Elsoft  is  a  manufacturer  of  automated  test  equipment  (ATE)  for  the semiconductor, optoelectronics  and automotive industries.  Apart  fromgrowing  its  LED-related  business,  it  also  has  its  eyes  on  the  medical equipment  market.  We  believe  this  may  propel  earnings  growth,  for which we are forecasting a CAGR of 30% for FY14F-FY16F. The stock is NOT RATED.

Existing focus.  Elsoft’s  core business  is in the  manufacture of  testing equipment for the  light-emitting diode (LED)  segment. Market demand inthis  area  is  still  relatively  strong,  particularly  from  the  automotive industries.  Its  orders  to  date  amount  to  MYR30m,  which  management expects to grow in the coming quarters.

Diversifying into medical equipment. To tap on its core competency inembedded control systems, Elsoft  plans  to diversify from its core LEDrelated business to the medical equipment market, particularly in relation to  automated dialysis machines. We gather  that the  company has rolled out  the  pilot  phase,  and  management  expects  maiden  sales  roll  in  by 1QFY15.  Should this materialize, we foresee this new earnings streampropelling  earnings growth over FY15F-FY16F. 

Dividend.  Taking  into  account  its  healthy  net  cash  balance  of  over MYR25m  currently,  we  estimate  the  stock  may  provide  an  annual dividend  yield  of  2.7-4.6%  from  FY14F-FY16F.  This  is  based  on  our assumption of a 50% payout ratio. 

Risks.  Among  the  key  risks  Elsoft  may  encounter  are:  i)  rapid technological changes within the ATE industry; ii) increased competition;  and iii) its dependence on major customers and suppliers.

MYR1.78  FV,  with  a  potential  23%  upside.  We  value  Elsoft  at MYR1.78, based on 16x FY15F P/E, at  a 12% premium over its closest listed local peers. We believe this is justified due to: i) its relatively stable earnings track record;  ii)  forecast  earnings CAGR of  30%,  driven by  its new business venture; and iii) relatively clean balance sheet .

Good Prospects
A brief introduction. Elsoft  is involved in the research, design  and development of test  and  burn-in systems and application-specific embedded systems. The company provides solutions to the semiconductor, optoelectronic (eg  LED, sensors, infra-red, ultraviolet (UV), smartphones  and lightings industry), as well as  automotive (eg head and tail  lamp) industries.  Listed in Aug 2004  on the ACE  market of Bursa Malaysia, its market capitalisation has risen two-fold to MYR266.1m currently.Key management  members.  Mr Tan Cheik Aik, who  helms  the group  as  its  chief executive  officer,  is  an  engineer  with  more  than  20  years  of  experience.  He specialises in the areas of test metrology and embedded application system design that contribute to the fundamentals of the Elsoft Group. He is being assisted by Mr Koay  Kim  Chew,  another  electrical  engineer  who  manages  the  company’s technological  direction  as the  chief  technology  officer.  Mr Koay  plays  a  role  in  the group’s hardware and software design and development.

Products  and  services.  The  group’s  business  activities  are  divided  into two  main divisions:-a)  Test, burn-in system development and embedded peripherals divisionUnder the test and burn-in system  division, Elsoft  utilises its unique Source and  Measurement  Unit  (SMU)  solutions  to  enable  customisation  in customers’  test flows that can reduce the design-to-volume-production test time  and costs.  The  systems  are  used  by  its customers  who manufacture optoelectronic devices (eg LED, image sensors, and automotive lightings) to test their products before launching into market.

Meanwhile,  the  embedded  peripherals  division  offers  a  wide  range  of  PC based embedded products range such as I/O products, motion control card, and  motor  drivers.  Currently,  this  overall  division  makes  up  49%  of  its 1HFY14 sales.b)  Automation equipment/system divisionThe division designs innovative and advanced machinery for the handling of electronic components, namely the test handling system and robotic factory automation  system.  This  division  is  contributing  the  remaining  51%  of Elsoft’s 1HFY14 sales.

Technological capabilities. The group’s design capabilities include competencies in advanced  analog,  digital  test,  mixed  signal,  embedded  systems,  microprocessorsand microcontroller  applications. The test systems are designed for high speed and high performance testing, with an output above 10,000 units per hour. Elsoft has also developed technology  in optoelectronic metrologies and spectroscopy development,putting it in the position of becoming a test solution partner of choice.

