Avi-Tech Electronics - CGS-CIMB Research 2020-06-01: Burn-in Testing Specialist; Initiate Coverage With ADD

AVI-TECH ELECTRONICS LIMITED (SGX:BKY)

Avi-Tech Electronics - Burn-in Testing Specialist; Initiate Coverage With ADD

We initiate coverage on Avi-Tech with an ADD rating and Target Price of S$0.422 as we believe it is a proxy for the rising semiconductor content in automobiles.
Prospective dividend yields over FY20-22F of 6.49% are backed by strong free cash flow (limited capex) and a net cash balance sheet, in our view.
Accretive M&A are upside share price catalysts. See Avi-Tech share price.

Avi-Tech Electronics - Company background

Incorporated in 1981, Avi-Tech Electronics (SGX:BKY) provides burn-in services, burn-in board manufacturing and printed circuit board assembly and engineering services for the semiconductor, electronics and life sciences industries.
Based on our industry checks, Avi-Tech’s key customers are Analog Devices, Infineon Technologies, and Marvell Technology.
Avi-Tech has marketing offices or representatives in Singapore, Malaysia, Thailand, Vietnam, the Philippines, Taiwan, the People’s Republic of China, Japan, the US and Europe.
Singapore based customers accounted for 57% of Avi-Tech’s FY19 revenue.
Avi-Tech’s three key business segments are:

Burn-in services (31% of FY19 revenue):

Avi-Tech conducts burn-in testing for semiconductor customers whose chips are used in high reliability semiconductor devices such as microprocessors used in automotive and networking products. Burn-in is a reliability testing process where semiconductor components are stress-tested in various voltages to detect defective components. Avi-Tech provides round-the-clock delivery and collection services for its customers.

Manufacturing/PCBA (56% of FY19 revenue):

Avi-Tech provides the design, manufacturing and assembly of a wide range of burn-in boards and automatic test equipment/load boards for various types of burn-in systems as well as other types of reliability tests.
Avi-Tech also designs printed circuit boards (PCB) and provide niche PCBA services for the medical, mobile communications, optics and aviation industries.

Engineering services (13% of FY19 revenue):

Avi-Tech’s engineering services offers design and development to full turnkey outsourced manufacturing and system integration of semiconductor equipment and lab automation systems for the life sciences and biotech industries. Avi-Tech is also able to add value and improve its customers’ products for manufacturability. One of its competitive strengths is the provision of system integration services for refrigerated-based high power burn-in systems as well as lithography tools for front-end semiconductor applications, in our view.
Avi-Tech’s only factory is located in Singapore (19A Serangoon North Ave5), which has a built-up area of 12,000sqm. Its burn-in systems are capable of performing burn-in testing of different semiconductor device types ranging from microprocessors, microcontrollers, automotive control circuits and custom made chips. This facility supports all the business segments and is equipped with advanced burn-in systems, which are designed and fabricated in-house.

Avi-Tech Electronics - Outlook

Robust automotive semiconductor growth

Avi-Tech is a beneficiary of the long-term demand growth for burn-in services for automotive semiconductors.
PricewaterhouseCoopers (PwC) Research (Apr 2019) expects the global automotive semiconductor market to expand by a CAGR of 11.9%, from US$43bn in 2018 to US$68bn in 2022F, fastest of all semiconductor markets, due largely to strong penetration of electric and hybrid cars, which require about twice the semiconductor content of conventional cars.
Advanced driver-assistance systems (ADAS), light detection and ranging (LiDAR), infotainment, and safety and convenience functions are gaining more attention as cars become more automated and thereby require more semiconductors per vehicle. According to Deloitte Research (as at Apr 2019), the cost of semiconductor content has grown from US$312 per car in 2013 to c.US$400 in 2019, and is expected to reach close to US$600 per car in 2022F.
Automotive semiconductor vendors are benefiting from a surge in demand for various semiconductor devices in cars, such as micro-controller units, sensors and memory, in our view.
There are 3 key drivers of the growth of semiconductor content in automotive electronics and subsystems:

