Broker's take: CGS-CIMB initiates coverage on Nanofilm with 'add', S$5.52 target price

CGS-CIMB has initiated coverage on Nanofilm Technologies International with an "add" rating, given its proprietary technology and sole supplier status to major customers.

In a research note dated Friday, CGS-CIMB analysts William Tng and Darren Ong noted that the nanotechnology solutions provider is the only company to offer filtered cathodic vacuum arc (FCVA) coating technology on a commercial scale as at Oct 23 this year.

The technology provides functional and cosmetic advantages against conventional coating technologies, and is also environmentally friendly, the analysts wrote.

They noted that Nanofilm's technology enables it to perform vacuum coatings at room temperature on base materials such as ceramic and plastics, allowing it to penetrate new markets, as conventional technologies had been uneconomical previously.

"Due to the superior advantages that its in-house developed advanced materials provide for its customers end-products, Nanofilm has earned itself the single source supplier status among many of its customers, making the company an integral part of the manufacturing process," the analysts wrote, noting that the company is the sole coater for 90 per cent of its major customers.

"We believe Nanofilm is poised to benefit from secular growth trends such as the Internet of Things and 5G adoption which raises overall demand for coating and surface solutions."

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The brokerage noted that Nanofilm had commissioned a study which identified only three other companies globally to be involved in FCVA technology, with Nanofilm the top provider of surface solutions based on its patented technologies. They added that Nanofilm's FCVA technology creates a barrier to entry, with key patents expiring only from 2025 to 2039, allowing the company to derive potential long-term profitability and gain market share.

The analysts also toured Nanofilm's plant in Singapore, which reaffirmed their "strong conviction" of the company's growth. The brokerage estimates revenue to grow around 34 per cent compound annual growth rate (CAGR) over financial year (FY) 2019 to FY2022. They also expect earnings per share (EPS) to similarly rise 35 per cent CAGR over the same period.

CGS-CIMB said that conversations with factory supervisors and management have led them to infer that a capacity ramp up is underway, backed by strong demand from the wearables and tablets segment. The brokerage noted that global smartwatch revenue had grown 20 per cent year on year in the first half of 2020.

"We think strong demand for smartwatches will sustain the high growth momentum of its wearables business," the analysts wrote. They added that demand from products such as the Microsoft Surface tablet can benefit Nanofilm, which is the sole coater of the logos on the tablet.

The brokerage has a target price of S$5.52 for Nanofilm, based on 35.3 times forecast EPS for FY2022.

While Nanofilm currently trades at a higher price to earnings multiple compared to the simple average of its peers, the analysts believe that this could be due to a higher forecast EPS CAGR over the next three years for the company.

They also think the premium reflects Nanofilm's sole coating supplier status to nine out of 10 of its major customers, and its patented and environmentally friendly coating technology.

Some downside risks identified by the brokerage were customer concentration and competition from bigger and notable companies globally.

Last week, UOB Kay Hian raised its target price on Nanofilm by 11 per cent to S$4.52, while maintaining its "buy" call.

Nanofilm shares traded at S$4.18, as at 1.16pm on Monday, up 7.2 per cent or S$0.28.