KCE Electronics

KCE Electronics Plc (KCE)

Investment thesis: We attended KCE’s analyst meeting recently and left positive about its outlook. The Q2 2012 core operation should bounce into black ink and the prospects for 2H12 are even better. Further ahead, we expect superb FY13 numbers with the full recovery of KCE Tech and a possible takeover deal. We have upgraded our target price to Bt 8.05 from Bt7.00. Our new target price is pegged to 0.4SD above its long-term mean EV/EBITDA. Although there is only 5% to our target price, we recommend letting profits run for the moment.
Q2 2012 core turnaround: We anticipate core earnings of Bt6m, a turnaround from the loss of Bt105 m reported for 1Q12 because KCE Technology (Ayudhya) broke even in June. GM should jump YoY, as a newly-designed panel uses less raw materials (particularly copper). Management guides for an FX loss for the quarter, but insurance payouts for business interruption should have outweighed the effect of the FX loss. As such, we anticipate a reported net profit of Bt73m. The firm received payouts for asset claims of around Bt770m, but cannot recognize them in the income statement, so we have slashed our full-year earnings forecast to Bt1.1bn from Bt1.8bn.
2H12 outlook even better … We expect 2H12 earnings to improve with a full quarter of operational earnings at KCE Technology. The firm targets ramping up KCE Tech’s utilization rate to 60-70% in 3Q12 and to 80-90% 4Q12, backed by a huge order from a set-top box manufacturer. Furthermore, there is scope for upside from an increasing the proportion of the newly-designed panel from 20% of KCE Tech’s production currently to 40% within the next two months.
…and best ever core profit in FY13 & scope for upside from an acquisition: FY13 should be the best year ever, due to a full year of production at KCE Tech. Additional capacity of 20% will enable the firm to accept more orders from customers. Moreover, there would be scope for upside from the possible acquisition of a chemical recycling firm. The acquisition would give KCE some implied natural hedging of its copper exposure and expand its overall net margin by 0.5-1%. If the firm were to seal the deal, we would expect upside to our FY13 EPS in the range of Bt0.09-0.13.

Outlook

Q2 2012 core turnaround: We anticipate a core profit of Bt6m, a turnaround from the loss of Bt105m reported for Q1 2012 because KCE Technology (Ayudhya) broke even in June. GM should post a 280 bps YoY jump because a newly-designed panel uses less raw materials (particularly copper). The panel currently accounts for 20% of KCE’s Tech total production. The SG&A/sales ratio should have declined 20% QoQ (but still be above the normal range of 13-16%, as remaining flooding expenses from Q1 2012 would have been booked during Q2 2012). Management guides for an FX loss for the quarter, but insurance payouts for business interruption should have outweighed the effect of the FX loss. As such, we anticipate a net profit of Bt73m. We expect a DPS of Bt0.1, based on 20% payout assumption.
Received payouts for asset damages of around Bt770m: KCE said it received insurance payouts for damaged assets of Bt770m in Q2 2012, but its auditor didn’t allow it to recognize the cash as an extra gain in the income statement. The payouts will be booked directly to the balance sheet, so we have slashed our full-year earnings forecast to Bt1.1bn from Bt1.8bn. However, we anticipate that the insurance payouts will be used to pay down debt, so net gearing should drop to around 1.1x from 2.0x at end-March.

2nd half 2012 outlook even better … We expect 2nd half 2012 earnings to improve with a full quarter of operational profit at KCE Technology. The firm targets ramping up the utilization rate of KCE Tech to 60-70% in 3Q12 and to 80-90% in Q4 2012, backed by a huge order from SAGEM (a set-top box manufacturer). Furthermore, there is scope for upside from increasing the proportion of the newly-designed panel from 20% of total production currently to 40% within the next two months. We roughly estimate that every 10% increase in the proportion of production that the newly-designed panel comprises, raw material costs would decline by Bt3.7m, based on 2010 raw material prices.

and best ever core profit in FY13 & scope for upside from an acquisition: FY13 should be the best year ever, due to a full year of production at KCE Tech. A 20% capacity expansion at KCE Tech will enable it to accept more orders from customers (which pushes up maximum quarterly revenue from US$70m to $75m). Moreover, there would be scope for upside from the possible acquisition of a chemical recycling firm with an equity size of about Bt130m for a price of around Bt 240m (implying a core PER of 4.3x, cheap in our view, as global fertilizer chemical companies typically trade at an FY12 PER of around 9.9x).

Upside from possible acquisition: The acquisition would give KCE some implied natural hedging to its copper exposure and expand its overall net margin by 0.5-1%. The sources of funds are likely to be internal cash and debt. If the takeover were to go ahead, we would expect upside to our FY13 EPS in the range of Bt0.09-0.13. Note that the recent share price spike was prompted by rumors of an upcoming takeover deal. As such, there would be risk of stock price downside if KCE were to fail to acquire the target firm (but we are confident that the deal will go through). In that case, the stock price might drop to trade at around an FY13 PER of 9x, which would imply a YE12 target price of around Bt7.25.

Recommendation and valuation

Target price upgraded, TRADING BUY maintained: The firm’s outlook keeps getting better—a 2Q12 improvement on 1Q12, even stronger prospects for 2H12 and a record high bottom-line outlook for FY13. As such, we think KCE deserves to trade at a premium to its long-term average. We have upgraded our YE12 target price to Bt 8.05 (pegged to 0.4SD above its long-term mean EV/EBITDA) from Bt7.00 previously (pegged to long-term average EV/EBITDA). Our new target price implies an FY13 PER of 10x, comparable with the PERs of high-GM peers in Electronics space. With upside of 5% to our target price we recommend letting profits run.