• Frencken Group's 3Q19 core net profit was 24% above our S$9.2m expectations due to better cost control and contributions from higher gross profit margin filter business.
• For 4Q19, the key industrial automation (IA) segment is expected to report a revenue decline q-o-q and y-o-y.
• Maintain ADD call and Target Price of S$0.94. We are already factoring in slower growth for the IA segment in FY20-21F.

3Q19 Above Our Expectation

• FRENCKEN GROUP (SGX:E28)'s 3Q19 core net profit at S$11.4m was above our expectations of S$9.2m. 3Q19/9M19 core net profit formed 30%/82% of our full-year forecast. There was judicious cost control and contributions from the higher margin filter business.
• By division, the mechatronics division saw a 10% y-o-y revenue growth in 3Q19, while the IMS division revenue declined 3% y-o-y for the quarter. In the mechatronics division, the key revenue contributor remained the IA segment at 36% of segmental revenue and 30% of group revenue. This segment also registered the strongest growth at 10% y-o-y in the third quarter.

4Q19 Revenue Set to Slow Down

• For 4Q19, the segments that are expected to grow y-o-y are the semiconductor segment and the medical segment. The analytical, industrial automation and automotive segments are expected to post y-o-y revenue declines.
• In particular, the IA segment revenue will likely fall below S$51m in the fourth quarter. The IA segment revenue is lumpy as growth is driven by the capex requirement of a key hard disk drive customer. We have been careful not to extrapolate the growth trajectory for this segment into FY20-21F. However, given the increasing need to store data, we believe Frencken Group will continue to benefit from its exposure to this customer.

Maintain ADD

• Our revenue change for FY19 is mainly to reflect the lower revenue outlook for the analytical segment in 4Q19.
• Frencken Group is well-positioned in the new economies of cloud computing, big data, artificial intelligence, Internet of Things and life sciences. Frencken Group's share price could re-rate if Frencken can improve the profitability of its IMS division or restructure this division.
• Our Target Price of S$0.94 is still based on 10x FY20F P/E (17% discount to the domestic peer average of 12.1x).
• Key re-rating catalysts could come from new customer wins and stronger-than-expected sales in its industrial automation segment.
• Downside risks are order delays or pullback by customers. A key specific risk is in the industrial automation segment given the high reliance on a single customer.

Source: CGS-CIMB Research - 6 Nov 2019