• We lift FY19-21F core EPS by 6.5-14.5% as Intel seeks to expand its TAM and fight back against competition.
• We expect AEM’s 3Q19 net profit to rise by 16% y-o-y on the back of orders from its customer.
• Maintain ADD. We switch from P/E valuation to P/BV valuation to factor in the cyclical nature of the business.
• Our target price rises to S$1.44.

Record Profit in Sight for FY19

• On 12 Sep 2019, AEM (SGX:AWX) raised its FY19 guidance for the third time. The company announced that its order book for delivery in FY19 has been increased to S$280m (previously S$255m) and that FY19 revenue guidance was between S$285m to S$305m (previously S$265m to S$280m).

What’s Driving AEM’s Guidance Upgrade?

• AEM’s guidance upgrades are being driven by orders from Intel. In turn, we think Intel’s orders are being driven by
  1. Intel’s decision to venture into new growth areas relating to data demand,
  2. production technology migration, and
  3. the need for system level testing.

AEM Reports 3Q Results on 1 Nov

• Our base case expectation is that AEM could report 3Q19 net profit of S$13.2m (+16% y-o-y, -16% q-o-q). In a bull case, we think net profit for 3Q19 could be S$15.7m (+38% y-o-y, flat q-o-q).

Earnings Upgrade

• We lift our FY19-21F earnings forecasts given Intel’s efforts to expand its Total Addressable Market (TAM) and fight back against competitors. We now see a stronger FY20 versus our previous expectation and the tapering of orders from Intel may be delayed to FY21.

Transformational Performance Shares

• On 7 Oct, AEM issued an initial award of 1.3m performance shares to its Executive Chairman and its CEO. The options are with respect to a 3-year (FY19-21) Transformational Roadmap and contingent on certain achievements. A further 5.2m performance share options were granted to its Executive Chairman, CEO and other key management. This scheme aligns management’s interest with minority shareholders.

Maintain ADD With Target Price Raised to S$1.44

• We lift our Target Price to S$1.44 based on justified P/BV multiple of 3.24x on FY19F BVPS to factor in the earnings cyclicality. Note that we used a 10x P/E multiple previously. Potential re-rating catalysts include further order wins from its major customer. The key downside risk to our ADD call is order pullbacks/slowdown from its major customer.

TAM Expansion – CPU to XPU

• Intel Corporation (INTC US) held its Investor Meeting on 8 May 2019 in the US. From its meeting transcript, we noted three key takeaways:
  1. Intel has expanded its TAM in an increasingly data-centric world where demand is rising for more computing power, storage and faster connectivity;
  2. Intel is moving from its traditional strength in Central Processing Units (CPUs) to XPUs. XPU is a term coined by Intel to include products that cater to the demand for data;
  3. Intel will accelerate the rate of innovation for its products.

Technology Catch Up – From 14nm to 10nm and 7nm

• Intel is currently investing in the three technology nodes of 14nm, 10nm and 7nm. In 14nm, Intel is getting more performance out of this node and has also expanded capacity at this node. Meanwhile, Intel has already launched 10nm products and could have an internode transition at 10nm++ before moving to the 7nm node.
• Based on information from Intel’s Investor Meeting in May this year, the company is targeting to launch 7nm based products in 2021.

New Requirements - SLT

• While System Level Test (SLT) is not something new, fault coverage and reducing the cost of testing has led to renewed interest in SLT. Systems are getting more complex and now involves different processors, storage and other elements. Hence, the behaviour of the multiple processing elements in a system will vary depending on power, performance or electrical characteristics. As these devices will be deployed in safety-critical markets such as automotive, industrial IoT or medical, they need to function under harsher conditions and for possibly 10 to 15 years, versus a typical 2-3 years for a consumer device. Hence, there is a growing need to test the products at a system level.
• According to Astronics Test Systems, at the 10nm node, with current test methodologies and test speeds, millions of transistors may not be tested. As semiconductor usage in automotive increases, this could become an issue.
• We understand that AEM has received orders for its legacy SLT Test Handlers in FY19. Sales of such SLT Test Handlers tapered off in FY11 as its customers have started to move towards newer technologies.
• AEM has been providing customised SLT solutions since 2001 and has an installed base of more than 700 units of such Test Handlers (THs). With the industry interest in SLT on the rise, AEM has introduced its own Asynchronous Modular Parallel Smart (AMPS) platform.
• The features of AEM’s AMPS platform are:
  • modular and configurable with massively parallel and asynchronous in operation;
  • a singular platform that could co-exist with different testers to accommodate different test processes being executed simultaneously;
  • a singular platform supporting development, validation and mass production, ease of scalability and time to market.
• AEM has secured its first AMPS customer in late 2018, and a prototype system to the customer’s facility for evaluation.

FY19-21F Earnings Revised Upwards

• Given Intel’s strategy of expanding its TAM, migration to more advanced technology nodes, the need for SLT testing and AEM’s latest revised FY19 guidance, we have raised our FY19-21 earnings forecasts.
• Investors should note that AEM will need to invest in hiring more senior executives as it seeks to win new customers.
• On 7 Oct, AEM announced:
  1. grant of performance shares to its Executive Chairman (EC) as well as to its Chief Executive Officer (CEO) and
  2. grant of share options to its EC, CEO and other top management.

Valuation and Recommendation

• Our Target Price is raised to S$1.44, based on AEM’s theoretical P/BV of 3.24x on FY19F BVPS. We switched from P/E methodology to P/BV methodology to better factor in the earnings variance over FY19-21F. See AEM Holdings Share Price; AEM Holdings Target Price; AEM Holdings Dividend History.
• Potential re-rating catalysts include further order wins from its major customer, and new customer wins for AEM’s own handler platform and test solutions for optical fibre cables. Order pullbacks/slowdown from its major customer remains the key risk to our ADD call.
• Given that AEM’s earnings are driven by Intel’s orders, investors’ need to track AEM’s order and revenue guidance closely as well as corporate developments at Intel.

Source: CGS-CIMB Research - 21 Oct 2019