INVESTMENT MERIT

· A direct proxy to the growing segments of the semiconductorsector. Differentiating itself from the standard test and inspection solutions equipment manufacturers, ELSOFT focuses on LED test and burn-in systems as well as application-specific embedded systems that are specifically designed to meet customers’ various requirements. More importantly, 85% of its revenue (as of 9M15) is derived from customers with exposure in the fast-growing Smart Devices and defensive Automotive segments, which made it a direct proxy to the bright spots in the semiconductor sector. Unlike some other components manufacturers which are already seeing slowdown in sales from a high base, ELSOFT, being an equipment manufacturer which benefits from LED products innovation, is still resilient due to its niche markets.

· Healthy LEDs demand to spur ELSOFT’s earnings outlook. We came away from the recent visit to its Penang office feeling upbeat as we gather that the group’s 2016 earnings performance should fare better than 2015, anchored by its Automotive and Smart Devices segments. For the lion’s share revenue contributor - Automotive segment (contributed 75% in 9M15), the rapid proliferation of Daytime Running Lights (DRL) in modern cars has been the main catalyst in propelling the demand of its test equipment and burn-in systems for the last two years. Management believes the momentum will continue this year amid the proliferation of DRL beyond high-class car models as well as the mandatory DRL requirement imposed by the European Union for all new cars. Note that management’s view is also echoed by one of the reports by the world-leading LED industry researcher- LEDinside; that DRL- which the group’s test and burn-in systems specifically cater for, will experience compounded annual production values of 21% from 2014-2018. Meanwhile for its Smart Devices segment, we also gathered that the orders for its new customised LED test and burn-in systems will be higher this year in conjunction with the brand-new smartphone launching by one of the world’s leading smartphone vendors. Management believes this segment could register at least low-teens revenue growth given the low base in FY15. Recall that in 9M15, contribution from Smart Devices segment only stood at 10.5% (-

20.5ppts) as smart devices back then did not contain substantial new LED contents, which require new equipment for testing purposes.

· Medical Devices to be the next earnings driver. While the group has in 2014 started to foray into the medical equipment segment with application of specific embedded system, earnings yielded from this were immaterial at 3%/0.2% respectively in FY14/9M15 due to the low production volume during the pilot program. From our channel checks from the media press, we were delighted to gather that the respective authority has just granted the greenlight to its clients, which will eventually lead to the mass production of its embedded systems. While management keeps its lips tight on the potential earnings contribution from this business given the infancy stage of the deal, our back-of-theenvelope calculations suggested that at least RM15m additional

revenue per annum could be achieved assuming a charge of RM5,000 per system with 3,000 units being produced in the blue-sky scenario. To be on the conservative side, we only projected 1,000 units to be produced in FY16.

· Trading Buy with a TP of RM2.12. We are projecting ELSOFT to register FY15E/FY16E CNP of RM20.0m/RM25.6m with key earnings assumption being: (i) 5-29% growth assumptions from Smart Devices and Automotive segments, (ii) additional 1,000 units embedded systems produced for medical equipment in FY16E, and (iii) core NP margins assumption of 40-44%. Meanwhile, our TP of RM2.12 is based on an ascribed 15x FY16E PER which is broadly in line with the industry average forward PER of its global peers. Coupled with our net dividend yield of 4.2% in FY16E (DPR assumption of 50%), our TP of RM2.12 suggests a total upside of 15% from here.