What a swashbuckling return! From a low of $3.08 on 21 October, AEM share price stormed back in style to hit a high of $3.47 in recent days. The recovery of AEM share price came on the back of a stellar 3rd quarter financial result. In this blog, I have always maintained that on its day, AEM share price can be unbeatable. Conversely, when the tide goes against AEM share price, the counter can spiral out of control. In view of this, this counter is not for the faint-hearted.
The recent rout of AEM share price was attributed to the troubles faced by its key customer – Intel. Consequently, various analysts came out slashing their targets for AEM share price. Intel is struggling to turn around its business as it incurred loss of US$500 million in 2nd quarter.
While 3rd quarter saw Intel recording US$1 billion profit, the result still paled in comparison to the US$6.8 billion profit recorded in Q3FY2021. As the US chipmaker tried to revive its business, it announced cost reductions of US$3 billion in FY2023. Being a key supplier of back-end test equipment for Intel, AEM may be affected if Intel chooses to defer its test equipment orders from AEM. In this context, many investment analysts had written off AEM share price.
Despite the near-term headwinds, I am 200% convinced that AEM share price will rise from the ashes to hit another new high, possibly in 2023. This conviction is not based on blind faith. Rather, it is due to the recent decision by the management to rejig its business model in tooling consumables. Recent data from the financial results suggests that the management may have hit the jackpot. Before I go into the details, I would like to share my insights on the company’s decision to pivot in tooling consumables for its System Level Test equipment.
As an engineer in the aviation industry, I have seen Singapore aviation established itself as an MRO hub since 1990s. The aviation MRO industry is dominated by two big boys – ST Aerospace and SIA Engineering Center. For the past three decades, these two companies had gone on to thrive to new heights due to the recurring nature of its MRO business model. While they do not manufacture nor design aircraft or equipment to the airlines, their businesses are pivoted on the provision of maintenance and replacement parts of aircraft, which require continuous maintenance in order to operate safely.
Back to AEM, the company’s core business is selling test solutions to chipmakers. Even though the profit margin is high, the business model is not sustainable as chipmakers do not keep buying new test equipment. Furthermore, there are always alternative suppliers to choose from. As such, the contracts are usually one-off in nature. A more sustainable approach should be the provision of maintenance for the test equipment, which include tooling consumables. Due to the high-volume chip testing, the sockets and jigs in the test handlers will wear out and need to be replaced with new ones. As the Original Equipment Manufacturer, the parts will have to be purchased from AEM.Note that this is an opinion article and not meant to be a financial advice. Please do your due diligence or engage financial advisors before investing in the stock market. I am vested in this counter, so my views on AEM share price (SGX: AWX) may be biased.
AEM share price in transformational journey
Don’t get me wrong. I am not suggesting that AEM is dumping its test equipment business in favour of tooling consumables. Instead, both business segments go hand-in-hand. The strategy is to secure customers’ purchase of the test equipment, build up the network and then provide the maintenance contracts. Gaining market share in the sale of System Level Test equipment is important and is the first step. Currently, AEM’s test equipment competitors are Teradyne and Advantest.
Recent data indicates that the tooling consumables segment has become the biggest revenue contributor for AEM. For 9MFY2022, the Consumables segment contributed 40% of the revenue ($297.4 million) whereas the Test & Automation Equipment segment contributed 35% ($264.8 million). Services segment accounted for the rest ($184.4 million). On a year-on-year basis, the revenue from Consumables jumped the highest (by $177.3 million) vis-à-vis the increase of $171.7 million recorded by the Test & Automation Equipment segment.
Total revenue for 9MFY2022 more than doubled year-on-year to smash a high of $746 million while net profit surged 118% year-on-year to hit $115 million. According to the management, the robust growth in revenue and net profit were due to “volume ramp up from new and existing customers for its System Level Testing handlers and peripheral tools as well as contributions from CEI Pte Ltd”. However, in my view, the financial performance was largely due to the Consumables segment, which helps to mitigate the volatility from equipment sales.
Of noteworthy is that in the latest business update, the Group shared that the Serviceable Addressable Market (SAM) for its Test 2.0 equipment is an eye-popping US$3 billion. The growing recurring demand for AEM’s kits, pans, and spares is underpinned by a growing install base of more than 1,000 Test 2.0 tools. Based on my estimation, this volume ramp is still at the early phase as AEM has recently acquired three new customers. As the Group deepens its technical engagement, the SAM for its Test 2.0 should grow further.
Despite the positive long-term business outlook for AEM, the short-term should see much volatility for AEM share price. Apart from Intel troubles, another shock-wave for AEM share price came from the latest US curbs on chip export to China. The new ban should affect global chipmakers like Intel but the immediate impact on AEM is not so clear to me. My assessment is that the move by US could prolong the downturn of the semiconductor industry and further exacerbate the decline in the demand for global semiconductor chips in the short-term.
The recent wave of uncertainties had certainty caused AEM share price to sink into a quicksand. Nonetheless, my opinion is that the counter may have bottomed due to the share buybacks and substantial shareholders purchases.
In the month of October, the management purchased shares from the market on 12th, 18th and 19th. As at 19th October, the cumulative shares repurchased amounted to 733,100. During this period, Aberdeen bought 616,700 shares while Malaysia’s EPF bought 457,100 shares. The corporate actions of the big boys had helped to shore up confidence and broke the fall of AEM share price.
