ASE Technology: SPIL Integration Should Drive Margin Expansion In 2020 And 2021 (NYSE:ASX)


Ploutos Investing

Investment Thesis

ASE Technology (ASX) delivered an impressive Q1 2020 as it saw its revenue increase by nearly 10% thanks to strong demand for its services. The company’s Q2 2020 will remain strong thanks to a surge in demand for semiconductors as people work and study from home. The company should see material margin expansion through 2021 thanks to the benefit of its integration of its SPIL acquisition. In addition, its advanced packaging technologies such as AiP and SiP will continue to deliver growth in the long term. Hence, we believe this is a good stock to own for investors with a long-term investment horizon seeking capital appreciation.

Data by YCharts

Recent Developments: Q1 2020 Highlights

ASE reported a solid Q1 2020 with net revenue of NT$97.4 billion. This represented a growth rate of 9.6% year over year. Its gross profit also increased significantly to NT$16.2 billion in Q1 2020 from NT$11.4 billion in Q1 2019. Its gross margin expanded considerably to 16.6% from 12.8% in Q1 2019 primarily due to better portfolio mix thanks to growth in higher margin ATM (Assembly, Testing, and Material) segment but a decline in lower margin EMS (Electronic Manufacturing Services) segment.

Source: Q1 2020 Press Release

Earnings and Growth Analysis

Expect synergies from its SPIL integration

ASE acquired SPIL several years ago, but the two companies were not allowed to communicate and collaborate for 2 years due to anti-monopoly restrictions. However, in late March, 2020, China’s anti-monopoly agency finally lifted the ban to have communication and collaboration between SPIL and ASE. The removal of the restriction will allow ASE to further integrate its business operations with SPIL and this should result in material synergies. In fact, management expects operating margin for its ATM business to expand by 2 percentage points in the first half of 2020. This margin expansion is expected to continue in the second half of 2020 and into 2021 as the company continues to execute its integration strategy (e.g. manufacturing flexibility, capacity sharing, more efficient capital expenditure management, etc.)

ASE is well-positioned to capture the trend towards minimization of semiconductor components

ASE is in a good position to capture the trend towards miniaturization of electronics (e.g. smart watch, 5G handsets, earpods). The company has advanced packaging capability to help place different semiconductor dies together into one single package (also known as Silicon in Package (“SiP”)). This will help its customers save much needed space. It also has the capability to package antennas and chips together (also known as antenna in package (“AiP”)). AiP and SiP are very important technologies for mobile phone makers in the era of 5G as designing handsets becomes even more sophisticated and complicated. In addition, SiP and AiP businesses are higher margin businesses and should help ASE to continue to expand its margin in the coming few years. In fact, we are already seeing growth in this area in Q1 2020. As can be seen from the chart below, bump/FC/WLP/SiP now represent 38% of ASE’s ATM revenue in Q1 2020. This was much higher than last year’s 34%.

Source: Q1 2020 Investor Presentation

Although demand is strong in the near-term, visibility is likely limited in H2 2020

Like other semiconductor companies, ASE is also experiencing strong demand in the first half of 2020. This is because COVID-19 has resulted in a spark of demand for semiconductors (e.g. chips used in laptops, tablets, data servers, etc.) as people need to work and study from home. However, these are mostly one-time items and it is unlikely people will buy another laptop in the second half of 2020 if they have one already. Hence, we think visibility may be limited in the second half of 2020.

Valuation Analysis

There is a good chance that ASE may see its EPS increase to NT$5 per share in 2020 thanks to improving margin and product mix. Its 2021 EPS may grow to NT$6.4 per share thanks to synergies and revenue growth in SiP and AiP services that it can provide. ASE has been trading at an average forward P/E ratio of 14.55x in the past 5 years. Using a multiple of 14.5x, we derive our target price to be NT$72.5 per share by the end of 2020 and NT$92.8 by the end of 2021. This is equivalent to US$4.89 per ADR by the end of 2020 and US$6.27 per ADR by the end of 2021. Therefore, the return is expected to be 40.3% by the end of 2021.

Risks and Challenges

A prolonged economic recession

Although ASE should benefit from several future industry trends such as Internet of Things, 5G and artificial intelligence, the entire semiconductor industry is still highly cyclical. In a prolonged economic recession, its customers’ inventory level may rise and demand can quickly diminish. In such a scenario, the company will be forced to run its facilities with much lower utilization rates.

Integration risk

ASE also faces integration risk as its integration of SPIL may be delayed or there may be higher integration costs than expected.

Investor Takeaway

ASE is well-positioned to grow its business with its capability to provide state-of-the-art package and testing services to its customers. In fact, we see margin expansion through 2021 thanks to its SPIL integration. Therefore, this is a good stock to own for investors with a long-term investment horizon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.




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