Amid the recent AI craze following <a href="https://www.theedgesingapore.com/news/semiconductor/nvidias-blowout-forecast-sparks-huge-rally-all-things-ai">Nvidia’s forecast raise</a> due to strong demand for its AI chips, Seet says that semiconductor-related stocks have “mostly rallied”, even in Singapore.

This bodes well for Frencken, which manufactures components and modules for various industries including the semiconductor, life sciences, automotive and industrial automation sectors.

The analyst’s channel checks show that orders have yet to be positively impacted but semiconductor inventory could be depleted faster if the trend persists. He believes that most of Frencken’s weak outlook for FY2023 have been priced in as one of the few semiconductor stocks trading below its net asset value (NAV) of 93 cents.

As a result, Seet has maintained his target price of 94 cents, pegged to a 9x FY2024 price-to-earnings ratio (P/E).

The analyst says that the inventory levels of key customers, especially in Singapore, will be vital to Frencken’s financial performance. In 1QFY2023, the company was impacted by low utilisation and excess capacity as its largest semiconductor customer in Asia reduced orders due to high inventory levels after a downturn, notes Seet.

See also: <a class='gtm_see_also_1_inread' style='text-decoration: underline;' href='/capital/brokers-calls/brokers-digest-ihh-healthcare-flct-boustead-singapore-brc-asia-starhill-global?utm_source=website&utm_medium=article&utm_campaign=ONPAGESEO'>Broker's digest: IHH Healthcare, FLCT, Boustead Singapore, BRC Asia, Starhill Global REIT, MPACT, Kimly</a>

Meanwhile, Frencken’s largest customer in Europe continues to perform well due to its “ample backlog orders” and longer lead times, he adds.

According to him, the company expects inventory levels to only normalise in 4QFY2023, although this could happen sooner if the strong demand for AI chips continues. “If this happens, Frencken will likely benefit as an increase in orders from its key customer would likely ramp up utilisation and allow it to enjoy the operating leverage it had in FY2022,” says Seet.

The analyst adds that Frencken is well-positioned to take advantage of a demand rebound when this eventually happens.

See also: <a class='gtm_see_also_2_inread' style='text-decoration: underline;' href='/capital/brokers-calls/keppel-corporations-acquisition-aermont-capital-checks-all-boxes?utm_source=website&utm_medium=article&utm_campaign=ONPAGESEO'>Keppel Corporation’s acquisition of Aermont Capital ‘checks all boxes’</a>

“We believe subsequent quarters should see a slow pick up, but at the same time signal the worst might be over,” says the analyst. “While signs of a sustainable rebound are still lacking, a persistent AI trend would  greatly benefit the sector and will definitely be worth watching.”

Seet’s upside risks include stronger-than-expected semiconductor and industrial automation contributions, robust margin accretion from new products and improving efficiencies, as well as improving institutional interest, which could help the stock re-rate towards peers’ valuations.

On the other hand, a drop in demand, supply chain disruptions that impede Frencken’s production ability and revenue recognition and a lower-than-expected dividend pay-out are risks on the downside.

As at 2.42pm, shares in Frencken were trading 1.5 cents or 1.72% down at 85.5 cents.

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