Intel Corp shares were hit this past week as the leading chipmaker said it was a year behind in its multi-year schedule to develop the process technology needed to manufacture its next-generation 7 nanometre (nm) chips. This delay comes on top of an earlier delay in its move to the current generation of 10nm chips.
Intel, according to its CEO Bob Swan, is even mulling to outsource the manufacturing of the chips come 2023 despite the company priding itself in achieving its industry leadership position through R&D and manufacturing capabilities in the face of stiff competition.
In response, investors did not react well to what has been interpreted as a big misstep by Intel, sending its shares down some 16% on July 24. On July 27, the company announced Murthy Renduchintala, its chief engineering officer and potential CEO successor, is leaving the company.
However, as order visibility becomes clear, analysts such as Maybank Kim Eng’s Lai Gene Lih sees “little to no impact” to Singapore Exchange-listed AEM Holdings, whose key customer is Intel. Lai, who has a “buy” call and $4.04 target price on AEM, is leaving his FY2020 forecast intact. “Our revenue estimate is firmly within guidance that we see is highly achievable, and we believe our margin assumptions are conservative,” writes Lai in his July 27 report.
In contrast to many other sectors, the semiconductor industry has seemingly been immune to the fallout from the Covid-19 pandemic. This is because demand for servers, PCs, mobile phones and all manners of tech equipment — without which people cannot connect for work and play — has grown. Year to date, AEM has gained 67% to close at $3.49 on July 28, valuing the company at $963 million.
While Lai acknowledges AEM might run into a headwind for FY2021 with the delay of the 7nm chips, there are mitigating factors. These include continued growth of AEM’s new products, potential underestimation of equipment demand as a result of Intel’s new product launches, and AEM’s proven capabilities in so-called system-level testing.
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System-level testing ensures the designed hardware and software can work together faultlessly. In contrast, so-called functional tests focus more on the hardware. Indeed, with demand for such capabilities rising, Lai believes AEM makes an attractive acquisition target.
Meanwhile, KGI analyst Kenny Tan has become more bullish on AEM after the announcement, saying how the company is enjoying strong momentum not just in earnings growth but also its profile among the business and investment communities. Tan’s new target price is $4.24, pegged at 14 times FY2020 earnings and up from $3.61 previously. At the target price level, AEM will still be trading at more than 50% discount to its peers.
Besides AEM, Tan favours another semiconductor-related counter called Frencken Group. Tan has an “outperform” call on the stock and fair value of $1.01, pegged at a conservative 10 times FY2020 earnings. Tan believes Frencken too is an attractive takeover target for those looking to diversify their end-user market to Europe and the US. Frencken is trading at four times EV/Ebitda, or a discount of about 20% to its peers.
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Frencken’s key client is Dutch-based ASML, the dominant player in lithography systems used by semiconductor companies. ASML’s CEO said 2Q2020 sales would be 50% higher q-o-q had it not been for the disruption caused by Covid-19. ASML added demand for its products remained strong but the company stopped short of giving guidances for 2Q2020 and the full year due to market uncertainties.
In addition to ASML, Frencken has many market-leading customers including Philips, Siemens, Seagate and Thermo Fisher Scientific. Over the years, the company has gained market share with its customers, riding on long-term trends such as 5G broadband network and cloud services. Now, that trend has been accelerated by the Covid-19 disruptions as people work from home and stay indoors, says Tan.
KGI also likes ISDN, another company with some exposure to the wider semiconductor industry. Formed in 1986, ISDN is an engineering solutions company specialising in industrial automation (IA). KGI notes IA has had a substantial downcycle, which was further dragged down by Covid-19 and US-China trade tensions.
While global demand for IA is likely to remain sluggish, China will be the first to revive the industry, given its focus on digitalisation and attempts at replacing human labour with tech and robots. As the bulk of ISDN’s sales come from China, KGI expects traditional industrial factories to be upgraded into smart factories, equipped with higher levels of automation and enabled by 5G, AI and IoT.
Based on latest results, a Chinese rebound may have already occurred as IA players report- ed strong orders or sales from China. One of them is Yaskawa Electric Corporation which reported in its latest financial statements released on July 10 that its motion control and robotics segment have seen an improvement in sales.
As such, KGI expects a substantial pickup in order book, and therefore sales, for ISDN. ISDN trades at undemanding valuations of eight times earnings and between four and five times EV/Ebitda which is substantially below global peers. ISDN also stands to gain from China’s transformation plan as well as from the strength of the semiconductor industry.
Beyond the semiconductor industry, KGI likes financial software provider Silverlake Axis. Earlier in July, KGI initiated coverage on the stock with an “outperform” call and target price of 30 cents.
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While Covid-19 has caused delays in the implementation of new projects, clients have stepped up requests for more maintenance works in the meantime. This has helped cushion the drop in Silverlake’s sales. There has also been little to no cancellation in orders, with management expecting a large contract to be signed in early FY2021.
Silverlake is trading at between eight to 10 times historical earnings, which is fairly pessimistic for a stable business. KGI sees further upside from potential contract wins, adding to both non-recurring and recurring income.
