EKC (FV RM4.24 - BUY): Company Update: Banking on Cosway China's Aggressive Expansion Plan

Eng Kah is banking on Cosway’s aggressive expansion plan, particularly in China. Besides benefitting from its joint venture (JV) with Cosway China, the company is anticipating more exports to China. It is also expecting orders from new clients, which were affected by the massive floods in Thailand, to come in by 2HFY12. With 1QFY12 results coming in below expectations, we are revising our FY12 earnings projection downward and introducing our FY13 forecast with a new target price of RM4.24, based on the enlarged share capital post-bonus issue.  

Cosway is eyeing the Greater China market with boiling interest. Cosway is aggressive in expanding its China footprint. This would augur well for Eng Kah’s earnings prospects, as it can ride on Cosway’s exposure to Asian markets. Cosway has a physical presence in Hong Kong, Taiwan, Macau and more recently, China. Cosway utilized the eCosway online channel to sell products in China before it was granted the licence to operate physical stores in this fast growing economy in early 2012.

1QFY12 results below expectations. Eng Kah’s 1QFY12 results were below expectations with revenue and earnings constituting 17.1% and 18.2% of our full-year estimates respectively. Earnings came in at RM2.9m (-13.8% y-o-y, +16.4% q-o-q) while revenue stood at RM23.8m (-6.0% y-o-y, -5.0% q-o-q). The poorer y-o-y performance in 1QFY12 was mainly due to more stringent credit control policies being applied on smaller customers, in light of the uncertainties in the global economy. Traditionally, Eng Kah has relied on a relatively conservative approach in managing its business. The EBIT margin fell y-o-y from 18.1% to 16.7% on the back of additional costs incurred for its China venture, with product trial runs and product testing taking place in 1QFY12.

Spill-over effects from Thailand floods. Eng Kah has received enquiries from a few prospective clients after the floods in Thailand. To mitigate supply shortages, a number of companies have approached Eng Kah to find an alternative for their outsourcing requirements. Currently, a few companies have completed the quality auditing of Eng Kah’s manufacturing process. We are expecting new orders from such companies to flow in by the second half of 2012. However, this contribution would be insignificant for FY12. Despite this, we are fairly optimistic on the small orders from its new clients. Based on Eng Kah’s past track record, the company is expected to clinch more orders since its research and development (R&D) team is capable of formulating new products for its clients. This would be crucial for winning the clients’ heart over time and provide the solid foundation for maintaining long-term client relationships.

Maintain BUY with RM4.24 FV. We are fine-tuning our FY12 earnings projection downward by 12.6% on the back of lower-than-expected earnings and higher cost incurred during the initial development stage for its China venture. We are also introducing our FY13 forecast with a new target price of RM4.24, based on an enlarged share capital post-bonus issue. All in all, we continue to like Eng Kah given its: (i) innovative and prudent management, (ii) impressive dividend payout track record, (iii) solid balance sheet, and (iv) immense growth potential from Cosway’s aggressive expansion in China. Despite the recent sell down in the equity market, Eng Kah’s share price has been holding up quite well.

Source: OSK