AEM Holdings Ltd - CIMB Research 2017-03-08: Another upcycle begins

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AEM HOLDINGS LTD AWX.SI

AEM Holdings Ltd - Another upcycle begins

• Successfully restructured with a net cash balance sheet.
• Return to profitability driven by orders for a new equipment product from a major customer (sole source).
• We expect an EPS CAGR of 55% over FY16-19F driven by orders from customer.
• Announced a 25% dividend payout policy and proposed a 1-for-2 bonus issue.
• Projected dividend yields of 4.7-6.7% over FY17-19F.
• Potential rerating catalysts include higher order wins. In the longer-term, could be a possible acquisition target by competitors. Initiate coverage at Add.

Company background 

AEM then 

• AEM Holdings Limited (AEM) traces its roots to AEM-Evertech (AEM-Evertech) Holdings Ltd, which listed on the SGX on 19 Dec 2000. 
• The major shareholders of AEM-Evertech then were founders, Tok Kian You (12.5% stake), Ang Seng Thor (11.2% stake) and Transpac Capital Pte Ltd (25.9% stake). Transpac Capital Pte Ltd (Transpac) is a direct investment management company.
• AEM-Evertech’s businesses then were: 
  1. Equipment - design, develop and manufacture equipment for the assembly, testing and finishing processes of semiconductor manufacturing. Through its in-house design and development capabilities, AEM-Evertech was able to integrated various processes into a single machine.
  2. Precision Engineering - design, develop and manufacture precision engineering products for equipment used in the semiconductor assembly, testing and finishing processes.
  3. Chemicals and Services: develop processes and associated chemical formulations for the surface finishing of semiconductors and connectors. AEMEvertech also provided surface finishing services for high-end and specialised requirements in deflashing and plating of connectors.
  4. Distribution: distribute a range of engineering materials and products to the semiconductor manufacturing industry.
• AEM-Evertech Holdings Ltd changed its name to AEM Holdings Limited in 2007.

What changed? 

• Key changes for AEM were 
  1. In 2012, Tok Kian You and Ang Thor Seng were sentenced for bribery charges. Both Tok and Ang are no longer involved with AEM and as of 16 Dec 2016, Tok ceased to be a substantial shareholder of AEM as his stake fell to 1.04%.
  2. Orion Phoenix, through its Novo Tellus PE Fund 1, L.P., became the major shareholder of AEM with an initial 16.59% stake on 23 Nov 2011 as Transpac sold its stake. As of 28 Dec 2016, Orion Phoenix’s stake was 28.1%.
  3. In the past few years, the group has exited its non-core businesses and assets, and has focused on its core competency.
  4. There were also various management changes, and its current CEO, Charles Cher, was appointed on 1 Apr 2014.

AEM now 

• Today, AEM has a healthy net cash balance sheet and the company aims to be a leading global provider of equipment systems solutions and manufacturing services. 
• AEM’s key business segment today is Equipment Systems Solutions (ESS) that makes up the bulk of its revenue. It also has a smaller Precision Component Solutions (PCS) division. 
• For FY16, the ESS segment accounted for 92% of sales, while the PCS segment accounted for the remaining 8%. Its factories are located in Singapore, Malaysia and China. Of the 92% of sales from the ESS segment, 43% was revenue derived from the sales of tools and machines, while the balance 49% was from the sale of consumables used in these machines (kits, spares and services).
• ESS Segment 
  • AEM specialises in providing customised systems solutions to both mass volume manufacturers and new technology development laboratories. The company is a partner for customers in product development from concept to mass production. Its equipment solutions involve integrating Precise High Speed Motion, Innovative Mechanical Design, Advanced PLC (Programmable Logic Control), Sophisticated GUI (Graphics User Interface) and Reliable SECS/GEM [SECS (SEMI Equipment Communications Standard)/GEM (Generic Equipment Model)] compliance communication protocol.
  • AEM’s systems are deployed globally at world-class semiconductor and solar manufacturing facilities. Under its ESS segment, AEM strives to be an Innovative and Proactive Business Solutions Provider, promoting early involvement and a partnership approach. AEM’s solutions include Test Handlers (key product), Wafer Handling Systems, Laser Marking, Laser DeFlashing, Vision Inspection and Unique Handling Systems.
• PCS Segment 
  • AEM specialises in high precision components and mechanical assemblies. The company designs, develops and manufactures precision engineering products used in the electronics, life sciences, instrumentation and aerospace industries.
  • The group has state-of-the-art machines, consisting of 5 axis CNC (ComputerNumerical-Controlled), Turn Mill, EDM (Electric Discharge Machining) and Wire Cut machines enabling it to deliver a broad range of customised precision engineering solutions with metals as well as plastics (such as Vespel and Torlon).
  • Major products produced for customers include standard and customised items such as test sockets, device change kits, stiffeners, golden units, holding jigs, preventive maintenance kits and precision mechanical assembly modules.