Better contribution from existing business.  Elsoft continues to grow in its area of expertise as a testing equipment manufacturer for the LED segment. The LED testers produced  inspect  high-brightness  LED  modules  used  in  the  general  lighting  and automotive industries. The testers are highly customised with special functions,  and are  capable  of  testing  between  3,000  and  8,000  units  of  LED  chips per  hour.  The group  has  received  nearly  MYR30m  worth  of  orders  since  January  this  year,  and management  believes  that  it  can  continue  to  secure  new  orders  in  the  coming quarters.

Diversification  into  medical  equipment  the  next  growth  driver.  Elsoft’s management  has  taken  measures  to  diversify  from  its  core  LED  equipment manufacturing.  This  field  capitalises  on  the  company’s  core  competency  in  the embedded control system by applying it to the medical equipment market. Embedded systems  contain programmes for every electronic device, and in the case of medical instruments,  such  system s  can  be  used  in  devices  for  chemical  analyses  of  fluid samples  (eg  urine, blood, etc.) or automated dialysis machines.  We gather  that the pilot phase was rolled out in June and is currently ongoing. Management expects it to 
post maiden  sales  by  1QFY15.  Based on  our channel checks, the pricing of each of these machines vary from as low as MYR2,000 to as  high  as MYR7,000.  This  new stream  of  income,  in  our  view,  would  help  to  spur  the  company’s  FY15F-FY16Fearnings growth.

Earnings  track  record.  The  company’s  management  has  made  efforts  to  ensure that its  financials  are in good shape. Notably, Elsoft has  never reported any quarterly losses despite being in the relatively volatile  semiconductor industry.  The group  has maintained  its  PBT margin in  the  region of 30-50%  since its listing, which  is above average and higher  than  most of its peers in Malaysia. This is achievable due to its low fixed cost, with  a  small workforce (60+ employees) contributing to the efficiency of the company. Management indicated that its emphasis on  R&D and  staff training has allowed the group to retain talent.

Earnings projections.  Looking ahead, we expect Elsoft’s core LED testing business to grow 9%-10% over FY14F-FY16F. This will be driven by increasing demand in the automotive  sector,  where  LED  penetration  is  on  the  rise  as  most  automakers  are changing to LED-based lighting, especially in headlamps and daytime running lamps.In addition, we believe its venture into the medical equi pment segment will bear  fruitcome FY15F when  the company  starts  delivering  the devices on  a bigger scale. We believe that these factors would help to boost its earnings growth, which we estimate at 33.1%/40.0%/20.9% over FY14F/15F/16F.

Sturdy balance sheet.  Elsoft Group has been able to maintain zero debt since  its listing. This has definitely helped the company to maintain its net cash position, which stood  at  MYR24.3m  as  of  June.  It  is  worth  noting  that  Elsoft  has  been  actively investing  its  excess  cash  in  bonds  and  mutual  funds,  with  current  balance  of MYR17.9m as of June.  It has  also  consistently recorded positive free cash flow for the past four  years, except  in  FY12 when  it  invested  in a new plant. Its traditionally 

low capital expenditure has risen in the past two years at MYR4m-6m per annum due to its new plant investment. 
Consistent dividend payout. We foresee the possibility of the company continuingto reward its shareholders  as  Elsoft has been steadily paying dividends ranging froma DPS  of 1-6  sen since its listing. We estimate  Elsoft to produce an annual  dividend yield of 2.7-4.6% going forward, based on our assumption of a consistent payout ratio of 50%.

Valuation.  We have a NR call on the stock. Pegging it to a 16x FY15F P/E, we arrive at  our FV of  MYR1.78.  Although Elsoft lacks a direct competitor in the local market, we  believe  that its  closest listed  peers  are Globetronics  (GTB  MK,  NR),  Malaysian Pacific Industries (MPI MK, NEUTRAL, FV: MYR6.40), Unisem (UNI MK, BUY, FV: MYR2.16),  Inari  Ametron  (INRI  MK,  BUY,  FV:  MYR3.82),  and  Vitrox  (VITRO  MK, NR), which are all involved in the technology manufacturing segment. We believe our valuation, which  implies  a 12% premium over its listed local peers,  is justified given Elsoft’s  relatively  more  stable  earnings  track  record  as  well  as  exciting  growth prospects, with an earnings CAGR of 30%. 

Source: RHB