KCE Electronics

Earnings growth to outweigh dilution effect

KCE Electronics Plc (KCE)

Investment thesis

KCE remains our top BUY in Electronics space for its superior order and GM expansion profile. We expect FY13 earnings growth to outweigh the effect of EPS dilution of 24% (due to warrant conversion). Our recent talk with management made us more upbeat about KCE earnings outlook. We have revised up both our FY13 and FY14 earnings forecasts by 12% and raised our post-XW YE13 target price to Bt17.40, pegged to PEG of 0.8x (an FY13-15 core earnings CAGR of 18%). Our target price implies a PER of 15x, 0.6SD above its long-term mean.

New warrant issuance suggests 13.1percent stock price dilution …

The firm recently announced that it would issue warrants to existing shareholders at a ratio of one warrant-to- four existing shares (1 warrant = 1 stock at an exercise price of Bt5), XW on April 1. Given that the warrant has a three-year term, a risk-free rate of 2.75%, price volatility of 40% and a market price of Bt16.80 (yesterday's close), we estimate the current market value of the warrant at Bt8.85—a post-XW stock price dilution of 13.1%. We didn't expect a capital increase so soon. Management guides that the capital injection from warrant conversion will provide working capital for the next three years.

…but boosts the FY14 earnings outlook

The planned new plant in Ladkrabang is currently being designed; construction of the first phase will be completed in about 15 months. New capacity of 700K sq.f/month (equal to around 30% of total existing capacity) will start up in 3Q14. KCE guides that the new plant will have streamlined production processes, minimizing the need for workers. As such, FY14 earnings could potentially beat our forecast. Note that we have yet to incorporate the new capacity into our model. KCE will need only around Bt100-200m for the capacity expansion in 4Q13. The firm expects an insurance payout to fully cover 4Q13 CAPEX. However, major CAPEX (Bt1.4-1.5bn) will be required in 1Q-2Q14.

1Q13 earnings likely to beat market expectations …

Our previous GM assumption seemed too conservative. Based on our last talk with KCE, the new PCB drills (installed on Feb18) not only boosted PCB drilling capacity by 15%, but also eased a production bottleneck. Moreover, raw material prices (fiberglass and copper) softened. As such, we have revised up our 1Q13 earnings forecast by 23% to Bt152m to incorporate our new GM assumption of 21.5%m, up from 21%.

…and revised FY13 growth should more than offset share dilution

We have also revised up our FY13 and FY14 earnings projections by 11.5% and 11.9%, respectively, as we now assume lower financial costs and fatter GM (up by 50 bps for FY13 to 21.7% and by 70 bps for FY14 to 22.0%). The YoY core profit jump (due to the low base set by FY12) should outweigh the effect of 24% EPS dilution. Looking further ahead, we anticipate 18% core earnings growth for both next year and FY15.