Grand Venture Technology - DBS Research 2022-08-12: Look Beyond Near-Term Margin Pressure

• Grand Venture Technology (SGX:JLB)'s 1H22 revenue increased to $67.1m (+6.9% h-o-h, +25.3% y-o-y), in line with expectations. Although 1H22 revenue makes up 46.1% of our full year forecasts, we note that this is due to seasonality where first half is usually weaker.
  • Semiconductor: Revenue from the semiconductor segment was higher on the back of sustained demand for semiconductor chips as well as contribution from recent acquisitions. New customers and front end-semiconductor projects helped to drive the increase, but this was offset by a delay in equipment deliveries. The delay was caused by a myriad of factors such as the Russia-Ukraine crisis, China lockdowns and a deteriorating macroeconomic environment.
  • Life sciences: Growth in the life sciences segment was brought about by higher wallet share from new customers and higher production volumes for mass spectrometers and its related products. Customer supply chain constraints continue to dampen the growth of the life sciences segment.
  • Electronics, Medical, and Others. The surge in revenue can be attributed to maiden contributions from Grand Venture Tech’s recent acquisitions and strong demand from key customers
• 1H22 gross profit margins dipped to 26.9% from 33.1% in 1H21, below expectations. Consequently, net profit fell to $7.1m (-16.2% y-o-y, - 21.2% h-o-h). Grand Venture Tech's 1H22 net profit amounted to 36.4% of our full year forecasts, below our expectations. The net profit decline is in line with the slump in gross profit margins. Notably, Grand Venture Tech incurred S$0.9m of non-recurring expenses mainly related to mergers and acquisitions.
• Grand Venture Tech managed to increase EBITDA by 4.5% y-o-y despite near term headwinds. EBITDA rose to S$16.1m in 1H22, which represents a 4.5% y-o-y increase from S$15.4m in 1H21. 1H22 EBITDA was also slightly higher than the S$16.0m recorded in 2H21 despite the deteriorating macroenvironment.

Our Thoughts on Grand Venture Tech's 1H22

Further advancements into the semiconductor front end to mitigate back-end semiconductor customer weakness.

• The softer macroeconomic outlook for Grand Venture Tech’s semiconductor back-end customers has resulted in a slowdown in order momentum. However, Grand Venture Tech is in discussions with several front-end customers and onboarding of new customers in due course should alleviate back-end semiconductor weakness.
• Contributions from front-end customers are expected to start trailing in from 4Q22, with the full ramp up only likely in 2024. We believe that the foray into the front-end space is expected to help cushion back-end customer softness. Further penetration into the front-end with increasing customer acquisitions will be a key catalyst of Grand Venture Tech’s growth.

Life sciences segment and medical segment remain resilient; seeing pockets of growth from synergistic acquisitions.

• Since the product lifecycles of the life sciences segment are typically long, the life sciences segment is expected to remain sturdy. The synergistic acquisition of J-dragon also gives rise to customer development and cross-selling opportunities, particularly for the medical segment. The acquisition of Formach will also facilitate Grand Venture Tech’s growth in the front-end semiconductor and life sciences segment.

Near-term margin pressure from unabsorbed capacity improvements contingent on revenue growth.

• The margin pressure largely stems from depreciation and amortization which are non-cash in nature. This is due to the unabsorbed capacities as the group has expanded rapidly in the past year. We should see an improvement in margins as utilization rates improve due to wallet share growth and new customer acquisitions.
• Additionally. while inflation may lead to margin erosion, we believe that this could be offset by passing on the cost increases to customers. Industrial automation, cross-site production synergies and mid-term fixed utility contracts are also in place to manage costs.
• We have thus revised our gross margin assumptions to 29.4% and 31.0% from 31.7% and 32.7% for FY22 and FY23 respectively.

Look beyond short-term negatives.

• With digitalization in play, the need for semiconductors has not diminished. Worldwide semiconductor shipments in June came in at US$50.8b, which is still 13.3% higher y-o-y. Even though the growth momentum is slower, Grand Venture Tech comes from a small base and has been increasing its wallet share from existing customers and winning new customers.
• We have forecasted a 20.9% and 22.7% increase in revenue for FY22 and FY23 on expansion across all three segments, particularly with its foray into the semiconductor front-end space.

Maintain BUY recommendation on Grand Venture Tech with lower target price

• In line with the lower valuations for the technology sector, we have changed our P/E peg to 16.0x, close to +0.5 standard deviation of the 5-year historical mean, from 18.0 x previously. Our P/E peg is +0.5 standard deviation from the historical mean as we think that the foray into the front-end space would be a game changer for Grand Venture Tech.
• We have reduced our topline estimates for Grand Venture Tech by 3.3% and 3.1% for FY22 and FY23 due to back-end customer weakness. Net profit estimates have also been revised downwards by 18.7% and 14.0% on margin pressure.
• Maintain BUY recommendation on Grand Venture Tech with lower target price of S$1.07, from S$1.40 previously.
• Key catalysts for Grand Venture Tech include new customer acquisitions in the front-end.