AEM Holdings (AEM SP) - Maybank Kim Eng 2017-04-25: Accelerating Up The S-curve?

AEM Holdings (AEM SP) - Maybank Kim Eng 2017-04-25: Accelerating up the S-curve? AEM HOLDINGS LTD AWX.SI

AEM Holdings (AEM SP) - Accelerating up the S-curve?

R&D with leading chip manufacturer paying off 

  • AEM has begun volume production for its patented High Density Modular Test (HDMT) handler in 2H16, which culminated a four-year joint R&D effort with a key US-listed client, one of the world’s largest semiconductor manufacturers with more than USD170b market cap. 
  • As the sole supplier of the test handler, order book surged about four-fold in six months to SGD152m
  • Against this backdrop, management has guided 9M17 revenue and operating profit of SGD142m and SGD17.5m (FY16: SGD6.5m), and a dividend payout policy of not less than 25%.

Revolutionising chip testing 

  • Conventional test handlers are typically set up for one test environment, and are costly and time-consuming to reconfigure for other tests. To improve efficiency, industry leader Intel is adopting the HDMT platform, which can achieve 2x cost reduction due to its ability to simultaneously support different test stages for multiple chip types across heterogeneous test environments.

Burgeoning testing needs from new technologies 

  • IT research firm Gartner projects that the number of connected devices will quadruple to 20.8b units by 2020, spurred by the proliferation of 5G network and IoT applications, with each unit likely to be powered by one or more chips. The rising needs for mission critical chips from automotive, healthcare, logistics, telecom and other industries, as well as safety issues would also place greater emphasis on testing to ensure chip reliability.

Single product / customer risks 

  • As its key client accounts for ~80% of group sales, AEM’s fortunes are closely tied to the client’s business performance, as well as capital investment plans. Rapid technological advancement that could render its HDMT handler obsolete may also threaten sales. 
  • The group’s equipment segment, comprising test handlers and related consumables, contributed 92% of FY16 revenue.

Investment pros and cons ~ Growth strategies and value proposition 

Growth strategies 

  • AEM estimates about 400-500 units of final test equipment that it sold are still in use, and could potentially be replaced with the new HDMT handlers over the next few years.
  • Plans to double production capacity to 10 test handlers/quarter from 2H17 onwards.
  • Demand could come from chip makers that prefer to consolidate test handlers for various stages of chip testing by using a single HDMT platform.
  • Higher profitability from higher margin consumable sales as its installed-base of HDMT handlers grows.
  • Develop new variants of HDMT handlers to expand its customer base.

Value proposition 

  • Strong growth trajectory, as evidenced from order book and 9M17 guidance for operating profit before tax, which is more than 2.5x higher than that of FY16.
  • Trading at annualised 9M17 P/E of 5.6x 1 , as compared to 21.6x average for US-listed test handler makers.
  • Dividend policy of not less than 25% annual payout on core net profit, starting from 2017.

Major risks factors 

  • Client concentration risk – Highly dependent on key client’s business prospects, as well as capital investment plans.
  • Obsolescence risk – Emergence of more advanced equipment may threaten relevance of HDMT handlers or development of chips that are not compatible with HDMT platform.
  • Order execution risk - Unexpected disruptions to production and order execution could weigh on financials and relationship with key client.
  • Product & service quality risk – Challenges in delivering test handlers with consistent quality and reliability, as well as seamless field service support across different geographical locations.
  • Foreign currency risk – Orders are largely in USD, while reporting currency is in SGD, with costs spread across multiple geographical locations.

Target Price: N/A

Teh Kwong Yew Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-04-25
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