And then on 14 October, the management of AEM revised its revenue guidance upwards to between $820 million and $850 million. It is very rare that the management issued revenue guidance prior to the release of financial result. I guess they had to do it to halt the crisis of confidence on the share price. Based on the announcement, the result for FY2022 should be stellar. However, FY2023 may be a challenging year. A lot depend on whether AEM can manage to weed off its unhealthy reliance on Intel for revenue and pivot in the consumables business.
Uncertainty beckons in FY2023
The semiconductor industry is notorious for being cyclical. Historically, huge capital expenditures by chip-makers will always precede the downturns. During the pandemic, we have seen demands for chips rocketed and that demand continued all the way till 2022. Based on the historical trend, the demand for chips should have peaked in 2022.
AEM’s key customer is Intel which announced expansion plan in Europe ($124 billion) over the next decade. In Penang, Intel is spending US$7 billion to build a new plant. In addition, Intel is also spending US$20 billion on a new plant in Arizona. In total, Intel is spending $158 billion to compete against its competitors. However, these expansion plans will take at least 2 to 3 years to materialize because these facilities require high-technology equipment in order to commission.
Taking into consideration the macro-economic condition, it is safe to say that the global demand for chip is slowing. However, it is too early to claim that Intel would cut back on capital expenditure and reduce equipment orders. A lot would depend on the upcoming financial result due to be released on 27 October and also the extent of the restructuring.
In my opinion, Intel is likely to increase prices for its chips in order to achieve turnaround. Furthermore, it has already set up a new unit to do chip contract manufacturing. In late July, Intel won a contract to manufacture chip for MediaTek. Henceforth, my view is that the volume ramp up from Intel may continue. Even so, the uncertainty of the macroeconomic environment means that AEM should expedite its efforts in securing new customers.
New patent obtained in September 2022
On 27 September, AEM obtained its second patent in 2022 for the thermal control used for its System Level Test equipment. The first patent obtained in July 2022 had led to contract wins from two major customers. The contract wins came from “a leading High-Performance Computing (“HPC”)/Artificial Intelligence (“AI”) company” and “a leading mobile devices company”. In my assessment, the contract wins should help to offset the potential sales order reduction from Intel.
One should not underestimate the potential impact of the patents. Back in 2012, AEM was on the brink of collapse when the company was placed on the SGX Watch-List. Despite the challenges, Non-executive Chairman Loke Wai San saw the potential in the equipment business due to the partnership with leading US chipmaker, Intel. The decision proved to be pivotal as the partnership between AEM and Intel led to a patent for its test handling stacking technology. The patent was granted in March 2018. If investors look back, AEM share price used to trade at less than $0.10 in 2016. The patent turbocharged AEM share price to nearly $2.00 in March 2018.
Obviously, the 2018 patent has led to a significant volume ramp up from Intel, thereby increasing the revenue for AEM. Fast forward to 2022, Intel is no longer the force it used to be. As such, my sensing is that the management of AEM is trying its very best to weed off its heavy reliance on Intel for business.
To sustain business growth, AEM continues its merger and acquisition program through the acquisition of a 53.3% stake in Nestek, a South Korean Company that specialises in the design and manufacture of pins and sockets. The acquisitions should strengthen AEM’s consumable business.
If I am not wrong, AEM should need at least one more acquisition. Hopefully, it would be one of the listed technology companies in SGX – Micro-Mechanics, UMS, ISDN or Frencken. With so much cash on hand and with Temasek’s backing, I would like the next candidate to be Micro-Mechanics, which produces tooling and precision components for the semiconductor industries.
Micro-Mechanics’ business would fit in nicely with AEM as it could support the System Level Test Consumables segment, which had a Target Addressable Market of USD300 million. Furthermore, the recurring revenue nature of consumable parts will reduce the revenue volatility for AEM.
Apart from the good fit, Micro-Mechanics’ diversified customer base may also help AEM to secure more customers, thereby reducing the latter’s unhealthy reliance on Intel for business.
Besides Micro-Mechanics, Global Testing is another potential acquisition target for AEM’s Wafer Level Test business segment. The acquisition would have strategic value as AEM could diversify its customer base to include TSMC and UMC. Global Testing would also offer AEM the opportunity to deepen its business presence in China and expand product offering. With its current cash holdings, AEM can also afford to acquire Global Testing with cash without taking bank loans.
Is this the end of the road for AEM? Honestly, I do not think so. While the downturn in the semiconductor industry has led to a crisis of confidence in AEM share price, the Group has been making record revenues and profits in FY2022. Obviously, most investors would point out that this feat is unlikely to be repeated for FY2023. To this end, I do not disagree. However, I do think that it may be too premature to deem that AEM’s revenue and profit will decline in FY2023 for sure. A lot will depend on whether AEM can reinvent itself, secure new customers and make new acquisitions.
Will this counter rise to my expectation or turns out to be a fallen angel? Nobody knows for sure but I am taking a calculated risk based on the strong business fundamentals of the company. With so much upside potentials, I honestly doubt this counter will bomb out as the debt is nearly zero. Till then, enjoy the ride.