• Frencken (SGX:E28) reported higher y-o-y revenue growth of 9.3% to S$198.36m but NPAT declined 12.6% to S$12.8m due to higher raw material, freight, and overhead costs.
• We cut our FY22F earnings forecast for Frencken by 17.5% to factor in lower margins. In addition, we also lowered our pegged target price P/E to 10x from 14x as NPAT growth will probably be hampered by higher costs, along with the devaluation of global tech stocks.
• Downgrade Frencken to NEUTRAL, from Buy, with a lower target price of S$1.24 from S$2.10, 5% upside.

Margins Likely to be Muted in the Near Term

• Gross profit margins remain around 15.4% as compared to 17.3% a year ago, mainly due to higher prices of materials, freight, energy, and increased production overheads costs. Depreciation also surged due to significant capital investments of around S$28.6m during FY21. These were in relation to upgrading and expansion programs for the group’s global manufacturing facilities and the acquisition of Avimac Pte Ltd in Singapore as part of its strategy to add space, capacity, and capability to generate sustainable growth.
• Frencken's management will likely pass on some of these costs to their customers which may help to improve margins. However, we expect these to only flow in majority in 3Q22 and expect margins in the near term to remain muted at 15.3-16.0% which would impact profitability.

Semiconductors and Analytical Segments Are Still Going Strong But Automotive Declines

• Semiconductors segment increased by 15.5% y-o-y to S$76.1m, while analytical and life sciences are up 16.7% y-o-y to S$38.9m and will likely continue to do so for the rest of FY22F. However, the automotive segment dropped 10.7% y-o-y to S$19.3m mainly due to one of its key customers not being able to procure other key components to complete the products, resulting in lower volumes ordered by the customer.
• We understand that the particular customer is trying to mitigate this and expect orders to gradually recover in the following quarters ahead.

Headwinds Ahead With Muted Margins

• We expect margins for the next quarter to remain low as costs remains high while Frencken tries to pass on some costs to its customers. In addition, shortage on components impacting clients, especially in the automotive industry, will continue to be a dampener to orders from its automotive key client.
• As a result, we downgrade Frencken to NEUTRAL from Buy with a lower target price of S$1.24, pegged to a 10x FY22F P/E, lower than the average 5 years peer’s multiple of 12x due to the negative growth ahead.
• Key risks include a rise in material costs and overhead costs, plus a downturn in semiconductors demand.

ESG

• Using our in-house proprietary methodology, we derive an ESG score of 3.0 for Frencken, which is on par with the country median. As a result, we apply a 0% discount to our target price.

Source: RHB Invest Research - 23 May 2022