued restructuring and rationalisation exercise in place to optimise productivity and improve efficiencies and profitability, we believe Frencken should trade up to +1SD of its mean i.e. 8.5x.

Initiate BUY with Target Price of S$0.75.

• We believe a valuation of 8.5x PE based on blended FY19F and F20F earnings is fair, pegged to a 20% discount to peer average, given its smaller scale. This valuation peg also coincides with the +1SD PE band.
• Target price works out to S$0.75 per share, which translates to an upside of 25% from the current Frencken share price.
• Refer to the attached PDF report for further details on Frencken’s critical factors and financials analysis.

Key Risks to Our View

Dependent on global market conditions.

• As Frencken has exposure to customers in the US, EU and Asia, a broad global economic slowdown could impact demand and earnings.

Source: DBS Research - 15 Apr 2019