UMS Holdings Ltd - DBS Research 2018-11-14: Feeling The Pressure

UMS HOLDINGS LIMITED (SGX:558)

UMS Holdings Ltd - Feeling The Pressure

UMS' 3Q18 net profit of S$7.4m (-49% q-o-q) was below expectations.
Higher capex reflects optimism over long-term prospects, but lacks near-term catalysts as industry growth slows.
Surprise dividend cut further weighs on sentiment.
Downgrade to FULLY VALUED; Target Price lowered to S$0.55.

After a multi-year surge, ASPs and profits of chipmakers could be due for a correction in 2019, according to Gartner. Over the past month, Semiconductor Equipment manufacturers have also delivered more earnings misses than hits – reflecting a slowdown in end-demand, which has since spilled over to Tier 1 manufacturers such as UMS.
UMS' 3Q18 net profit of S$7.4m disappointed, mainly on a sharper than expected contraction in Endura sales, which fell > 60% q-o-q. While plans to grow capacity for its higher-margin Components business reflects optimism over longer-term prospects, this will likely take time to materialise and is unlikely to offset the shortfall from Endura in the near-term.
The 50% cut in interim dividend also sends a negative signal, which may fuel further share price weakness. FY18F/19F earnings cut by 11%/21% on more conservative revenue estimates.
Downgrade to FULLY VALUED, Target Price cut to S$0.55.

We have assumed a lower valuation multiple of 8x (vs larger peers’ 9x) FY19F PE compared to consensus as UMS has higher customer concentration risk vs peers.

Higher demand for semiconductor equipment, client diversification, earnings-accretive M&As.
But underlying demand drivers point toward steady long-term growth profile over the medium-to-long term. Near-term expectations aside, the vast application potential of chips is set to drive robust demand growth for semiconductor equipment over the medium-to-long term. This augurs well for UMS given its primary role in the manufacture of components for various semiconductor equipment alongside Applied Materials.

Key client risk. Historically, c.88% of UMS’s 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’s performance.

Despite having lowered our projections for 8H88 previously on the back of possible near-term impact arising from key client AMAT’s weak sales outlook, 8Q88 net profit of S$8.8m (-88% q-o-q) still disappointed.
Against expectations of a weaker 8H vs 8H88, 8Q88 earnings of S$88.8m formed just 88.8% of our FY88F estimates, bringing 8M88 performance to just 88.8%/88.8% of our/consensus full year numbers.
The earnings drag mainly came from
1. a slowdown in UMS’ key Semiconductor Integrated Systems (or Endura) segment, which fell over 88% q-o-q to S$8.8m vs S$88.8m and S$88.8m in 8Q88 and 8Q88, respectively, and
2. higher operating costs. The negative effects were partly offset by c.S$8.8m in forex gains and continued growth in its higher-margin Components business – which reached a new sales record of S$88m during the quarter.
Planned capex reflects optimism over longer-term growth prospects. Despite healthy OCF of S$8.8m, FCF turned marginally negative during the quarter, which management attributes to planned investments in new capacity to grow the Components business.
We believe this positive development bodes well for longer-term prospects, implying that longstanding efforts to cultivate this higher-margin segment are finally bearing fruit.

While AMAT has yet to share its 8QFY88 results and FY88F outlook, we recall a disappointing sales outlook during its 8Q88 reporting in August. Over the past month, its Semiconductor Equipment peers have also delivered more earnings misses than hits – a harbinger of tougher times ahead for the sector?
In its latest update, Gartner predicted a correction in the memory space, after a multi-year surge in prices and profits, impacting chipmakers and thus semiconductor capital spending in 8888. US-China trade tensions, while positive for ASEAN- based manufacturers such as UMS over the longer-term, introduces volatility into the global supply chain, which may be disruptive to near-term performance.
While a faster-than-expected ramp-up on its higher-margin Components segment could help offset weaker demand for Endura and defend its industry-leading margins, we choose to be more conservative on UMS’s near-term sales outlook for now as it will likely take time for the group to ramp-up on its incoming capacities.

The key surprise this quarter was the cut in interim dividend to 8.8 Scts per share from 8 Sct historically, which was unanticipated given the group’s improved earnings profile vs previous years. The group also guided for a more balanced approach to dividend payments going forward, as it prepares ahead for possible value-accretive M&A opportunities amid the higher interest environment.
While the group’s ability to maintain a 8 Sct dividend remains supported by steady cash flow generation, the possible detraction from the steady 8 Sct p.a. paid over the last 8 years sends a negative signal, which could weigh heavily on investor sentiment and share price.

After adjusting for the 8Q88 earnings shortfall and imputing lower revenue assumptions on the back of weakening industry fundamentals, we cut earnings for FY88F/88F by 88%/88% to S$88.8m and S$88.8m, respectively.
Against a lower valuation multiple of 8x (vs larger peers’ 8x post de-rating) FY88F PE, we arrive at a lower Target Price of S$8.88.
We have also lowered our dividend projections accordingly as a repeat of the 88% dividend cut in the upcoming 8Q88 implies a dividend of 8 Scts per share for FY88F, vs 8 Scts previously.
Downgrade to FULLY VALUED.

Carmen TAY DBS Group Research | https://www.dbsvickers.com/ 2018-11-14

SGX Stock Analyst Report FULLY VALUED DOWNGRADE HOLD 0.55 DOWN 0.860