Frencken Group - UOB Kay Hian 2022-11-30: 3Q22 Impacted By Cost Pressures, Weaker Currency & Inventory Write-Down

• Frencken's 3Q22 earnings of S$11m (-26% y-o-y/-17% q-o-q) was below expectations, 9M22 formed 66% of our full-year estimate. 3Q22 revenue fell 1% y-o-y, with semiconductor (+16% y-o-y), life science (+8% y-o-y) and medical (+3% y-o-y) recording growth while industrial automation (-35% y-o-y) and automotive (-7% y-o-y) declined.
• Frencken expects to pass on higher costs to customers in 4Q22 and expects stable h-o-h revenue in 2H22.
• We cut our 2022 and 2023 EPS forecast for Frencken by 16%. Downgrade Frencken to HOLD.

Flattish revenue in 3Q22 with mixed performance across different segments.

• Frencken Group (SGX:E28)’s 3Q22 earnings of S$11m (-26% y-o-y/-17% q-o-q) was below expectations mainly due to weaker-than-expected revenue growth, depreciation of the euro against the Singapore dollar and inflationary cost pressures in Europe. Frencken also recognised a write-down of S$2.4m due to inventory obsolescence.
• 3Q22 revenue of S$195m (-0.6% y-o-y/+2.5% q-o-q) was led by growth from the semiconductor (+16% y-o-y), life science (+8% y-o-y) and medical (+3% y-o-y) sectors.
• Growth in the semiconductor space was lifted by higher orders for front-end semiconductor equipment from customers in Europe and Asia. However, sales in the industrial automation (-35% y-o-y) and automotive (-7% y-o-y) sectors were impacted by reduced customer demand and bottlenecks in the global supply chain.

Cost pressures expected to ease in 2H22.

• Frencken's gross profit margin eased to 13.7% in 3Q22 from 17.1% in 3Q21 as the inflationary cost pressures remain prevalent in Europe.
• Business costs in Europe continued climbing at a fast pace due to soaring energy expenses and increased manpower costs as a result of the labour crunch. Together with higher material costs, these inflationary pressures have affected the Europe operations.

Positive on cost-sharing efforts; 2H22 to be stable h-o-h.

• Frencken expects its cost-sharing efforts with customers in Europe to yield positive effect from 4Q22 and expects group revenue in 2H22 to be stable h-o-h. Breakdown of outlook by segments:
  • semiconductor: stable,
  • medical: increase,
  • automotive: increase,
  • analytical & life science: slightly lower, and
  • industrial automation: decrease.
• The global business environment continues to face headwinds arising from geopolitical tensions, supply constraints, cost inflation and rising interest rates. In the face of heightened economic and market uncertainty, Frencken believes that its highly diverse exposure to multiple market segments and customers in the high technology industry will continue to provide resilience.

Frencken – Earnings forecast revision & recommendation

• We reduce our 2022/23/24 earnings forecast for Frencken by 16%/16%/20% after reducing our revenue estimate by 3%/9%/12% to reflect lower demand across all the sectors due to slower global economic growth.
• Also, we lower our gross margin assumption to 15.0%/15.8%/15.8%, down from 16.1%/16.1%/16.2%, to factor in supply chain disruptions and inflationary pressures due to rising raw materials, labour and energy prices.
• Downgrade Frencken to HOLD with a 9%-lower target price of S$1.07, pegged to 8x 2023F P/E, based on -1 standard deviation of mean P/E to reflect the more challenging growth environment.
• We note that Frencken has a diverse stream of revenue sources, which could help the company stand firm amid a volatile macro environment.
• Catalysts to Frencken's share price include higher-than-expected factory utilisation rates, and better-than-expected cost management.