Investment Merits

• Increasing adoption of automotive LED lighting to spur long-term demand for Elsoft’s testing and burn-in systems

• Introduction of more sophisticated LED modules in next-generation smartphones could spark demand over the medium term

• Our MYR2.15 fair value is based on 15x 2018 P/E

Company Profile

Elsoft is a manufacturer of test equipment for the semiconductor industry focusing primarily on the light-emitting diode (LED) lighting components for the automotive and smartphone segments.

Highlights

Automotive segment a long-term catalyst. 45-50% of Elsoft’s 2016 revenue came from the automotive segment. According to market expert LEDinside, the transition of global automotive lighting to lightemitting diode (LED) light sources from traditional light bulbs accelerated further in 2016. Developed markets have steadily migrated to a high portion of LED light sources, while emerging countries, too, have started to follow suit. Its latest research data showed that 2016 exterior LED lighting market value reached USD1.57bn and is projected to grow at CAGR of 6% to 2020. Ultimately, we believe the transition could propel long-term demand growth for Elsoft’s automotive testing and burn-in solutions. The group is currently conducting R&D on developing high-speed LED tile testers. We expect it to roll this out commercially by 2H17.

New smartphone LED modules could spark demand. Elsoft derives 35-40% of its 2016 revenue from the smartphone-related LED testing segment. Although the double-digit growth era for global smartphone shipments is likely over (industry expert International Data Corporation estimates that global shipments grew by 2.3% in 2016, from 10.4% in 2015), we believe the progressive introduction of increasingly sophisticated LED modules would likely sustain demand growth for Elsoft’s testing solutions over the medium term. We highlight that new LED modules would typically require investments in new testing equipment – given potential differences in form factors, specifications as well as technical requirements. We gather that the group is in the midst of delivering new testers for 2017 flagship smartphones.

Solar industry is next. Beyond that, management is currently developing new automated testing equipment for the solar cell industry. We understand Elsoft is currently working closely with its customer to meet technical specifications as well as testing efficiency. We estimate that each of these new testers is worth close to MYR500,000. This, if it materialises, could mark its penetration into the solar industry with more orders likely to be secured over the next 12-24 months.

Company Report Card

2016 results review. Elsoft closed 2016 with record-high core earnings of MYR30.8m (+43.1% YoY), boosted predominantly by its smartphone segment (which booked a 92.3% YoY jump in revenue). We are forecasting earnings CAGR of 12.9%, going forward. This takes into account higher orders under its smartphone segment to cater for the next-generation smartphone LED components to be launched in Aug or Sep 2017.

Balance sheet/cash flow. Elsoft has been able to maintain zero debt since listing. Its net cash (inclusive of other liquid investments) position stood at MYR45.1m as at Dec 2016. We expect free cash flow to remain healthy going forward, at MYR30-35m pa.

ROE. Owing to its clean balance sheet and stringent costs control with a total headcount of 70-75 people, the group’s ROE closed at an aboveaverage level of 34.3% in 2016.

Dividend. We foresee the possibility of the company continuing to reward its shareholders, as Elsoft has been steadily paying dividends ranging from 0.7 sen to 8 sen per share since its listing (after adjusting for a 1-for-2 bonus issue completed in Dec 2016). We expect Elsoft to declare DPS of 10-11 sen for FY17 and FY18 respectively, based on our assumption of a payout ratio of 70-80%. This translates to appealing yields of over 6% pa.

Management. Mr Tan Cheik Eaik, who helms the company as its CEO, is an engineer with more than 20 years of experience. He specialises in the areas of test metrology and embedded application system designs that contribute to the fundamentals of the Elsoft group. He is assisted by Mr Koay Kim Chew, another electrical engineer, who manages the company’s technological direction as chief technology officer. Mr Koay also plays a role in the company’s hardware and software design and development.

Recommendation

Pegging it to 15x 2018 P/E, we arrive at a fair value of MYR2.15. Our target P/E is in line with the range of 10-15x P/Es that we peg to exportoriented technology counters under our coverage. It is further supported by its relatively more stable earnings track record and superior profitability margins.

Source: RHB Securities Research - 5 May 2017