AEM Holdings (AEM SP) - Maybank Kim Eng 2017-09-14: Sunshine After The Rain

AEM Holdings (AEM SP) - Maybank Kim Eng 2017-09-14: Sunshine After The Rain AEM HOLDINGS LTD AWX.SI

AEM Holdings (AEM SP) - Sunshine After The Rain


Game-changing breakthrough 

  • AEM specialises in back-end semi-con equipment and components manufacturing. 
  • Notably, it has spent the past four years restructuring the company and co-developing the latest test handler for Customer I’s (USD170b market cap chipmaker) High Density Modular Test (HDMT) platform. HDMT has provided a significant edge to Customer I in terms of reducing testing costs, without sacrificing throughput and accuracy.
  • Management is optimistic towards short to medium term prospects as it embarks on a multi-year roll-out of this test-handler.


Mission critical partner 

  • AEM believes that few or none of current test handlers can rival its latest specs. This handler is an integral part of the HDMT, which has helped Customer I achieve up to double their intended cost savings.
  • Management believes that with its
    1. engineering capabilities in fluid and thermo dynamics,
    2. adaptability and keen understanding of Customer I’s stringent requirements, and
    3. dedicated on-site support, 
    AEM will continue playing a strategic role in Customer I’s growth trajectory. 
  • AEM is the sole-supplier for HDMT handlers, and management believes it has a 3-4 year lead time before a competing technology can be developed.


Growth outlook 

  • AEM aims to replace a substantial portion of Customer I’s test handlers over the next three years. 
  • Looking ahead, profitability will be driven by higher-margin consumables sales. AEM estimates the total lifetime value for the test handlers is 20:80 split between equipment and consumables.
  • AEM is also actively seeking to acquire adjacent companies in the value chain (e.g. testers for specialised chips), and/or new technologies in other industries. 
  • Management is guiding for FY17 revenue of SGD200m and EBIT of SGD24m. Orders for FY17 delivery was SGD198m as at Jul-17.


Valuation

  • AEM is currently trading at 7.6x FY17 P/E, based on the estimate of the single broker covering this stock. (See AEM Analysts Report)
  • Singapore-listed peer UMS is trading at 10.2x forward P/E, while global peers are trading at 14.5x forward P/E.





COMPANY PROFILE


Business 

  • AEM specialises in back-end semi-con equipment and components manufacturing. It has three plants across Singapore, Malaysia (Penang) and China (Suzhou).
  • Specifically, AEM is the sole supplier of test handlers for Customer I’s (USD170b market cap chipmaker) game-changing HDMT platform. The customer contributes 90% of revenue.
  • Operates under two segments: 
    1. Equipment systems solutions (ESS, 92% of FY16 revenue): Split into two sub-segments, machines and tooling (43%) and consumables (49%), such as kits, pans and services for the test handlers.
    2. Precision components solutions (PCS, 8% of FY16 revenue): Designs, develops, and manufactures precision components such as hand test jigs, stiffeners and test sockets for semiconductor, solar and aerospace industries, etc.

Company milestones 

  • Then AEM-Evertech was listed on SGX in 2000. Its name was changed to AEM Holdings in 2007.
  • In 2010, AEM was placed in the SGX Watch-list after three years of losses. Separately, major shareholders Tok Kian You (12.5% stake), Ang Seng Thor (11.2% stake) were charged with bribery. Tok and Ang were sentenced in 2011.
  • Novo Tellus Capital Partners became substantial shareholder with initial 16.6% stake in 2011. Currently, its stake is 23.3%.
  • Began co-developing its latest generation test handler in 2013.
  • AEM took one-off restructuring expenses amounting SGD39.6m in FY14, arising from the disposal of its 57.7% stake in the substrates business Microcircuit Technology, as well as from inventory and out-of-favour equipment related write-offs.
  • Began volume production of current generation test handlers in 2016.


SWOT ANALYSIS


Strengths 

  • Entry barriers and wallet share gain: AEM believes it has a four-year head-start before a rivalling handler can be developed. Since Customer I has adopted the HDMT as its primary testing platform, AEM believes the purpose-built handler is poised for wallet share gain.
  • Strong engineering capabilities: AEM has strong fluid and thermo dynamics engineering capabilities, which are key in developing hi-tech handlers to facilitate the testing of increasingly complex chips. About a fifth of its 380 staff are engineers.
  • Dedicated on-site support for Customer I: Such level of support is typically rare for small companies such as AEM.

Weaknesses 

  • Single customer risk: Customer I contributes 90% of revenue. This could limit AEM’s bargaining position, and/or expose AEM to Customer I’s missteps.
  • Vulnerable to growth slump: Unless AEM secures new areas of growth, revenue will decline after the current multi-year replacement cycle of Customer I. AEM cannot deploy its HDMT handler technology to Customer I’s direct competitors.
  • Conflict of interest: AEM cannot seek out new customers directly competing with Customer I, as it represents a conflict of the latter’s commercial interests.

