Avi-Tech Electronics - Riding On March Towards Cloud And Smart Cities
- Avitech, a total solutions provider for burn-in, burn-in board manufacturing and printed circuit board assembly (PCBA), has successfully recovered from its M&A mishap, and is now in a prime position to ride on the world’s march towards smart cities and digitalisation.
- Avitech is on track to record stable YoY NPAT growth of 10- 15% in FY17F-18F, with a strong balance sheet (net cash of over SGD31m or 50% of its market cap). The stock is trading at undemanding valuations – FY18F ex-cash P/E of only 4.4x.
- We initiate coverage on Avitech with BUY, and a DCF-derived TP of SGD0.52 (30% upside).
- Avitech was incorporated in 1981 and is engaged in providing total solutions for burn-in services, Printed Circuit Board Assembly (PCBA) and engineering services in the semiconductor, electronics and life sciences industries. With market presence in South- East Asia, and major countries such as China and the US, Avitech works with global original equipment manufacturers (OEM).
- Fully equipped with advanced burn-in systems, its production facility also supports Burn-in Board Manufacturing and PCBA services.
- In 2008, Avitech was awarded the prestigious Singapore Quality Award, which is a testament to its world-class standard of performance.
Niche services provider
- Reliability tests. Burn-in is a test where components are subjected to thermal and electrical stress to detect early failures in components. This is to ensure a high level reliability as semiconductor devices are sensitive to impurities. Microprocessors and automotive products such as sensors require fail-safe and high reliability semiconductor devices, which need Burn-in services to maintain quality.
- Burn-in Boards. Besides conducting tests, Avitech is involved in designing and manufacturing a wide range of Burn-in systems as well as other reliability test equipment. In addition, it has built a niche position as it is qualified to build Burn-in boards, which are catered for high powered devices.
- PCBA. Avitech provides PCBA services for various industries ranging from medical and mobile communications to aviation. Management has been constantly improving its capabilities in order to adapt to the changing demand of customers.
- Engineering services. The group is also involved in providing engineering solutions for the life sciences and biotech industries. Ranging from design, development and full turnkey outsource manufacturing, and systems integration of semiconductor equipment to lab automation, Avitech seeks to provide value-add and improve its customer’s designs. One of its competitive strengths is the provision of system integration services for refrigeration-based High Power Burn-In Systems and Lithography Tool for semiconductor front-end applications.
Trading at undemanding valuations – FY18F ex-cash P/E of 4.4x.
- Avitech is on track to record stable annual NPAT growth of 10-15% in FY17F-18F. The group has a strong balance sheet representing net cash of over SGD31m or 50% of its market cap.
- Avitech is currently trading at undemanding valuations, with FY18F ex-cash P/E of only 4.4x. Based on our conservative DCF model, which assumes 0% terminal growth, we arrive at an intrinsic value of SGD0.52 per share for Avitech, which implies FY18F ex-cash P/E of just 5.7x.
SGD31+m war chest for M&As.
- With an SGD31m war chest at its disposal, management is looking at accretive acquisitions and new avenues of growth which would fit synergistically with the group’s existing service offerings.
- We believe that it would learn from past mistakes and utilise cash more efficiently this time round. With accretive acquisitions, Avitech would be able to enhance its NPAT drastically, with a combination of debt and cash financing.
50% payout ratio + possible special dividend.
- As of 2QFY17, management implemented a dividend payout policy of at least 30% of total profit. We believe this sends a strong signal of its positive business outlook, as well as its intention to return value to its shareholders. In fact, Avitech has a track record of paying out at least 50% of its NPAT over the past few years, and management has highlighted that it would likely maintain that going forward.
- With the positive outlook ahead coupled with the group’s strong cash balance, we believe there may even be a potential special dividend in FY17 to reward shareholders. This would boost FY17F yield to around 7.5-10%, based on our estimates.
Internet of things (IoT) to provide opportunities for semiconductors.
- The increasing IoT objective brings about higher demand for microcontrollers, sensors and memory, which we believe is a positive for the semiconductor industry. For example, self-driving cars (SDV) require sensors to capture data, and microprocessors to process the data as well as guide the vehicle. Semiconductors used within these sophisticated equipment are required to be fail-safe hence, increasing the demand for high-powered, burn-in services.
- Avitech’s burn-in services segment is therefore well-positioned to benefit from the increasing sophistication of vehicles and ultimately, the advent of driverless vehicles. With other disruptive technologies in the IoT era, and the march towards cloud businesses and smart cities, we believe another wave of demand for semiconductor burn-in and other related services is coming, which would be a further boost to the group.
- We therefore believe that the long-term growth prospects are positive, in line with the macro trend of global digitalisation. As a result, we view that a conservative and stable annual NPAT growth of 10% should be sustainable at Avitech.
Initiating coverage with BUY and TP of SGD0.52
- DCF-derived TP of SGD0.52 with WACC of 12%, TG of 0%. We initiate coverage on Avitech with a DCF-derived TP of SGD0.52, and a BUY recommendation.
- Our assumptions are listed below:
- Risk-free rate of 2.3% from the 10-year average yield of Singapore Government bonds;
- Expected market return of 10%, based on Bloomberg’s 10-year average return of the Singapore market;
- Beta of 0.5;
- Terminal growth rate of 0%.
Peer comparison Significantly undervalued.
- Avitech has successfully turned around and consistently generated stable profits over the past few years, while at the same time rewarding shareholders with over 50% NPAT payout as dividends.
- However, relative to its local peers, Avitech is trading at a significant discount, with FY17F P/E of only 9.7x, compared to the local peers’ average P/E of 13x.
- At our DCF-derived TP of SGD0.52, the implied FY17F P/E is only 12.6x.
Unable to synergise past M&As.
- In 2011, Avitech diversified its business and invested in two subsidiaries in the US, namely Aplegen and Verde Design. These investments turned out to be poor decisions as revenue projections from the two subsidiaries fell short of expectations. This was due in part to the market dynamics of bigger companies entering into the same space and competing aggressively on price, as well as delays in the launch of new products which impacted revenues. The group made substantial losses before management made the decision to liquidate the subsidiaries in 2014.
- The group has since recovered from this, with a cash hoard of over SGD30m currently. Management has expressed that they are open to synergistic and complementary investments. The group is looking at accretive acquisitions and new avenues of growth, which would provide a synergistic fit with its existing service offerings. Although we believe Avitech would learn from their past mistakes and utilise its cash more efficiently this time round, there is still the risk of the group not being able to integrate the new company into its operations, which would in turn negatively affect its profitability.
Cancellation of orders.
- With China’s constant efforts to solidify its position as the key player in semiconductor manufacturing, fierce competition from Chinese companies may persuade Avitech’s customers to switch suppliers, which would pose risks to Avitech’s revenues.
Inability to keep up with changing needs.
- Despite the vast potential within the automotive semiconductor space, the rapid pace of technological change may prove too difficult or unprofitable for certain semiconductor companies. If Avitech is not able to adapt to change, the group may lose its competitive advantage and long-standing partnerships.
Susceptible to semiconductor slowdown.
- Avitech is still largely dependent on the semiconductor industry. Furthermore with high customer concentration risk, a slowdown within the semiconductor industry would threaten its financial position Cyclical semiconductor industry.
- Avitech operates in the semiconductor industry, which is known for its cyclicality hence its earnings would be exposed to the swings of the industry.