Downgrade To HOLD On Limited Near-term Catalysts And Inventory Write-downs
AEM uncovered a shortfall in its inventories due to human error in transactions in its ERP system during the migration of production to its new Penang facility. The shortfall is expected to have a negative earnings impact of around S$22m in 4Q23 due to understated cost of sales. As a result, we trim 2023 earnings from S$14m to a S$6m loss. We also trim 2024 earnings by 17%. Downgrade to HOLD with a 16% lower target price of S$3.06.
WHAT’S NEW
• Uncovered shortfall in inventories during year-end stock-taking exercise. On 14 Jan 24, AEM Holdings (AEM) announced that a shortfall in the group’s inventories had been uncovered during its 2023 year-end internal stock-taking exercise. While the stock-taking exercise is still ongoing, the preliminary estimate suggests that AEM’s inventories are anticipated to be 5-7% below the 3Q23 figure of S$359m. The initial investigation into this issue attributes the shortfall to human error in transactions in the group’s Enterprise Resource Planning (ERP) system during the migration of production to the group’s Penang facility from Singapore. Management further elaborated that the errors were due to data entry of volume and unit of measurement. These errors were not detected by the existing controls and processes that are in place. As a result of the initial findings, AEM is reviewing its inventory and stock monitoring as well as tracking processes and systems.
• Expect negative earnings impact in 4Q23. The accounting adjustment for the inventory shortfall is expected to have negative earnings impact of around S$22m for 4Q23 as the writing down of inventories will increase the cost of sales. This is expected to drag 2023 earnings into a loss of S$6m. Previously, we were expecting S$14m earnings for 2023.
• Downgrade to HOLD as inventory issue will put a dent in confidence and weak earnings are expected in 4Q23. We downgraded AEM to HOLD as the inventory issue is likely to put a dent in the stock confidence in the near to medium term. In addition, we think there will be limited positive catalysts in the near term given that ramp-up of production is only expected in late-24 as previously guided by AEM. For the upcoming 4Q23 results, we expect AEM to report a loss of around S$10m and the new full-year revenue guidance for 2024 is also going to be lacklustre given that recovery is only expected in late-24.
STOCK IMPACT
• We expect ramp-up of product production in late-24 given the current visibility around customer product release schedules. Signs of stabilisation in the smartphone and PC markets have begun to emerge, with experts forecasting 2024 to be a year of growth for PCs and smartphones. Inventory levels are reducing across the board, and the semiconductor industry appears to be passing through the trough of the cycle. PC shipments recovered sequentially in 3Q23 and returned to pre-pandemic levels. Although the overall growth rate for the year remains negative, the percentage decline has moderated.
• AEM is starting to see the beginnings of AI in the consumer space, with PCs that feature built-in generative AI capabilities powered by AI processors being put up for demonstration. While the news is positive on the consumer side, analysts are of mixed views in terms of the pace and timing of recovery for the semiconductor test equipment market. Nonetheless, AEM is in a strong position to leverage the strong relationships it has fostered with its customers across a number of new programmes, and is prepared to support these customers’ new product releases and subsequent production ramp-ups with its Test 2.0 test solutions in 2024 and beyond
EARNINGS REVISION/RISK
• We have trimmed our 2023 earnings estimate to a S$6m loss, from a S$14m profit previously to account for the adjustment of inventory shortfall of S$22m, which is expected to increase the cost of sales in 4Q23.
• We have also reduced our 2024 and 2025 revenue by 7% per year to account for a potential delay in recovery of AEM’s order. As a result, our earnings estimates for 2024 and 2025 are reduced by 17% as well.
VALUATION/RECOMMENDATION
• Downgrade to HOLD with a 16% lower target price of S$3.06. This is based on 15x 2024F PE, pegged to 1SD above AEM’s historical mean. This is to account for the potential recovery in the semiconductor industry in 2024 and better earnings quality from increasing contributions of more new customers.
SHARE PRICE CATALYST
• Positive surprise in future revenue guidance and winning of more new customers.
