UMS Holdings - DBS Research 2017-11-13: Back To Growth Mode

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UMS HOLDINGS LIMITED 558.SI

UMS Holdings - Back To Growth Mode

• UMS's new earnings record of S$13.6m in 3Q17, alleviates earlier concerns over imminent market share losses.
• Industry trends augur well; review of key competitors provides further assurance of UMS’ ability to leverage on Applied Materials’ strong growth prospects.
• FY17F-19F earnings raised by 23-31%.
• Upgrade to BUY with higher TP of S$1.21.

Front-end semiconductor equipment play offering growth and attractive c.6% yield. 

• UMS Holdings (UMS) has partnered closely with Applied Materials for more than a decade. Notably, despite its exposure to a cyclical industry, UMS’ earnings have been less volatile since it was awarded the Endura contract in 2010. The company also stands out for its strong cash flow (even after paying dividends) generation capabilities and consistent dividends, thus offering both yield and growth.
• The positive earnings surprise in 3Q17, recovering order flows, and improved business fundamentals (vs a quarter ago) eases our earlier concerns over imminent market share losses. 
• Riding on the coattails of Applied Materials’ robust growth outlook, we raise our earnings projections for FY17F-19F by 23-31% and upgrade UMS to BUY, with a higher TP of S$1.21.

Where we differ: 

• We have assumed a larger discount to larger peers’ 15x FY18F PE compared to consensus given its higher customer concentration risk vs peers.

Potential catalysts: 

• Higher demand for semiconductor equipment, diversification away from key client, M&A.  

Positive outlook for key client Applied Materials augurs well for UMS. 

• SEMI predicts that global fab equipment spending could reach industry all-time highs of over US$55bn in 2017 and US$58bn in 2018. 
• Reports by Applied Materials also imply robust demand and growth of c.10% CAGR into FY20F. This augurs well for UMS given its primary role in the manufacture of components for various semiconductor equipment and that it handles c.70% of manufacturing and assembly for Applied Material’s Endura deposition system – especially given the successful extension of the Endura contract.

Valuation

• Upgrade to BUY with higher TP of S$1.21, which is based on 12x (or 11x ex-cash PE) FY18F PE, at a discount to larger peers’ 15x. An attractive prospective yield of nearly 6% is on offer.

Key Risks to Our View

• Key client risk. Historically, c.90% of UMS’ revenues on average can be attributed to Applied Materials. Disruptions to the relationship or weakness in Applied Materials’ end demand could significantly weigh on UMS’ performance.

WHAT’S NEW - UMS’ record 3Q17 earnings (+18.1% q-o-q) a positive surprise after earlier guidance of a weaker 2H17 

Record 3Q17 alleviates concerns over possible market share losses. 

• Earlier in Aug 2017, UMS cautioned of moderating demand from its key customer Applied Materials in 2H17, which came as a surprise given positive industry data and the latter’s robust demand outlook – raising concerns of possible market share losses amid its expansion in Penang. 
• 3Q17 results proved otherwise as UMS surprised once again with PATMI growing c.18.1% q-o-q to S$13.6m (vs S$11.5m in 2Q), alleviating concerns.

Slight dip in 3Q17 revenues, but margin improvement was key. 

• 3Q17 revenue declined c.7.7% q-o-q to S$39.4m, mainly due to lower average selling prices under its renewed Semiconductor Integrated System (-17.1% q-o-q to S$20.3m) contract which has lower third-party content, but largely made up for on the margins front. Components sales, which commands higher margins compared to Integrated Systems, also grew on a sequential basis by 5% q-o-q to S$19m.
• Benefiting from the higher-margin mix and efficiencies arising from ongoing material waste minimisation initiatives, gross margins were lifted from 51.1% in 2Q17 to c.58.8% in 3Q.
• However, we also acknowledge that gross margins can vary substantially between quarters and has fluctuated between 45.7% (4Q16) and 75.8% (4Q15) over the last twelve quarters. We attribute this mainly to the high-mix, low-volume Components business, which typically operates on a JIT basis.
• Both internal and external factors also augur well for UMS in FY18F: - 
  1. Long-term cost savings from Penang shift. UMS is set to benefit from the lower operating cost environment and 10-year Pioneer Tax status for its Malaysian operations following the shift of its Integrated Systems operations to its expanded Penang facility, which was completed in 3Q17.
  2. Growth prospects for Applied Materials increasingly positive. SEMI predicts that fab equipment spending (new and refurbished) will increase by 37% to a new annual spending record of c.US$55 bn in 2017, and could rise a further 5% to US$58 bn in 2018.
     Several underlying demand trends also support Applied Materials’ increasingly positive outlook, including 
     1. ongoing capacity additions to meet growing demand for sensors and IoT devices, and 
     2. demand shifts from lithography to materials deposition arising from the transition to 3D Memory. 
     
     Applied Materials guided positively during its 3Q17 (Aug 2017) results, reiterating expectations of c.20% growth in wafer fab equipment spending in 2017, and for an even stronger 2018 (on conservative estimates for spending in China). During its recent Analyst Day presentation in Sep 2017, Applied Materials also predicted growth of 10% CAGR for its Semi and Display segments – which are relevant to UMS - to a combined US$15.1bn by FY20F (vs US$11.4 bn in FY17F). 
  3. Competitive landscape largely stable. A review of key suppliers for the Endura desposition system (which represents c.50% of revenue) in the region suggests that UMS continues to hold the largest share, and commands the highest margins.
     With demand outpacing supply growth and absence of new capacities coming on stream (competitors have been relatively conservative in expanding capacity), UMS remains well-poised to ride the strong semiconductor uptrend. 
  4. Strong order pipeline. Management guided a “strong pipeline of orders from its key customer”, which implies that order flows have started to recover vs end-2Q17. The higher inventory levels as at end-3Q17 also implies management’s confidence in a stronger 4Q17 (vs 3Q).

Upgrade to BUY with higher TP of S$1.21. 

• With the better-than-expected 3Q17 earnings performance alleviating concerns over possible market share losses (at least over the medium term), we are now better assured of UMS’ ability to benefit from Applied Materials positive growth prospects. 
• Long-term cost savings arising from the shift of its Endura operations to Penang, which was successfully completed in 3Q17, further raises the attractiveness of its earnings profile. Given this, we have raised FY17F/18F earnings by 31%/ 23%/ 26% to S$47.9m/ S$54m/ S$57.5m, respectively.
• With 18% potential upside to our revised TP of S$1.21 (based on 12x FY18F PE, as we maintain a 20% discount to peers’ 15x given customer concentration risk) and an attractive 5.9% yield on offer, we upgrade UMS to BUY with potential total return of c.24%.

Carmen TAY DBS Vickers | Lee Keng LING DBS Vickers | http://www.dbsvickers.com/ 2017-11-13

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