AEM: Dispelling investor disbelief and concern with solid profitability

Right after AEM's 3Q17 results briefing last Friday, CIMB put out a report AEM HOLDINGS: CIMB maintains Add rating with $4.55 target price. Here, we present a qualitative story of AEM stitched together based on Q&As from several quarterly results briefings. Bottomline: What dispels investors' initial disbelief, and why AEM's best days lie ahead.

A lot has happened at AEM this year which define the company as an outlier in the global tech industry where cut-throat competition is common.  AEM Chairman Loke Wai San fields more questions after the 3Q17 results briefing. NextInsight photoI mean, how many companies do you know whose business has practically no competition? It defies basic economics. And how many companies have such a high customer concentration risk as AEM, which derives almost all its revenue from one customer --and still earns a pretty profit? This is Year 1 of AEM's production of a newly-developed equipment for a big-name customer. Deliveries are in the pipeline over a number of years.  The equipment is for testing semiconductor chips and replaces similar equipment at the customer's factories globally. As more investors increasingly overcome their disbelief and concerns, AEM's stock price has run up about 500% so far this year (from 57 cents to $3.39).  And none of the investors has caught even a glimpse of the AEM hardware, since the company does not welcome them into its production space in Serangoon North Ave 4, presumably as required by a confidentiality agreement with the customer.

Hardware aside, after almost a year, AEM has lots to show: Its 9M2017 net profit reached S$21.8 million (+470% y-o-y), and its market cap is now 10X larger than a year ago. (see table)

You may conclude that AEM can make decent dollars even though it's dependent on one customer. In other words, the customer is at least a decent one who would not bully AEM when it comes to pricing.

AEM doesn't talk about the identity of the customer but it's an open secret that it's Intel Corp, the world's No.1 chipmaker (market cap: US$217 billion). Their relationship goes back quite a number of years and AEM has for several years been the sole source of a particular equipment for Intel.

What's the moat that protects AEM from competition in the latest instance?

Firstly, its "high density modular test" platform was co-developed with the customer over 4-5 years. That tells you it's complex and it's highly customised and there was a lot of customer input.

With such a lengthy duration of development, no competitor would spend resources to develop a competing product for the same customer if the payoff is highly uncertain.

And any competitor with high engineering skill sets would probably be, say, American or Japanese, which implies that their development costs would be much higher than AEM.

Even if a competitor is certain it can deliver a "better product" a few years down the road, can it co-exist with AEM's in the factories?

It's a hypothetical question.

AEM management posits that, at the ground level, factory managers abhor the idea of multiple systems being used for the same processes as that means dealing with different ways of getting the work done, different procurement requirements, keeping different inventories of spares, etc.

"Last week, a member of the senior management of our customer was in town. He thanked us for helping them to achieve a stunning year -- we had made a sliver of contribution to their performance. Check out their stock price: it's at a 17-year high." -- Charles Cher (photo), CEO of AEM  (NextInsight photo)

The efficiency and design of AEM's equipment result in very substantial cost savings for the customer. That makes for a happy customer.

As Charles Cher, the CEO of AEM, said at last week's 3Q17 results briefing: "Last week, a very senior member of the management of our customer was in town. He thanked us for helping them to achieve a stunning year -- we had made a sliver of contribution to their performance. Check out their stock price: it's at a 17-year high."

Coincidentally, AEM's own stock price is also at a 17-year high -- which is also an all-time high since its IPO in Jan 2001.

There're a few other things to like about the business.

It is not based on line production but on cell production, and so doesn't require massive capex and production assets. Its PPE (property, plant and equipment) stood at only $2.2 million as at end-Sept 2017.

With that, the free cash flow is excellent: 9M2017 operating cashflow was $21.2 million while only $528,000 was spent on PPE. 

AEM paid a 1H2017 dividend and has just declared a 3Q dividend. Its policy is to pay out at least 25% of net profit, excluding non-recurring, one-off and exceptional items. 

While AEM has speedily harvested a bounty in Year 1, it wants now to improve its cost structure, expand production to Penang, do M&A, etc. 

And there's more business potential ahead with the key customer. Charles gave away no details, except to say that as the key customer moves significantly into 5G, the next generation of wireless networks, AEM would ride along.

His upbeat feeling was palpable at the 3Q17 briefing when he said: "We at AEM are very confident that for this year and at least the next few years, our outlook is very, very exciting. And it's not just because of this particular programme that we now have with the customer. We have insights into their technology road map and we are extremely excited." 

Watch Intel tell what 5G is about -->