1) Driving automation

Automakers, technology providers and smart mobility companies are racing to develop and invest in automation-related technologies for automobiles. Semiconductor vendors in particular are actively developing a wide-range of microchips, fusion and system-on-a-chip devices incorporating artificial intelligence (AI) and machine learning technologies to increase automation levels in a vehicle.
There are 6 levels of driving automation defined by SAE International (Society of Automotive Engineers), ranging from full manual (Level 0) to fully automated systems (Level5). Getting to full vehicle autonomy requires advancements in technologies such as ADAS safety systems that can reduce the number of traffic accidents, including electronic stability control, lane departure warning, anti-lock brakes, adaptive cruise control and traction control. All of these require complex electronic components that include high-speed processors, memory, controllers, sensors and data links to ensure the reliability and safety of a vehicle.
According to industry forecaster, IC Insights, semiconductor content per vehicle is five times higher for full automation than for partially automated systems.

2) Electrification of automobiles

The need for cars to be more fuel-efficient and lower-emission will drive semiconductor demand for both traditional vehicles and EVs/hybrid electric vehicles (HEVs).
For traditional vehicles which run on internal combustion engines (ICEs), there is a huge potential to lower CO2 emissions, which can be made possible by adding more sensors and controls for the engine to run more efficiently, in our view.

3) Digital connectivity

Digital connectivity includes in-car entertainment platforms, including media streaming services. There is also advanced vehicle connectivity, which connects vehicle-to-vehicle communication. This is a critical technology for autonomous cars to realise driverless technology and avoid accidents.

High barriers to entry

The automotive industry is governed by strict safety standards, as operating conditions in cars are much more demanding than in typical consumer electronics. Hence, automotive components need to meet stringent quality requirements before they can go into a vehicle; also, qualification processes are long. Potential recall of automotive products would involve lengthy investigations and costly processes. Therefore, it is in the semiconductor manufacturers' interest to ensure their IC chips are free from defects.
Requirements of the automotive electronics market are also vastly different from the consumer electronics market. Besides having to operate at a wider range of temperatures of -40°C to 160°C, devices are also required to operate correctly in a wider range of voltages in cars versus semiconductor components present in other consumer and industrial segments.

Global semiconductor recovery affected by Covid-19

According to industry forecaster, Gartner Inc (9 Apr 2020), worldwide semiconductor revenue is expected to decline 0.9% y-o-y in 2020F (down from 12.5% growth previously forecasted by Gartner in 1Q20) due to supply chain disruptions caused by the Covid-19 outbreak. On 4 May 2020, the Semiconductor Industry Association (SIA) reported that worldwide sales of semiconductors reached US$104.6bn in 1Q20 (-3.6% q-o-q, +6.9% y-o-y).On a month-on-month basis, global semiconductor revenue edged up 0.9% to US$34.9bn. According to SIA, 1Q20 semiconductor sales data has yet to fully capture the impact of the Covid-19 health crisis. SIA’s view is that the outbreak has caused significant uncertainty for the global semiconductor market that is likely to persist in the months ahead.
Sensors will play a critical role in the shift to autonomous driving, as they are required to enable autonomous capabilities. The number of sensors used in vehicles will increase as autonomy levels rise. At Level 4, the number of sensors could reach 29.

Avi-Tech Electronics - Historical financials

Revenue grew over FY15-17 driven by the demand for burn-in services. Avi-Tech's revenue fell 11% in FY18 (due to lower sales in the engineering service segment) and 6% in FY19 (cyclical downturn in the semiconductor industry).
Avi-Tech's Net profit fell 31% in FY18 as revenue declined.
Gross profit margin hit of a high of 32.3% in FY16 (as customers’ products entered mass production) before falling in FY17 and FY18. In FY19, gross profit margin recovered to 31.4% as the contribution from burn-on and burn-in related services increased.
By segment, the burn-in services segment has been growing over the past five years and reported the best operating profit margin in FY18.
Free cash flow positive over the past five years with limited capex spend.
Avi-Tech has maintained net cash balance sheet over the past five years.
Generous dividend payout ratios of 92% and 85% of net profit for FY18 and FY19. See Avi-Tech Dividend History.

