Analysts are mixed on Frencken Group’s outlook following the company’s release of its 3QFY2022 ended September results.
CGS-CIMB Research has downgraded its recommendation for the company to “reduce” from “add” with a lower target price (TP) of 95 cents from $1.12 previously, while DBS Group Research maintained its “hold” call with a higher TP of $1.05 from 95 cents previously.
In their report dated Nov 28, CGS-CIMB’s William Tng and Izabella Tan cite Frencken’s lower-than-expected 3QFY2022 ended September as the company was hurt by a weaker Euro and an inventory write-down of $2.4 million in the quarter.
The company’s 3QFY2022 net profit of $11.0 million, a 25.7% y-o-y decrease, was also 24.7% below the analysts’ $14.6 million expectation. Frencken’s revenue for the period stood at $195.3 million, 0.6% down y-o-y, 16.6% below Tng and Tan’s $234.3 million expectation.
Given the revenue miss, the analysts have reduced their FY2022 to FY2024 revenue forecasts by 5.7% to 7.7%, leading to 11.2% to 17.3% cuts to their earnings per share (EPS) forecasts. They have retained their valuation based on Frencken’s 10-year average price-to-earnings ratio (P/E) of 7.4x on their FY2023 EPS forecast, which led to a reduction in TP to 95 cents.
According to the analysts, Frencken’s business environment may only recover from 2HFY2023. Their downgraded call comes off the back of a challenging business environment, such as geopolitical tensions, supply constraints, rising interest rates and cost pressures.
“Frencken’s European operations were affected by rising business costs due to higher energy processes, the labour crunch and higher wages. Although the group negotiated to pass on some of the cost increases to its customers, the pace of cost increases continued post consultation with its customers,” say Tng and Tan.
They note that Frencken has guided that it expects 2HFY2022 revenue to remain stable as compared with 1HFY2022. “The group expects cost sharing efforts with its customers in Europe to yield positive effects from 4QFY2022 and has entered into discussions and agreements with certain customers to allow for a more proactive approach in managing supply chain and operational costs,” they say.
Frencken also expects the semiconductor segment to post stable revenue in 2HFY2022 compared to 1HFY2022. The company is anticipating its medical and automotive segments to post higher revenues h-o-h to offset lower h-o-h revenues from its analytical and life sciences segment and industrial automation segment, add the CGS-CIMB analysts.
Meanwhile, Ling Lee Keng of DBS says that although Frencken’s outlook remains “uncertain”, its margins could improve from the low in 3QFY2022. Although the company’s bottom line was hit by margin pressure and exceptional costs and came in below expectations, she says the company still managed to post “stable” revenue. She continues to expect a stable 2HFY2022, which implies an improved 4QFY2022 compared to 3QFY2022.
“We expect a slight improvement in margins from 4QFY2022 onwards, from the low in 3QFY2022. Net margin for 3QFY2022 plunged to 5.6%, from 7% in 2QFY2022 and 7.5% in 3QFY2021. This was due to continued supply chain disruptions, inflationary pressure, and investment for growth,” she explains.
“The group expects its cost-sharing efforts with customers in Europe to yield a positive effect from 4QFY2022, though some of the positive impact could be offset by the still high inflationary pressure, especially in Europe,” says the analyst, who adds that her projected net margins for FY2022 and FY2023 are 6.4% and 6.7% respectively, from 7.7% in FY2021.
She notes that the semiconductor segment, the biggest contributor to Frencken accounting for 43% of 3QFY2022 revenue, is still showing near-term weaknesses. “Industrial automation could still be affected by customers cutting capex, while the supply chain challenges and inflationary cost pressures continue to plague the automotive division. We could see improvements for the analytical & life science and medical segments, supported by an order backlog and new product initiatives,” she adds.
Although Ling has trimmed her earnings forecast by 6% to 7% for FY2023 and FY2023, her TP is raised slightly to $1.06 by pegged it to an 8x PE, slightly below the five-year average, compared to 7x previously, considering that 3QFY2022 could be the low point for margins.
She highlights Frencken’s dependence on global market conditions, with exposure to customers in the US, the EU and Asia, which could impact demand and earnings should the global economy slow down further. “We are cautious about the demand outlook on the back of the macro headwinds,” she says.
For Tng and Tan of CGS-CIMB, upside risks for Frencken are less severe, including slowdowns in its semiconductor segment, better cost controls and greater concessions from customers on costs passed on by the company, while potential de-rating catalysts include further cost escalations affecting net profit negatively and a further weakening of demand in its semiconductor segment.
As at 12.15pm, shares in Frencken were trading 3 cents or 2.86% down at $1.02.