UMS Holdings - DBS Research 2018-08-15: Stable Yield Play

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UMS HOLDINGS LIMITED SGX:558

UMS Holdings - Stable Yield Play 

• UMS’s 2Q18 net profit of S$14.5m (+28% y-o-y); in line.
• Margin improvement; possible beneficiary of trade shifts away from China.
• FY18F/FY19F earnings cut by 14%/11%.
• Maintain BUY with lower Target Price of S$1.01.

Maintain BUY with lower Target Price of S$1.01; front-end semiconductor equipment play offering attractive c.8% yield.

• UMS Holdings (UMS) has partnered closely with Applied Materials for more than a decade. Notably, despite its exposure to a cyclical industry, UMS’s earnings have been less volatile since it was awarded the Endura contract in 2010. The company also stands out for its strong cash flow generation capabilities and consistent dividends, thus offering both yield and growth. 
• In 2018, growth will mainly be supported by a ramp-up in its higher-margin Components business and cost benefits arising from its shift to Penang.

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• To capitalise on opportunities arising from trade shifts away from China into ASEAN, we believe that UMS may sacrifice some of its ASPs and margins over the near-term in favour of volume growth. We lower our earnings projections for FY18F/19F by 14%/11% to reflect this.
• Applying a lower valuation multiple of 10x (at 20% discount to larger peers, which have derated to 12x vs 15x previously), we arrive at a lower Target Price of S$1.01. Maintain BUY.

Where we differ:

• We have assumed a larger discount to larger peers’ 12x FY19F PE compared to consensus given its higher customer concentration risk vs peers.

Potential catalysts:

Higher demand for semiconductor equipment, diversification away from key client, earnings-accretive M&As. 

• 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$60.1bn in 2018. Reports by Applied Materials also imply robust demand and a CAGR of c.10% into FY20F. This augurs well for UMS given its primary role in the manufacture of components for various semiconductor equipment and sub-assembly for Applied Materials’s flagship Endura deposition system – especially given the successful extension of the Endura contract in early 2017. 

Valuation: 

• Maintain BUY with lower Target Price of S$1.01 on a lower valuation multiple of 10x FY19F PE, as we maintain a 20% discount to larger peers’ 12x (vs 15x previously). 
• An attractive prospective yield of c.8% is on offer. 

Key Risks to Our View: 

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

RESULTS HIGHLIGHT

2Q18 net profit of S$14.3m (+28% y-o-y).

• UMS’s 2Q18 net profit rose by 28% y-o-y to S$14.4m, in line with management’s guidance of a stable 2Q18 vs 1Q18, mainly as stronger gross margins of 64% vs 51.1% in 2Q17 and favourable forex environment (forex gain of S$1.4m in 2Q18 vs loss of S$0.87m in 2Q17) helped to offset higher staff costs and negative associate contributions from JEP Holdings (SGX:1J4). 
• Revenue fell 18% y-o-y to S$35.2m (vs S$42.7m in 2Q17) as contributions from Semiconductor Integrated Systems (-40% y- o-y to S$14.7m) was partly offset by higher demand from the Components (+13% to S$20.5m) business, which carries higher margins.
• Revenue trends were broadly similar to that of previous quarters – the sharp y-o-y decline in Semiconductor Integrated Systems sales was due in part to lower Endura shipments, but also reflected revised contractual terms with lower third-party content requirements, which kicked in from 3Q17.
• 1H18 sales and net profit formed 41% and 44% of our FY18F forecasts respectively, which were in line. An interim DPS of 1 Sct was declared.

OUTLOOK

AMAT’s lower near-term guidance has weighed on investor sentiment toward UMS.

• To recap, Applied Materials (AMAT) reported strong 2Q18 results but simultaneously lowered 3Q18 guidance for its Display business on concerns over weakness in the high-end segment of the smartphone market. During its results call, AMAT reiterated expectations of strong double-digit growth of c.22% for FY18F.
• UMS and AMAT have a strong historical share price correlation of +0.95. Thus, despite the negative guidance for a largely unrelated Display segment (UMS is principally focused on the Semiconductor Systems and Applied Global Services segments), AMAT’s negative share price reaction still spilled over to UMS.
• AMAT is due to report its 3Q18 results later this week. Similarly, we believe that any surprises to its earnings or guidance may influence UMS’s near-term share price performance.

Underlying demand drivers remain supportive over the medium term.

• Near-term expectations aside, rosy demand forecasts for chips in attractive end-sectors such as automotive and IoT also bode well semiconductor equipment companies’ prospects over the medium term.
• SEMI (the global industry association serving the manufacturing supply chain for the electronics industry) projects that connectivity, data centres, communications, automotive, and advanced software will spur strong demand for semiconductors through 2025.

Starke acquisition to also yield longer-term cost savings for the group.

• UMS successfully completed the acquisition of a 70% stake in Starke Singapore, a profitable and key raw material supplier to the group on 13 August 2018. 
• We estimate that the acquisition of Starke would provide the group with a good opportunity to secure cost savings, improve gross margins and enhance business and operational synergies through upstream integration of the supply chain of raw materials, and contribute c.1.5% of FY18F earnings.

Possible beneficiary of trade shifts away from China.

• Notwithstanding an escalation of US-China trade tensions which may have broader implications for the global manufacturing supply chain, UMS could be a beneficiary of the ongoing diversion of production flows from China into ASEAN.
• New capacities for Endura kicking in and headroom to further ramp up on its Components segment, we believe that UMS could be well positioned to ride these positive trends, if it is willing to make concessions on the pricing front, especially given its industry-leading margins currently.

Sustainable 6-Sct dividend; prospective 8% yield.

• UMS has been paying 6 Scts dividend per share each year over the last five years, and at least 5 Scts per share historically. 
• All else equal, we believe a 6- Sct dividend for FY18F is achievable for UMS given steady operating cash flows and net cash of > S$20m (which translates into c.4 Scts per share) which can be used to support dividend payments in the event of fluctuations in operating performance.

EARNINGS & RECOMMENDATION

FY18F/FY19F earnings cut by 14%/11%.

• We have lowered our revenue growth assumption to 5% p.a. for FY18F/19F vs 10%/5% previously, as UMS could take time to fill the new capacity given the trade war uncertainty.
• Gross margins for FY18F/19F is also reduced to 51%/52% respectively, as we believe UMS could improve on its pricing competitiveness by sacrificing some margins in favour of volume growth as new capacity comes on stream.
• A lower valuation peg of 10x, maintained at a 20% discount to larger peers’ average of 12x vs 15x previously as peers have de-rated, is used to derive our Target Price of S$1.01 (Prev S$1.37). 
• Maintain BUY.

Carmen TAY DBS Group Research | https://www.dbsvickers.com/ 2018-08-15

SGX Stock Analyst Report BUY Maintain BUY 1.01 Down 1.370