Fresh from oven

INITIATE COVERAGE

 

Frencken Group (FRKN SP) 

 

BUY | Price/Tgt: S$0.86/S$1.15 | Mkt Cap: S$364.9m

 

Resilient And Stable Portfolio Stands Out In Tough Times

 

High-tech component manufacturer Frencken is a longer-term beneficiary of positive trends in the technology sector. With a diverse blue-chip clientele, its earnings should be more stable than peers&rsquo amid the temporary slowdown brought about by the COVID-19 pandemic, which has affected manufacturing plants worldwide. Initiate coverage with BUY and target price of S$1.15.

· Revenue stream from multiple industries. Frencken Group (Frencken) serves leading corporations across multiple industries, a wide range of end-user markets and different geographical regions. Top- (+5.6%) and bottom (+41.1%) lines delivered healthy performances amid tumultuous business conditions in 2019. For the year, we expect a slight revenue contraction of 6.4% as the healthy demand growth from the semiconductor business would be offset by the worsening dynamics in the automobile industry. A resumption of orders in the company&rsquo s analytical and industrial automation subdivisions is expected to lift 2021-22 top-lines by 8.7% and 9.5%, respectively.

· Longer-term beneficiary of positive tech sector trends. Frencken is in a good position to ride the positive market trends in 5G, Internet of Things and artificial intelligence. As a component supplier and provider of modular parts for companies in industries such as analytical & life sciences, healthcare and industrial automation, the group will benefit from higher demand for parts as the technology trends evolve towards mass consumption.

· Taking operational efficiency to the next level. Despite expected lower sales in 2020, operating margin should normalise above 11%, compared with the sub-9% region between 2014 and 2017, due to cost-cutting measures and efficiency improvements. Management is still making investments to upgrade its equipment and facilities.

· Supportive balance sheet to weather volatile conditions. As at end-1Q20, its net cash of S$92.9m, or 25% of market cap, should help weather any uncertainties in the current demand environment due to the COVID-19 outbreak. Past the volatile period, we believe Frencken would emerge with a leaner cost structure, which translates into greater operating leverage as revenue normalises. Shareholders should be rewarded with a consistent dividend payout of > 30% of net income, which Frencken has made since its listing in May 05.

· Initiate coverage with BUY and target price of S$1.15, pegged to 12.6x 2020F PE, in line with that of SGX-listed peers, and implies 5.7x EV/EBITDA. We believe current valuations are attractive, given the exposure Frencken has to favourable market trends in the technology sector. Assuming a 30% payout ratio, 2020-21F DPS of S$0.0275 and S$0.029 would translate to yields of 3.2% and 3.4% respectively. Frencken currently trades at 9.4x 2020F PE and 4x EV/EBITDA.