Frencken - Maybank Research 2022-11-29: Rising Costs; Downgrade To SELL

• Downgrade Frencken to SELL from HOLD as we expect net margins to decline further due to rising costs.
• Soaring energy and labour costs reduced net margin and Frencken (SGX:E28)'s 3Q22 core PATMI was 4% below our estimate. And although some customers have agreed to share the added costs, we expect continued cost increases to further hamper margins and potentially even new orders, especially as winter is approaching.

Impacted by higher energy and labour costs

• Frencken’s weaker 3Q22 was mainly due to soaring energy and manpower costs, especially in Europe where its main manufacturing facilities are based. Depreciation of the EUR and slower-than-anticipated recovery of the global automotive industry also impacted Frencken’s performance. Net margin fell to 6.7% in 3Q22 from 7% in 2Q22 (excluding one-offs).
• Frencken also incurred a one-off write-down of S$2.4m, mainly for inventory adjustment and obsolescence.

Sharing higher costs with customers

• Frencken's management is re-negotiating with customers to share the higher costs and pass on majority of its increased costs to its customers and we expect this to contribute positively in 4Q22. Some customers have already agreed to a more proactive approach in future with regards to managing the supply chain and operating cost.

Winter is coming

• New orders secured in the medical, analytical and life sciences segments will help to buffer any slowdown in the semi-con segment but rising costs in Europe may continue to hamper Frencken’s margins and growth.
• As a result, we lower our FY22 and FY23 PATMI forecasts for Frencken by 6.9% and 5.9%, which in turn lowers our target price slightly to S$1.02, based on 8.5x FY23E P/E.
• We prefer Venture Corporation (SGX:V03) and UMS (SGX:558) instead.