We initiate coverage on Elsoft Research Berhad, an automated test equipment solutions provider, with a HOLD call and TP of RM3.00.

Ability to Transform and Adapt. Over its 21 year journey, it has withstood two down cycles, but has successfully recovered each time. During the global financial crisis, it ventured into the development of a LED total test solution, with the higher value product leading revenues to current highs.

Smart Devices and Automotive Generate >85% of Sales. For smart devices, demand is driven by the flash LED market, which is estimated to grow 9% YoY to US$811mn in 2017. The exterior automotive LED market is expected to grow at a 5 year CAGR of 8% YoY. The penetration of LED in exterior lighting is estimated at less than 15% in 2015.

FY17 Flat, But Growth to Resume in FY18. We are expecting FY17 core net profit (+2.0% YoY) to be flattish due to lower margins. Profit growth is then expected to resume in FY18 (+32.5% YoY), helped by the development of new test equipment for IR/VCSEL devices. Thanks to an explosion of consumer applications, the 3D imaging and sensing devices market is projected to grow at a 5 year CAGR of 37.7% YoY to 2022.

Stellar Financials. EBITDA and PAT margins have consistently been at ~40- 50%. It operates a clean and lean balance sheet with no outstanding debts. With an asset light business mode (capex <1% of revenue) and healthy cash flows, its dividend payout ratio is expected to be maintained at 70%, translating into dividend yields of 2.9-4.0%.

Decently Priced. Based on our target PE multiple of 20x, we believe the stock is decently priced. While new test equipment for IR/VCSEL devices could potentially result in better than expected growth, there are still uncertainties at this point in time. The test equipment is still under development, with clearer indication on demand/price likely to occur only in 2018.

Source: TA Research - 14 Sept 2017