AEM HOLDINGS: At the cusp of new order cycle

Excerpts from CIMB report

Analyst: William Tng, CFA

AEM Holdings Ltd FY17: counter cyclical for sure  Loke Wai San, non-executive chairman of AEM Holdings. NextInsight file photo ■ Discussions at 1-day NDR centered on the company’s business, total addressable market, length of current order cycle, and key risks and risk mitigation strategy. ■ AEM is at the cusp of a new order cycle but the key lies in the after-market for consumables (better margin) as the current order cycle will end at some point.  ■ Maintain Add and TP, based on 2.95x FY17 P/BV.

AEM needs more investor engagement
● Eleven participants representing nine fund management houses attended our 1-day NDR for AEM on 24 Mar. We sense that most attendees were unfamiliar with AEM’s business and its current opportunities.

Key question 1: What is the business about?
● AEM supplies a product known as a Test Handler (TH) to its sole major customer. AEM currently does not manufacture any testers.
● Volume shipment of this TH started in FY16.

Key question 2 : customer risk
● Its sole major customer contributed more than 80% of AEM’s FY16 sales.
● It is unlikely that AEM can reduce this dependence in the next few years but this is mitigated by the lock-in effect. AEM and its customer have spent considerable resources to ensure that their products work in tandem. AEM has sufficient patents to render a near-term entry by another supplier futile. At the same time, its customer cannot afford to wait for another supplier to develop as AEM’s current TH shipments are going into its production sites, making its products cost competitive.

Key question 3: Total Addressable Market (TAM)

● Participants were also interested in the product’s TAM and AEM’s ability to meet the demand.
● Although AEM could not quantify the TAM, it noted that its customer was moving to a new testing platform requiring AEM’s TH given the significant cost savings and volume shipments only began in FY16. AEM has also ramped up capacity to meet the demand.
● What is more important to grasp is that the requisite consumables offer better margins and profitability should improve as the installed base grows.

Key question 4: what is the exit plan?
● The major shareholder clarified that its fund has another five years to end of life and it is currently under no pressure to exit this investment. We believe there are less disruptive ways for the major shareholder to exit the investment, such as a dividend in specie to its partners, thus reducing the size of the potential exit.

Maintain Add – upside risks to earnings
● We maintain Add with a TP of S$2.69 (unchanged 2.95x CY17 P/BV; Gordon Growth derived).
● Key risk to our view is operational hiccups and order cancellation by key customer.

Full report here.