• We recently hosted a conference call with NanoFilm’s CFO. The key takeaways are:
  1. FCVA technology opens up opportunities in new markets;
  2. growth would be driven by larger wallet share and organic growth; and
  3. growth in medium term will be supported by additional capacity from second Shanghai plant.
• Further improvement in profitability and wider analyst coverage should help NanoFilm re-rate upwards.
• We maintain BUY and raise our target price by 11%.

Differentiated Technology-based Solutions Open Up Opportunity in New Markets

• The benefit of NanoFilm Technologies International (SGX:MZH)’s filtered cathodic vacuum arc (FCVA) technology is the ability to deposit advanced materials on substrates at room temperature, unlike conventional coating processes where high temperature is required.
• The technology opens up the possibility for usage of materials that have lower melting points such as metals, plastic and rubbers that are generally cheaper materials. As such, NanoFilm is able to metalise these materials and achieve some functionality and surface properties which are similar to metal.
• Furthermore, the technology provides FCVA with the ability to enter new markets such as personal grooming, new energy, 5G, biomedical and aerospace industries that were previously inaccessible by conventional coating technologies.

Bigger Wallet Share and Organic Growth to Drive Revenue From the 3C Market

• We believe NanoFilm has gained market share in the smartphone segment. This is evident through revenue growth from smartphones, within the advanced materials segment, (10.8% 2017-19 CAGR) that has outpaced that of customer Z’s (NanoFilm’s largest customer) smartphone sales (1.1% FY17-19 CAGR). We expect this trend to continue as we understand the group’s market share (% of total addressable market for surface solution for smartphones) is still relatively small.
• Furthermore, the recent launches of 5G-enabled smartphones could spark:
  1. a meaningful upgrade cycle;
  2. a premiumisation trend; and
  3. a change in design language which could lead to a growing involvement for surface solution providers such as NanoFilm.
• NanoFilm should also benefit from organic growth in the wearables & accessories market, which has a relative low penetration rate and is expanding rapidly. We highlight that smart watch market leader Customer Z’s wearables, home and accessories revenue has grown at a FY16-19 CAGR of 30%.

Second Plant in Shanghai to Support Growth

• The group has in the past, increased production capacity in tandem with revenue growth. Similarly, in order to provide additional production capacity to support the group’s push to gain market share for the next few years, NanoFilm is in the midst of constructing its second Shanghai plant.
• The plant, which is expected to be fully operational by end-21, will be able to house 200 more coating equipments which would potentially increase its total number of coating equipments by 2.6x from 122 as at 1H20 to up to 322 units.

Potentially Robust 2H20

• As customers in the computer, communications and consumer electronics (3C) industry prepare for product launches ahead of the holiday season in December, demand for NanoFilm’s surface solutions and nanoproducts generally tend to ramp up in July, and such heightened demand would last until December. As such, NanoFilm typically enjoys significantly better results in the second half of the year (2H19 earnings formed 68% of full-year earnings).
• As its key client (customer Z) has recently launched a series of new products (smartphones, wearables & accessories and tablets), we anticipate a similar seasonality trend for 2H20. With that, we expect NanoFilm's 2020 core earnings (ex-listing expense) to grow by 59.5% y-o-y.

Maintain BUY on NanoFilm With Higher Target Price

• We value NanoFilm based on a higher PEG of 1.0x (growth based on 3-year CAGR of 38.7%), up from 0.9x, as we narrow the discount to peers’ PEG from 25% to 17% given more analyst coverage and potential earnings upside from better-than-expected margins and new projects.
• Our target price implies a 38.7x 2021F PE.
• We believe NanoFilm's unique technology, superior net margins and sole supplier status for most of its major customers provides a strong competitive advantage and warrants a premium to peers.
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NanoFilm's Share Price Catalyst

• Better-than-expected ramp-up of nanofabrication business in Vietnam.
• New applications in advanced materials segments such as automotive (bi-polar plate electrodes in fuel cells) and fast-moving consumer goods.
• NanoFilm is also added as one of the UOBKH's latest Singapore stock alpha picks. See report: Singapore Stock Alpha Picks (Dec 2020) - Reshuffling After A Strong November; Drop DBS, Short SIA, Add Nanofilm

Source: UOB Kay Hian Research - 10 Dec 2020