• Semiconductor recovery underway; recent data points and news surrounding the semiconductor industry reaffirm our view that the recovery is playing out.
• Although AEM's share price is at an all-time high and trading at 9.5x FY2020F’s earnings, we have noticed that AEM’s forward PE closely tracks the semiconductor equipment billings. We remain bullish that the recovery will drive a re-rating of its forward PE upwards to 11.2x FY2020F earnings (+2SD).

FY2019 Above Expectations

• AEM Holdings (SGX:AWX)'s FY2019 earnings of S$52.8m (+57.5% y-o-y) was above our estimate of S$46.7m. Earnings growth was driven by higher sales and gross profit margin expansion.
• Sales increased to S$323.1m (+23.2% y-o-y), beating its own guidance of S$305-315m. The increase was mainly due to higher Equipment Systems Solutions (ESS) revenue, which is mainly from Intel. The ESS business segment contributed S$307.9m (+22.3% y-o-y) to revenue.
• Gross profit margin expanded 6.5ppts from 34.0% to 40.5%

4Q19 earnings grew to S$16.7m (+281.3% y-o-y, 22.0% q-o-q).

• Strong earnings growth was led by topline growth as well as gross profit margin expansion to 49.4%, a record high. 4Q19 revenue grew to S$88.7m (+125.3% y-o-y) due to an increase in new orders across all product lines and consumables in its ESS business.
• Gross profit margin expansion was unusually high due to higher margins recognised during the development stage of certain products.

Received sales orders of S$338m for delivery in FY2020.

• As of 25 February 2020, AEM had sales orders totaling S$338m for delivery in FY2020. This is a 38% increase from its earlier level of S$245m as at 7 January 2020. Based on sales orders received and business outlook, the Group has increased its guidance for FY2020 revenue by 9% to S$360-380m.

Higher final dividend per share (DPS) of 3.1Scts/share.

• This brings FY2019 total dividend to 5.1Scts/share, representing a dividend payout ratio of 26%, which is higher than FY2018’s DPS of 3.4Scts/share.

Acquisition of Mu-Test in December 2019.

• AEM acquired Mu-TEST for EUR7.5m. Mu-TEST is a French company that provides full test solutions for medium and high-end integrated circuits, and is a pioneer in offering disruptive, low-cost testers based on Field Programmable Gate Arrays (FPGA). The acquisition is highly complementary to AEM’s Asynchronous Modular Parallel Smart (AMPS) platform.
• AEM continues to look for M&A targets to expand its technology portfolio.

Outlook and Recommendation

COVID-19 disruption still unclear.

• The COVID-19 has disrupted global supply chains in China and dampened economic outlook. With the recent alleviation of the situation in China, some companies in the semiconductor industry have indicated that their orders have merely been pushed back to the later part of this quarter, barring unforeseen escalation of the outbreak.

New technology to drive a structural increase in test times.

• The complexity and shrinking nodes used in mission-critical applications in 5G, electric vehicles (EV), and artificial intelligence (AI) present unique test cost challenges for the industry and require longer test times.

Revised FY2020F/21F earnings up 16%/10% on the back of higher revenue and margins.

• Intel is guiding for record capex in FY2020F. More than 90% of AEM’s revenue is currently derived from its key customer, Intel, which has guided for an even higher level of capex of US$17bn in FY2020F after having spent a record US$16.2bn in FY2019. Its capex will be spent on increasing its fab space as well as to purchase 7-nm and 5-nm equipment.
• We are optimistic that AEM will continue to benefit from Intel’s expansion plans and we have raised FY2020F/21F sales by 5%/4%. We have also lifted gross profit margins to 39.0%/38.0% in FY2020F/21 on the back of higher gross profit margins in FY2019.

Maintain BUY with higher Target Price of S$2.52 (from S$2.38).

• Our Target Price of S$2.52 is pegged to 11.2x (+2SD its historical mean) FY2020F earnings. AEM is currently trading at 9.5x FY2020F forward PE, which is +1.0SD of its mean valuation.
• We are optimistic that the recovery in the semiconductor sector will drive an upward re-rating of AEM’s forward PE multiple.

Source: DBS Research - 27 Feb 2020