UOB Kay Hian has maintained its “buy” rating on Frencken Group with a target price of $1.37 on the expectation of a stronger 2H20 earnings for the company. 

Analyst Clement Ho has noted that demand for semiconductor components remains strong and said the semiconductor segment is estimated to contribute 32% and 35% of group sales for Frencken in FY20/21F respectively. 

This will be driven by the huge demand stemming from the accelerating development of 5G technology, reflected in the record capital expenditure (capex) spending by major foundries TSMC and Samsung in FY20/21

Following some supply chain issues caused by the Covid-19 lockdown measures in 1H20, management has indicated that the majority of the issues has been resolved and factories are back in full operations, working to meet clients’ urgent deliveries.

Ho also said factory utilisation is understood to be high, and demand from clients currently outstrips production capacity. This reflects a “healthy pricing environment” for the components manufactured by Frencken, which is managing the delicate balance between maintaining clients’ relationships and maximising revenue opportunity.

Furthermore. Frencken is deepening its core competency to provide niche components, modules and designing of the whole product. The group has been moving away from the built-to-print model, i.e. contract manufacturing, which he said “does not provide any value add to its clients.”

For instance, Frencken is the sole global supplier of the reticle masking unit (REMA), a key module for the Extreme Ultraviolet (EUV) lithography system developed by ASML. Apart from the mechanical design, assembly and test, Frencken also manages the supply chain and provides lifecycle support for REMA.

Ho said the stock is “poised for recovery” and he believes management would be able to deliver the shortfall of orders in 1H20, particularly in the semiconductor segment, which is seeing a recovery into 2H20. As such, this should result in improved q-o-q earnings, with share price anticipated to move in tandem.

The group’s “improvement of operational efficiency has shown marked progress, and is expected to further bolster earnings before interest, taxes, and amortization (EBITDA) margin going forward.” Ho said Frencken’s FY18/19 revenue rose at a compounded annual growth rate of 13.1%, while EBITDA saw a marked improvement of 32.1%, mainly bolstered by the impressive 9.6% reduction in Selling, General and Administrative Expenses (SG&A) expense. 

He expects FY20-FY22 EBITDA margins to normalise above 11%, compared to the sub-9% region between 2014 and 2017. Additionally, management continues to make investments to upgrade equipment and facilities to elevate its competitive edge and enhance capabilities, which should help further lift efficiency.

As at 12.23pm, shares of Frencken Group were trading at 98 cents, with a FY20 price-to-book ratio of 1.2 and a dividend yield of 2.9%.