• Previously we had downgraded Frencken (SGX:E28) to Neutral and lowered our pegged P/E to 10x (from 14x) as considered NPAT growth would have been hampered due to higher costs, along with the devaluation of the global tech stocks.
• Over the past month, Frencken's share price has corrected ~20% and is now trading at just 8.5x FY22F P/E, an attractive valuation, which we consider represents a good entry for a long term investment.
• Upgrade Frencken to BUY, from Neutral, with an unchanged target price of S$1.24, 16% upside and ~4% yield.

Muted Margins Likely to Last for 1-2 Quarters

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

Semiconductor and Analytical Segments Are Still Going Strong While Automotive Declines

• Semiconductor segment increased 15.5% y-o-y to S$76.1m, while analytical and life sciences segment is 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 volume ordered by the customer.
• We understand that the customer is trying to mitigate this issue and expects orders to gradually recover in the next quarters.

Headwinds Ahead But Likely Priced-in

• Frencken's share price has corrected close pegged to a 10x FY22F P/E.

• Key risks include a rise in material and overhead costs, and a downturn in semiconductor demand
• Using our in-house proprietary methodology, we derive an ESG score of 3.0, which is on par with the country median. As a result, we apply a 0% premium to our target price.

Source: RHB Invest Research - 21 Jun 2022