Game Changer 

• The game changer for AEM is its current Test Handler business. Its Test Handlers are sold to a single customer who is the leader in the design and manufacture of advanced integrated digital technology platforms. This customer’s platform consists of a microprocessor and chipset, and may be enhanced by additional hardware, software, and services. Currently, AEM is the sole supplier for this customer.
• AEM spent more than 4 years collaborating with this customer to develop this new High-Density Test Handler product. This Test Handler designed for its customer represents a paradigm shift in how semiconductor chips are tested and also represents a multi-year migration for its customer. By the end of 4Q15, AEM was ready to ship production units and orders became sizeable necessitating disclosure in FY16.
• AEM’s major customer started to build its own test own test solutions from the ground up as the market was not meeting its needs. In 2014, AEM’s major customer announced the availability of HDMT (High-Density Modular Testing) for its foundry clients. AEM’s customer commented that its HDMT platform significantly reduces costs compared to traditional test platforms. HDMT also reduces test time to market and improves productivity as it uses a common platform from low-volume product debug up to high-volume production. The HDMT platform targets a range of products in diverse markets including server, client, system on chip, and Internet of Things.
• Automated Test Equipment (ATE) systems typically interface with an automated placement tool, called a "Test Handler", that physically places the Device Under Test (DUT) on an Interface Test Adapter (ITA) so that it can be measured by the equipment. There may also be an Interface Test Adapter (ITA), a device just making electronic connections between the ATE and the Device Under Test, but also it might contain an additional circuitry to adapt signals between the ATE and the DUT and has physical facilities to mount the DUT. Finally, a socket is used to bridge the connection between the ITA and the DUT. A socket must survive the rigorous demands of a production floor, so they are usually replaced frequently.
• AEM’s Test Handlers incorporate advanced robotics, thermal and fluid engineering and complex systems integration.

Risks 

• The key risks faced by AEM are: 
  1. Customer concentration risk. One single customer accounted for more than 80% of its FY16 revenue.
  2. Single product concentration risk. AEM’s business is currently being driven by the sale of a single product - Test Handler.
  3. Total Addressable Market (TAM). The TAM based on its customer requirements is also a source of uncertainty as the customer’s shift to its new testing platform implies efficiencies and thus, a reduced quantity of Test Handlers required compared to previous replacement cycles. The pace of replacement by its key customer is also not within AEM’s control.
  4. The order backlog at any point in time may not be representative of the actual sales in any future period due to the possibility of the customer changing the delivery schedules and cancelling orders, among other factors.

Outlook 

Global semiconductor industry to recover in 2017 

• On 23 January 2017, Gartner released its projections for the global semiconductor industry. According to Gartner, worldwide semiconductor revenue is forecast to total US$364.1 bn in 2017, an increase of 7.2% from 2016. 
• Gartner highlighted that the areas to watch for in 2017 are the industrial, automotive and storage markets, which are growing quickly. Additionally, the slow-growth outlook for traditional applications such as smartphones and PCs highlights the importance of semiconductor markets outside of these categories, notably the Internet of Things.

World economic outlook positive 

• In its Oct 2016 release, the International Monetary Fund (IMF) projected that global growth will slow to 3.1% in 2016 before recovering to 3.4% in 2017. 
• The US is expected to grow 2.2% in 2017 vs. 1.6% growth in 2016. Japan is also expected to grow 0.6% in 2017 vs. 0.5% in 2016. The European Union is expected to slow down to 1.5% in 2017 from 1.7% in 2016. China is also expected to experience slower growth of 6.2% in 2017 from 6.6% in 2016.

