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AEM Stock – Overexposure To Huawei’s Woes?

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AEM Holdings (AEM) had earlier announced on 09 October 2018 that it had signed an agreement to partner with the now controversial Chinese telecommunications equipment maker, Huawei to roll out AEM’s test solution.

The test solution was developed in collaboration with China Electronics Technology Group Corporation No. 23 Research Institute (CETC23) that will be used for qualifying high-performance short reach cabling links for Huawei’s fifth generation (5G) backhaul network.

Given this recent partnership announcement, we would like to examine potential impacts to AEM’s overall fundamentals, and model using discounted cash flows (DCFs) to analyse the fair value of the Company’s stock price, which was last traded at S$0.845 as of 14 December market close.

Issues Of Cancellations?

There are still a lot of unknowns relating to whether the arrest of Huawei’s Chief Financial Officer Meng Wanzhou and subsequent release on bail will result in suppliers cutting back on Huawei’s supply chain on concerns that they might be implicated for indirect or direct relationships with the Company.

Huawei is currently facing US allegations of circumventing Iran sanctions. Notwithstanding that, the Company is also facing possible indictment for cyber espionage like fellow telecommunications equipment maker ZTE Corp.

That said, we think that investors should be cautious when jumping onto conclusions based on the 09 October press announcement alone, given the arrest of Huawei CFO Meng. There is no outright causality just because AEM has business dealings with Huawei

On the other hand, the partnership with Huawei might allow AEM to actively work on rolling out 5G technologies as this is relatively new and many countries including Singapore are currently putting the system on test trials, and to be introduced in later phases.

An overview of AEM

AEM specializes in providing customised system solutions and manufacturing services, namely Equipment Systems Solutions, and Precision Component Solutions segments. The Company has offices in Singapore, Malaysia, China, Finland, the United States and Vietnam. The corporate headquarters is in Singapore.

Financial Performance

We noted that revenue in FY17 surged about three-fold year-over-year (YoY) to $221.6 million in FY17 from FY16. This was due to a significant growth in the Engineering Services (ESS) segment which risen 233.3 per cent to S$214.8 million in FY17 as a result of higher equipment, pans and kits sales.

AEM revenue

Source: Annual Report 2017

Another noticeable line item was the two-fold increase in inventories to $35.8 million in FY17 from $17.4 million. Management disclosed in the FY17 Annual Report that the increase in inventory cost was mainly due to a shift in the revenue mix towards sales of its new equipment and pans which require higher material costs.

The Company noted in 2H 17, there have been favourable changes in revenue and margin mix, cost reduction initiatives, and increase in engineering services revenue for new development projects.

Meanwhile, for the latest nine months period ending 30 September 2018, revenue rose 37.2 per cent to hit $223 million, while net profit during the same period rose 33.7 per cent to $29.1 million.

AEM 9M18

Source: Company’s financial reports

The Company’s cash and cash equivalents position as of 30 September 2018 stood at $42.5 million, and no significant net interest bearing debt. The Company’s net cash flows from operating activities for the nine months ending 30 September 2018 stood at $16.92 million, down from $20.83 million during the same period last year.

At the last traded price of S$0.845 as of 14 December 2018, the Company’s stock trades at a trailing 12-month (TTM) price-earnings multiple of six times, and its market capitalisation stands at $227.4 million.

Forward uidance Provided By Management

For FY18, management kept its January and April revenue guidance unchanged at $255.0 million in revenue, and $42.0 million operating profit before tax. We used the discounted cash flow (DCF) model to estimate the Company’s valuation per share.

Assumptions
Growth Rate (Next Five Years) 12.5%
Terminal Growth Rate (After Five Years) 0.0%
Risk-free rate 2.2%
Beta 2.65
Market Return 10.0%
Cost of Equity 22.7%
Cost of Debt 0.0%
Tax Rate 17.0%
WACC 22.7%
Terminal growth rate 0.0%

Source: Company financial reports and our own assumptions

DCF Model

AEM DCP

Source: Company Financial Reports; Assumptions

Our assumptions are for revenue to grow 12.5 percent (10 – 15 percent based on the Company’s latest revenue estimate for FY18 at $255.0 million, and FY17 revenue of $221.6 million. Taking zero terminal growth at the end of five years in FY23, the discounted cash flow (DCF) showed a valuation per share of $0.39. At the last traded price of $0.845, there could be a potential overvaluation in the share price given our assumptions.

How is the technical chart looking for AEM Holdings

chart aem

Source: Phillip Securities Pte Ltd (14 December 2018)

The above chart shows the one-year daily chart of AEM Holdings Ltd. At the stock price of $0.845 as of the last close on 14 December 2018, there appears to have no significant movements in the stock price. However, the stock did come down to as low as $0.64 in mid-August. There appears to be some consolidation at the current stock price.

Conclusion

Based on the current stock price of $0.845, our estimate derived from the discounted cash flow (DCF) of $0.39, after taking into account bonus share issue of 204,980,865 shares in June 2018, we think that the current stock price is relatively overvalued.

However, the Company currently has a net positive cash position of $42.3 million in the balance sheet with no significant interest-bearing debt, and trades at a trailing twelve-months price-to-earnings (P/E) multiple of close to five times.

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