Update on LKT

Here's an update to a previous blog posting: LKT Industrial

Here are some key points mentioned by Kenanga in its research article posted today. My comments in green:

Key Points

l M1 (92,500 sf) is fully operational. The visit confirms that M1 ( the first of the two new plants) is fully operational with the buzz of activities both in the sheet metal machine shop as well as assembly plant for the OEM machines. The sheet metal machine shop being the largest in the northern region has freed up bottlenecks in its production process for its own brand name and OEM machines.

l M2 (134,000 sf) is on schedule for completion in March 07. All of the OEM equipment will be built in M1 and M2. We had earlier underestimated the strictness of its OEM customers as we did not anticipate that they will be undertaking a plant qualification process before the load LKT with large orders. This has in turn delay ed the sharp pick up in earnings which we had anticipated in FY07 to FY08.

l The thoroughness of OEM customers reinforces high barrier of entry. On the flip side of the extenuating qualifications of the new plants, we are positive that the barriers to entry for being an OEM supplier to tier one semiconductor equipment manufacturers remain an exclusive club which is highly coveted and difficult to attain.

l We expect RM6m net loss in 4Q06 due to one-off forex losses and write down in inventory. The sharp appreciation in the Ringgit has resulted in some of its earlier contracts priced at lower exchange rate to result in a loss compared with the sharp appreciation at end of 2006. Some write down in value of inventory which could have been obsolete was also undertaken, we estimate the total one of net loss to be RM6m for 4Q06. This would result in FY06 net profit to be within RM33m to RM35m ie at around FY05 levels. (rm6m in losses... ahh... finally some light on what's happening. Kinda disgusting cos the market action recently which saw the saw tumble from rm4.00 indicated that them insiders knew something the minority investors did not know. And rm6m in losses is huge!!)

l Not too concern about one-off losses, business as usual. As we have indicated earlier in our strategy report 2007 that small–mid cap stock are likely to have volatile QOQ net earnings while the whole business model and direction remains intact and in fact poised for strong growth in FY08.

l Industry remains bullish. Largely front -end capital expenditure investment in 2007 in wafer fabrication would result in higher demand in back end equipment with a time large of 12 to 18 months. SEMI has forecasted global semiconductor equipment sale of USD42.1b for 2007 up 3.7% yoy. The growth for 2008 and 2009 is even more bullish with 13.3% and 5.4% yoy growth. ( err... industry remains bullish? Some had voiced concerns, no?)

l OEM business diversifies and grow LKT’s offering from back end to front end of the semiconductor equipment segment. With the OEM business, LKT’s equipment revenue mix is now 60% back-end and 40% front-end which is encouraging seeing that about 70% of the total global semiconductor equipment sales is in the front end.

l The departure of the previous president, Mr Lim Wei Yee will not affect the business. Dato’ Vincent Loh, the executive chairman has stepped up his involvement in the daily operations of the company and remains very hand-on, essentially taking over the duties of Mr Lim. (WOW!!! Departue of previous president... hmmm... did the investing public know about this? (i for one did not know cos i had not followed the stock closely)

l The customers remain confident of the continuation of business as usual. The institutionalisation of the management team with professionals rather than family members of controlling shareholders ensure that there is leadership succession and that no one person is indispensable. LKT has in place a board of management committee which oversees the strategic as well as day to day decision making of the company.

l OEM business has already obtained pioneer status. Meerkat Technologies and Meerkat Integrator have obtained poineer status with 100% tax exemption for 10 years and 5 years respectively. LKT has applied to MITI to activate the status retrospectively to 1 Jan 06 which could result in higher contribution from the OEM division. This could result in lower overall taxes for FY06 and boost its net profit when the approval to activated the status on 1 January 2006 is obtained.

l EPS revised downwards. Given the delay in OEM customer loading LKT with we are lowering FY06, FY07 and FY08 EPS to 39 sen, 51 sen and 65 sen from my earlier forecast of 70 sen, 87 sen and 89 sen respectively assuming lower growth in revenue and also higher overall operating costs. (huge downwards revision in eps!!!! )

l Reiterate BUY recommendation with revised price target of RM4.20 from RM5.60 previously. The target price is derived using a 6.5x PER multiple on FY08 EPS of 65 sen. The selldown in the stock represents good opportunity to purchase LKT at extremely attractive PER multiples 5x and 4x respectively (remember this cheap PE multiples is based on fy 2008 earnings. as it is. fy 2006 estimates is at 26.991 million. fy 2008 estimates is at 44.736 mil. And because the estimates is so much higher than fy 2006 earnings... LKT is surely looking mighty attractive and cheap)