AEM Holdings Ltd - CIMB Research 2017-10-16: Raising Guidance Once Again

AEM Holdings Ltd - CIMB Research 2017-10-16: Raising Guidance Once Again AEM HOLDINGS LTD AWX.SI

AEM Holdings Ltd - Raising Guidance Once Again

  • AEM raised its FY17F pretax profit guidance, citing higher sales, better margins and better operational efficiency YTD. It now expects FY17FF pretax profit to be at least S$32.0m, +33.3% from its previous guidance of S$24.0m.
  • AEM updated its 9M17F pretax profit guidance to S$25m-27m, up 42.9-54.3% from its previous guidance of S$17.5m.
  • We raise FY17-19F EPS by 19.3-32.6% to factor in the higher pretax profit guidance.
  • We roll forward our valuation basis to 10x FY19F P/E (multiple unchanged), which raises our target price by 32.7% to S$4.55.

AEM issues positive pretax profit guidance 

  • AEM issued positive pretax profit guidance on Monday, 16 Oct. 
  • The positive update in AEM’s guidance is mainly attributed to higher sales, better profit margin and better operational efficiency YTD as a result of strong customer demand, coupled with benefits from the company’s ongoing efforts to upgrade operational productivity.

Laying the foundation for future growth 

Major change 1 – Mr Loke Wai San assumes Chairman role 

  • On 30 Sep 17, AEM announced that Mr Loke Wai San was appointed as Executive Chairman with effect on 1 Oct 2017. Mr Loke has been AEM’s Non-Executive Chairman since 2011. 
  • We view this appointment positively as we think it would strengthen the major shareholder’s interest (Novo Tellus via Orion Phoenix) and be favourable for the minority shareholders. The appointment reaffirms Mr Loke’s commitment to AEM, as it indicates that he will be focusing on expanding the company. 
  • As the Executive Chairman, Mr Loke’s role will expand to include providing guidance in identifying, structuring and integrating future acquisitions as AEM expands it business scope. Mr Loke is concurrently the Managing Director of Novo Tellus Capital Partners and led Novo Tellus PE Fund I’s investment in AEM. 
  • Mr Loke’s appointment as the Executive Chairman reaffirms his continuing commitment to supporting AEM outside the context of Novo Tellus’ investment.

Major change 2 – delivering on acquisition strategy 

  • On 30 Sep 2017, AEM announced its first acquisition to diversify its business and build on its test handler capabilities. The company announced the acquisition of InspiRain Technologies Pte Ltd (InspiRain), a provider of network infrastructure test and measurement solutions, pursuant to a share purchase agreement signed on 22 Sep 2017. AEM will acquire 100% of InspiRain for up to S$3.6m.
  • InspiRain is a company incorporated in Singapore and engages in the business of research, development and production of network infrastructure test and measurement solutions. InspiRain has a portfolio of test products including a Vector Network Analyzer and a handheld network cable tester. 
  • As the net book value of InspiRain as at 31 Aug 2017 was S$43,000, preliminary goodwill to be recognised could amount to S$3.6m.
  • What InspiRain can add to AEM is: 
    1. InspiRain’s innovative test products address large potential global markets that are immediately adjacent to AEM’s core handling market. With its global sales and service infrastructure, AEM can develop global distribution and commercial traction for InspiRain’s products.
    2. InspiRain’s engineering team possesses strong technical capabilities and deep experience in creating test solutions for global industrial customers. AEM intends to leverage these capabilities to expand its current product portfolio to non-semiconductor industries.
  • The purchase consideration will be satisfied mainly via the re-issuance of treasury shares and a smaller cash payout. The actual purchase consideration will also be adjusted based on agreed upon performance milestones.

Smartflex gaining traction 

  • AEM owns a 21.2% stake in associate Novoflex Pte Ltd (Novoflex), which in turn owns 100% of Smartflex Technology Pte Ltd (SFT) and Smartflex Innovation Pte Ltd (SFI). 
  • SFT is a leading outsourced assembly and test company for smart card modules used in banking while SFI has developed proprietary manufacturing equipment, processes and intellectual property for producing low-cost SIM card modules for telecommunications and smart card modules for banking.
  • This investment will help AEM’s efforts to diversify away from the cyclical semiconductor industry and lower its business concentration risk from a single key customer, in our view.
  • According to information obtained from SFT’s website currently, SFT was founded in 2003 and has around 5% global market share. Its plant in Singapore is one of only two smart card industry contract manufacturers in the world with Evaluation Assurance Level 6 (EAL-6) certification. A key competitive advantage of SFI is that it owns a patent for technology that provides an efficient and economical solution to simplify the manufacturing of smart card at a lower cost.
  • This invention offers an opening to revolutionary technology that could replace the conventional subscriber identification (SIM) card with Smartflex’s eco.SIM solution. The eco.SIM product is a SIM card used in mobile devices to identify and authenticate subscribers in a mobile telephony network. This patented technology offers a breakthrough process that simplifies the manufacturing of traditional SIM cards, eliminates the use of precious metals and reduces material wastage to provide a highly economical solution with fast production turnaround compared to the existing conventional SIM card. 
  • We think this leading edge technology will help Smartflex to expand its market share in high volume markets with high churn rates, offering greater cost savings and promoting eco-friendly production.
  • According to the last available public disclosure, SFI has been granted the patent for this technology in Belgium, Czech Republic, France, Germany, Greece, Italy, the Netherlands, Poland, Portugal, Romania, Spain, Switzerland, Turkey and the UK, Mexico, Myanmar and the Philippines. Pilot runs using its patented eco.SIM technology have already been conducted in countries such as India and Indonesia, which have a large base of prepaid mobile phone subscribers.

Still has ample room to grow 

  • Our earnings forecasts for AEM only consider the server chips and silicon on chip (SoC) business segments of its major customer. Given the stabilisation of AEM’s capacity build-up and its experience in assembling the test handlers, we believe FY18F would be a good time for AEM to address business opportunities with the customer’s computing devices business segment.
  • Other possible growth opportunities include modem chips, Internet-of-Things (IoT) chips and automotive-related chips.

Rolling over valuation basis 

  • We raise our FY17F EPS by 32.6% to reflect the latest pretax profit guidance.
  • Our FY18F and FY19F EPS forecasts are also raised by 25.6% and 19.3%, respectively, as we factor in higher sales and better gross margins as AEM substitutes more of its higher material cost components with more competitively priced ones. Our new forecasts also reflect the potential positive margin impact of higher production contribution from its lower-cost Penang plant in FY18F onwards. 
  • We roll over our valuation basis to FY19F, which raises our target price to S$4.55 (previously S$3.43, based on 10x FY18F EPS) still based on 10x P/E (18% discount to major customer’s P/E and 34% discount to key peer Cohu’s P/E) applied to FY19F EPS of S$0.455. AEM is scheduled to report its 3Q17F results on 2 Nov 2017.
  • Our target 10x FY19F P/E represents peak valuation for AEM based on our 5-year product cycle assumption. As a sanity check, the average of our FY17-19F EPS forecasts is S$0.431. A P/E multiple of 10x applied to this average EPS of S$0.431 would equate to fair value of S$4.31.
  • In our view, AEM’s share price performance would be aided by improved trading liquidity of its shares. AEM’s current 3-month average trading value (as at 16 Oct 2017) is only US$0.74m or just 0.54% of its market cap. We think the company could enhance trading liquidity by executing a share split.

William TNG CFA CIMB Research | 2017-10-16
CIMB Research SGX Stock Analyst Report ADD Maintain ADD 4.55 Up 3.430