• Record-high 1Q20; AEM’s net profit surges 448% to S$36.1m.
• Cloud computing to drive demand for server chips.
• Key customer intends to add 20% to capacity in FY20.

AEM Reported Record-high 1Q20 Results Despite the COVID-19 Pandemic

• While AEM Holdings (SGX:AWX) is maintaining its FY20F revenue guidance of S$360-380m, it is expecting some 2Q20 revenue to be deferred to 3Q20.
  • 1Q20 revenue up 179% y-o-y. AEM achieved a record-high 1Q20 revenue of S$146.8m (+179% y-o-y), which is 50% higher than its last high revenue of S$97.9m in 2Q19. The surge in revenue was mainly due to increased orders from its main customer.
  • 1Q20 gross profit margin of 41.1%. Gross profit margins normalised to 40% from 49.4% in 4Q19 as it completed its revenue recognition from the development phase of its machines, which command higher margins.
  • 1Q20 net profit rose 448% y-o-y. AEM’s net profit surged to S$36.1m (+448% y-o-y) on the back of higher revenue and margins. Net profit margin increased to 24.6% from 12.5% in 1Q19 mainly due to economies of scale from the higher revenue base, and cost savings from the local sourcing of raw materials.

Our Thoughts: Overall Positive for AEM

• At this current state of flux, we are still overall positive on AEM based on several affirming developments in its key customer (Intel) and the industry.
  • Demand for cloud computing and notebooks surges on telecommuting; additional infrastructure needed. Cisco Webex saw a 22-fold increase in network traffic in February while Microsoft Teams suffered some outages as its number of daily active users (DAU) surged by 12 million (40%) to 44 million in the first week of March. Microsoft had to prioritise access to its cloud-based Azure services to cope with demand in the near term and is upgrading its cloud capacity. We are expecting service providers that rely on cloud computing to have to upgrade their infrastructure (expand their bandwidth) to cope with the increased traffic, thereby driving demand for server processors.
  • Intel achieves better yields on its 10-nm chips. Intel has noted that it is achieving better yields on its 10-nm chips and has axed its 14-nm Cooper Lake processor to focus on its 10-nm Ice Lake processor.
  • Intel intends to maintain adding 20% capacity in FY20. Intel is maintaining its plans to increase production capacity by 20% in FY20F.
  • Semiconductor supply chains remain sound. Semiconductors are classified as essential businesses as they are used in medical equipment, enabling telecommuting, and new technology (5G, AI). Semiconductor companies have been granted approval by governments to continue their operations despite lockdowns in certain countries.
• The increase in production volume, chips with smaller nodes, and production capacity all increase test times. This will drive demand for AEM’s test handlers, as well as increase the replacement frequency of its parts.

Intel is cautious on 2H20.

• While Intel had delivered an excellent set of 1Q20 results last week, it came with a cautious tone on 2H20. The company hinted of a possible pushback in capex by six to eight weeks in the near term due to economic growth concerns and regulations.

Earnings and Recommendation

• We are raising our AEM's FY20F/21F earnings by 7% each on the back of:
  • Higher gross profit margins of 40%/40% (previously 39%/38%) in FY20F/21F due to a better product margin mix and lower raw material prices.
  • Lower operating (SG&A) expenses as a percentage of revenue of 19.4% in FY20F (previously 19.7%) from economies of scale and the Singapore Jobs Support Scheme.
• We are now projecting net profit margin of 17.4%/16.6% for FY20F/FY21F, vs 24.6% in 1Q20 and 16% in FY19. Our Target Price of S$2.47 is still based on 10.0x its historical 12-month rolling forward PE (+1.5 SD).

Downgrade to HOLD on limited upside to Target Price.

• Despite the optimistic developments, we are downgrading our recommendation from BUY to HOLD on:
  • The uncertain economic backdrop.
  • AEM’s strong share price performance. AEM's share price has risen by 73% from its trough of S$1.37 in mid-March 2020. This outperforms its peer, UMS Holdings (SGX:558), whose share price has risen by 38%.

Source: DBS Research - 30 Apr 2020