Opportunities 

  • Consumables sales: Each test handler sold creates opportunities for consumables sales. Management believes the lifecycle of a HDMT test-handler is 10-15 years, and total lifecycle value is split 20:80 between equipment and consumables.
  • Structural demand for lower cost of test: Test-handlers with significant cost advantages will become increasingly appealing for semi-con manufacturers. AEM could explore business opportunities with chipmakers not in direct competition with Customer I.
  • Seeking growth outside semi-con: By deepening account penetration in solar and smart-card customers. New engineers have been hired to work on non-semicon opportunities. Selective M&A in other industries.

Threats 

  • Cyclicality risk: AEM’s tooling sales is affected by fluctuations in Customer I’s testing equipment budget, while consumables sales could be affected by enddemand swings for Customer I’s chips.
  • Competition: Competitors, such as Cohu, develop a high volume modular test handler for Customer I and/or its competitors with rivalling technology to lower testing costs.


MANAGEMENT GUIDANCE

  • FY17 outlook: In the 2Q17 earnings briefing, management reiterated its expectations of at least SGD200m revenue and SGD24m EBIT for FY17. Management has so far exceeded its own guidance. At the start of the year, they have guided for SGD70m/SGD6.5m for 1H17 in revenue/ EBIT, but achieved SGD104.5m/SGD14.6m respectively. Orders for FY17 delivery was SGD198m as at Jul-17.
  • Growth prospects: Beyond a multi-year roll-out to replace Customer I’s existing test handlers, profitability is driven by consumables sales. AEM is actively searching for growth opportunities to prevent a revenue slump beyond Customer I’s current capex cycle. This could be driven by a combination of increased penetration in its solar, industrial and smart-card accounts, as well as through acquiring technologies in other industries, or capabilities adjacent in the value chain.
  • Dividend policy: With effect in FY17, AEM has adopted a policy to pay out 25% of recurring net profit, subject to financial position and capex and expansion plans.
  • Capex: Nature of AEM’s business is typically not capex intensive, with capex over the past five years typically below SGD6m. The SGD17.8m capex spike in FY13 was due to spending for a new substrates programme, but the substrates business has been disposed in the subsequent year. AEM has hired additional manpower to cater for its burgeoning order book.


VALUATION & RISKS

  • AEM is currently trading at 7.6x FY17 P/E, based on a single broker estimate, which is currently forecasting FY17 EPS growth of about 4x.
  • In Singapore, the company with the most comparable business model is UMS, which is trading at 10.2x forward P/E. That being said, UMS’ key client AMAT serves a multitude of semi-con manufacturers, while AEM exclusively serves the back-end testing equipment needs for a single chipmaker.
  • Globally, the closest peer is Cohu, which also manufactures test handlers. Global peers are trading at 14.5x forward P/E for 63% FY17 earnings growth.

Growth 

  • Exposed to Customer I, the largest chipmaker globally specialising in microprocessors. In turn, Customer I is leveraged to rising server computing needs of emerging technologies like IoT, Big Data and 5G.
  • AEM’s HDMT handler consolidates multiple stages of testing into a single machine, whilst conventional test approach uses multiple machines. With this, AEM is aiming for maximum penetration into Customer I’s test handler wallet as its handler displaces legacy machines.
  • Have hired engineers, and seeking M&A, to explore opportunities beyond the HMDT handler.

Value 

  • Cash conversion cycle has normalised from 39 days in FY14 (when AEM delayed paying bills due to unprofitability) to 87 days in FY16, which is reasonable for tech manufacturers.
  • Adopted a 25% dividend pay-out ratio policy which will take effect beginning FY17. At current AEM share price, this could translate to a 3.3% yield, based on the EPS forecast of the single broker’s coverage.

Key risk factors: 

  • Single customer risk: Customer I contributes 90% of revenue. AEM cannot deploy its technology to Customer I’s direct competitors. While Customer I has a strong competitive advantage from its massive R&D and process equipment capex budget to continue the pace of Moore’s Law, AEM’s concentrated exposure makes it vulnerable to the former’s strategic missteps.
  • Execution risk: Failure of delivery could weigh on financials and relationship with key client. Lately, AEM has increased space and headcount in Penang by 87%/46% respectively this year to cope with the burgeoning order book. In Singapore, space and headcount was boosted by 41%/27%.
  • Competition: Competitors such as Cohu has stronger resources to come up with rivalling technologies that could challenge the relevance of the HDMT handler.
  • FX risk: Orders largely in USD, while reporting currency is in SGD. Operational costs are denominated in domestic currencies.
  • Legal risk: AEM has received two suits claiming CNY3.7m due to a dispute of assets, salaries and purchases arising from a disposal of its plating business and subsidiary AEM Suzhou in Feb-17. Last year, AEM Suzhou (ASZ) had transferred assets not under the scope of transaction to a new entity called AEM Microtronics Suzhou (AMSZ). Currently, the dispute is that Yunyi is claiming non-payment for these assets (that are not in scope) transferred last year. Also, Yunyi is claiming for the salaries and purchases that ASZ has paid on behalf of AMSZ. AEM believes that Yunyi’s claims are without merit.



NOT RATED 
Target Price: N/A



Neel Sinha Maybank Kim Eng | Lai Gene Lih Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-09-14
Maybank Kim Eng SGX Stock Analyst Report NOT RATED Maintain NOT RATED 99998.000 Same 99998.000



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