Key customers outlook 

• Based on Bloomberg consensus forecasts, AEM’s key customer’s revenue is forecast to experience a CAGR of 2.0% over FY16F-19F while net profit is expected to grow at a CAGR of 3.1% over the same period. 
• By FY19F, consensus expects this customer to achieve revenue of US$63bn and net profit of US$14.5bn.

Financials 

P&L trends 

• AEM turned around in FY15 with a pre-tax profit of S$4.9m. A tax credit in FY15 brought net profit to S$6.7m. AEM registered a net loss of S$27.3m in FY14. 
• In FY14, there was a S$26.2m charge under other expenses. The bulk of this charge was due to the loss on disposal of a subsidiary and inventory provision as its major customer discontinued orders for older equipment in favour of next generation platforms. 
• The earnings recovery continued into FY16 with pre-tax profit growing 25.1% yoy to S$6.1m. With deferred tax assets fully utilised, AEM resumed paying taxes on its profits in FY16, leading to a 28.6% yoy decline in net profit.

Balance sheet trends 

• AEM has been in a net cash position for the six years. The business is R&D intensive and not capex intensive. Over the past six years, the cash cycle has averaged 148 days. This is mainly due to the high inventory days.
• AEM resumed dividend payments since returning to the black in FY15. The company paid a DPS of 1.0Scts in FY15 and 1.8Scts in FY16.
• Competitors Direct competitors for AEM are US-listed Cohu Inc and Xcerra Corporation.
  • Cohu is a leading supplier of semiconductor test and inspection handlers, micro-electro mechanical systems (MEMS) test modules, test contactors and thermal sub-systems used by global semiconductor manufacturers and test subcontractors. 
  • Xcerra Corporation, formerly known as LTX-Credence Corporation, is a global provider of test and handling capital equipment, interface products, test fixtures and related services to the semiconductor and electronics manufacturing industries.
• On the SGX, UMS Holdings is a listed peer that is involved in the semiconductor business and is also dependent on one major customer for more than 80% of sales.

Key forecast assumptions 

• Our key assumptions are as follows: 
  1. We assume that the current addressable market for AEM’s Test Handlers with its major customer is approximately 180 units. This is based only on the customer’s server chip and Silicon on chip business. We note that its major customer has other business segments such as IoT, modems, memory etc that could represent business opportunities for AEM .
  2. We assume that the Average Selling Price (ASP) is S$3.0m per Test Handler and that there will be no cost down for FY17F as there is an order backlog. FY18-19F will see a 10.0% cost down. Depending on how many test cells the customer wants AEM’s Test Handler to handle, the ASP could range from S$1.0m to more than S$3.0m.
  3. We assume that gross material margin will decline to 26-28% as unit shipments of machines increase, as machines generally command lower margins than consumables.
  4. In its FY16 results announcement, AEM guided that it expects to achieve S$70m in sales and a profit before tax of S$6.5m for 1HFY12/17. On 2 Mar 17, AEM announced that it has received to date, purchases orders worth S$130m for delivery in FY17. In our FY17F forecasts, we have assumed that AEM will achieve S$138m in sales and a profit before tax of S$14.6m.

Valuation & recommendation 

• We value AEM based on the Gordon Growth implied P/BV method. We assume zero growth and an adjusted cost of equity of 11.10%. This leads to an implied P/BV of 2.95x (versus FY17F-FY19F average ROE of 32.7%) which translates into a target price of S$2.69 based on our FY17F BVPS.
• Our target price of S$2.69 translates into an implied FY18F P/E of 8.0x. This is at a 34% discount to its closest peer, Cohu’s FY18F P/E of 12.1x. AEM’s projected EPS CAGR over FY16A-FY19F is 55%.

William TNG CFA CIMB Research | http://research.itradecimb.com/ 2017-03-08

CIMB Research SGX Stock Analyst Report ADD Initiate NOT RATED 2.69 Same 2.69