• Frencken has announced an S$6.2m impairment loss to be booked in FY20F earnings. The group still expects to remain profitable in FY20F.
• The impairment loss does not affect our earnings forecast though it represents a lost long-term revenue opportunity.
• We raise our P/E target multiple to 12x, in line with the sector average; our target price for Frencken rises to S$1.39.

Impairment Surprise…

• Frencken Group (SGX:E28)’s subsidiary, Frencken Europe B.V. has been working on the development of a certain product for the healthcare industry for a US customer. The associated costs have been capitalised as deferred development costs on Frencken’s balance sheet. Due to a change in the strategic direction of this customer, Frencken now does not have visibility on the future revenue streams related to this product.
• Frencken expects to report a profit for 2H20F and FY20F even with this impairment.

…does Not Affect Our FY22F Forecast

• Factoring in the S$6.2m impairment, our reported net profit forecast (ignoring taxation implications for the write-off) of Frencken for FY20F falls to S$36.3m, down 14% y-o-y.
• The medical segment accounts for 13% of our FY22F revenue forecast. As the affected product was in the development phase, it represents a lost revenue opportunity at this juncture. We have not factored in any potential revenue contribution from this customer.
• We note that the lost revenue opportunity could return if the customer decides to revisit the project in future and that Frencken can utilise the knowledge and intellectual property rights arising from this project for other possibilities.

Positive Development in Industrial Automation (IA) Segment

• In its IA segment, key customer, Seagate (STX US) plans to ship its 20 terabyte (TB) heat-assisted magnetic recording (HAMR) hard disk drives (HDD) in Dec 2020 to select customers and has reiterated plans to introduce 50 TB HAMR HDDs in 2026.
• We note that Seagate has a head start over Western Digital (WDC US) which is using energy-assisted perpendicular magnetic recording (ePMR) and microwave-assisted magnetic recording (MAMR) technologies before moving on to HAMR. As HAMR HDDs will use new heads and new platters, this technology transition will require new capex on Seagate’s part, benefitting Frencken.

Reiterate ADD; Target Price Raised to S$1.39

• We raise our Frencken's target price to S$1.39, now based on 12x (in line with the sector average; previously 11x) FY22F core EPS forecast.
• Downside risks are order pullbacks by customers, while upside risks could come from new customer wins and stronger-than-expected sales in the industrial automation segment.

Source: CGS-CIMB Research - 22 Dec 2020