Downside Risks

Cyclical industry

The bulk of Avi-Tech’s revenue comes from the semiconductor industry, which is cyclical in nature. A downturn in the industry could result in downward pressure on the group’s selling prices and testing volumes, leading to lower profitability. The industry is also characterised by rapid technological changes which might result in high capital outlays should the group need to invest in new technologies and capabilities.

Customer concentration risk

Avi-Tech derived approximately 56% of its FY19 revenue from two main customers. In FY18, these two customers accounted for 45% of the group’s revenue.

M&A execution risk

In 2011, Avi-Tech invested in two subsidiaries in the US, namely Aplegen (Unlisted) and Verde Design (Unlisted) However, financial performance of these two subsidiaries fell short of expectations due to competition and delays in product launches. Management exited these investments in 2014. Successful M&A remain a viable growth strategy for Avi-Tech but execution remains a risk.

Avi-Tech Electronics - Forecast assumptions

We assume 3.3% revenue CAGR over FY20-22F driven mainly by the burn-in services segment. We note that the burn-in services segment has a strong track record of y-o-y revenue growth over the past five years. However, we expect FY20F revenue to fall 4.1% y-o-y due to the Covid-19 outbreak.
We forecast 34%/36.5%/37.0% gross profit margin for FY20-22F. In 1H20, gross profit margin reached 38.6%. Gross profit margin is affected by the revenue mix.
Operating expenses could increase by 2% annually over FY20-22F as Avi-Tech has historically been disciplined in managing costs.
Our effective tax rate forecast is 17% (Singapore corporate tax rate) as Avi-Tech has only one factory which is located in Singapore.
Avi-Tech has limited capex needs and we have estimated capex spend by referencing to yearly depreciation.
Given limited capex needs, Avi-Tech generates strong free cash flows yearly. The company also has a net cash balance sheet. We have assumed that Avi-Tech will pay a DPS of S$0.025 over FY20-22F.

Avi-Tech Electronics - Recommendation

We initiate coverage of Avi-Tech with an ADD recommendation and a target price of S$0.422. Our target price is based on 1.42x P/BV multiple derived from the Gordon Growth Model (COE: 8.8%; ROE: 11.7%).
We project dividend yields over FY20-22F to be 6.49%. See Avi-Tech Dividend History. Based on our forecast, Avi-Tech’s projected end- FY20F net cash accounts for 52% of its market cap. We use Gordon growth Model derived P/BV to derive our target price given the cyclicality of the business.
Over the past five years, Avi-Tech traded at a historical average forward P/E of 10.2x and a P/BV of 1.14x. Compared to its peers, Avi-Tech is trading at 11.4x/10.3x CY20F/CY21F P/E versus the peer average of 12.9x/11.2x. Avi-Tech is trading at 1.28x CY20F P/BV versus the peer average of 2.00x. See Avi-Tech Share Price. Avi-Tech’s CY20F projected dividend yield is 6.5% versus the peer average of 3.5%.
Given a total return potential of more than 10%, we initiate coverage on Avi-Tech with an Add and a Target Price of S$0.422.
See Avi-Tech Share Price; Avi-Tech Target Price; Avi-Tech Analyst Reports; Avi-Tech Dividend History; Avi-Tech Announcements; Avi-Tech Latest News.
Upside catalysts are stronger-than-expected customer demand/accretive M&A.
Downside risks are a deterioration in customer demand due to the escalation of the Covid-19 outbreak.
See attached 22-page PDF report for analysis.

William TNG CFA CGS-CIMB Research | Caleb PANG Huan Zhong CGS-CIMB Research | https://www.cgs-cimb.com 2020-06-01

SGX Stock Analyst Report ADD INITIATE ADD 0.422 SAME 0.422

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