Analysts from DBS Group Research and RHB group Research have cut their ratings on Frenken Group to “hold” from “buy” and slashed their target prices sharply.

DBS’s Ling Lee Keng cut her target price from $2.09 to $1.36, while RHB’s Jarick Seet made a deeper cut from $2.10 to $1.24.

Ling says in a May 19 note that there is “unrelenting margin pressure” on the company, with margins declining to 15.4% in 1QFY2022 ending March compared to 17.3% in 1QFY2021. Net margins eased to 6.5%, down from 8.1% in 1QFY2021.

Ling says: “this was due to continued supply chain disruptions, inflationary pressure, and investment for growth. We expect margin pressure to persist, at least in the near term.”

Furthermore, the analyst expects higher costs in the interim stage as the group continues to invest for growth.

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She says costs are expected to remain high as the group continues to create new pillars for growth with the recent acquisitions of Avimac and Penchem.

This is in addition to its expansion of facilities in Europe, Malaysia, and Singapore with large format machining and cleanroom assembly space, and the expansion of its workforce,

Frencken is also working on new product initiatives (NPIs) in the semiconductor space, which could enable the group to penetrate a new segment of the semiconductor value chain.

However, she says these NPIs generally yield lower efficiency during the initial phases before the ramp-up in production.

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“We are cautious on the margins front on the back of the still challenging supply chain environment and inflationary pressure,” Ling concludes. She also cuts her net earnings forecasts for FY2022 and FY2023 by 20% and 19% respectively.

Some risks that she sees are Frencken’s dependence on global market conditions. It has exposure to customers in the US, the EU, and Asia, so a worldwide economic slowdown could impact demand and earnings.

Separately, RHB’s Jarick Seet also noted the pressure on Frencken’s margins, saying that they are likely to remain “muted” in the near term.

This was mainly due to higher prices of materials, freight, energy, and increased production overhead costs.

Depreciation also surged due to significant capital investments of around $28.6 million during FY2021.

These were in relation to upgrading and expansion programs for its global manufacturing facilities, as well as the acquisition of Avimac in Singapore as part of its strategy to add space, capacity, and capability to generate sustainable growth.

A bright spot, Seet thinks, is that the group’s management will likely pass on some of these costs to their customers which may help to improve margins.

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“However, we expect these to only flow in mostly in 3QFY2022 and expect margins in the near term to remain muted at 15.3-16% which would impact profitability,” he elaborates.

On a broader view, Seet says that Frencken’s revenue for its semiconductors segment is still “going strong”, but its automotive segment has seen a decline, falling by 10.7% y-o-y to $19.3 million.

This was 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.

Semiconductor revenue increased by 15.5% y-o-y to $76.1 million, while analytical and life sciences are up 16.7% y-o-y to $38.9 million. These segments will likely continue to increase for the rest of FY2022, he says.

“We understand that the particular customer is trying to mitigate this and expect orders to gradually recover in the following quarters ahead,” says Seet.

As at 10.40 am, shares of Frencken are trading at $1.14, with a FY2022 P/B ratio of 1.3x and dividend yield of 3%.

Analysts downgrade Frencken as margin pressures continue

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