(09-05-2013, 10:43 PM)Musicwhiz Wrote: [ -> ]On your last point 7, I wonder if you know which part of the cycle UMS is in and whether they are actually counter-cyclical? Reason I ask is because they have been consistently FCF +ve and also paying a 1c/share dividend for so many consecutive quarters. Hence, I get a sense that cyclicality may not have a major impact on the Company. What are your thoughts on this? Has the Company ever been "tested" in a bad macro environment or when demand has fallen off a cliff?
Hi Musicwhiz,
Always great to see your questions here !
UMS operates in a very volatile industry and this will be reflected in its numbers as being cyclical. Granted, we may think of cyclical industries as boom to bust sequences like the 7 year recession and 3 year boom shipping cycle. I would like to think it also includes industries where demand for its goods are extremely volatile and well in-tuned with the economic conditions so the revenue in that industry will zig zag terribly implying shorter cycles. In this industry, chip-makers like Intel or TSMC often spent heavily on new equipments to produce more chips efficiently or more advanced smaller chips. This is the capex which chip makers incur and the revenue which equipment manufacturers earn. The equipment manufacturing sector is dominated by a few American based players and one of the largest player is Applied Materials - customer concentration risk is inevitable. Since 2010, Applied Materials has started to outsource its operations to Asia (especially Singapore). UMS, is one of Applied Materials suppliers and they do the 'high end' system integration for the machine parts (hence the high margins). They have followed Applied to Asia so there was a shift of revenue mixture from USA to Singapore after 2010. The equipment manufacturing industry is cyclical as chip makers will not continually incur capex when demand for chips slow down. Personally, I view the industry as trending upwards over the past decade due to the huge demand for electronic products and smaller chips though the demand can be somewhat lumpy. We can see this lumpiness in UMS revenue recently - in 1Q 11, semiconductor revenue was a solid $32.8 million before dropping to $20.7 million in 3Q 11 and recovering to $34.6 million in 2Q 12 and plunging to $20.3 million in 4Q 12 and in 1Q 13, it rebounded slightly to $27.4 million.
I would consider FY 2009, 2H 11 and 2H 12 to be pretty bad times for UMS. In 2009, it reported losses (though cash-flow positive) as the semiconductor industry faced a contraction. Looking at the numbers published from SEMI, the equipment manufacturing sector order bookings in FY 2009 was US$6.08 billion as compared to US$11.17 billion in FY 2008 and its subsequent recovery in FY 2010 of US$18.45 billion. The FY 2010 figure is probably the strongest order ever recorded in a year and it is of no surprise that it was also UMS best year with record revenue generated. Unfortunately, since then, both years after (2011, 2012) suffered from the case of strong 1H and weak 2H due to poor economic conditions forcing chip makers to defer capex and order wins fell to US$15.8 billion and US$14.2 billion respectively.
In UMS case, I would think its strong operations enabling it to meet Applied Materials demand and quality is an important 'moat'. It has climbed the value chain in recent years and embarked on system integration since 2009 giving it more jobs. Its recent acquisition of IMT Group is meant to further complement its service offerings to Applied Materials. This has resulted in relatively strong margins due to the quality of their work and consistent cash-flow (no receivables issue). Even in the midst of the GFC, they could command gross margins of 62% in 2008 and 58% in 2009. I do not expect consistent result from UMS - I expect fairly stable EPS of 4-6 cents in normal times, > 7 cents in great times and loss making in terrible times. So far, it seems the normal times tends to dominate the cycle with short good and terrible times. This is just my expectation - I could be very wrong here !
(09-05-2013, 10:43 PM)Musicwhiz Wrote: [ -> ]Next question would be - why would you want to own the Company if you feel it is cyclical and earnings are therefore not easy to predict? Does this still make UMS a value play - being defined as intrinsic value being higher than the market price?
I wish to question the assumption that a 'value' purchase MUST have consistent earnings (with growth). I don't think it is necessary as long as the price has some value imbued in it - naturally, it entails higher risk as GreenGiraffe succinctly puts it and so I would demand higher returns. Note: I am not saying the current share price is a BUY. I could very well lose a lot in this investment if my analysis is wrong since it is cyclical. So that's a risk and I do understand where you are coming from.
UMS has been generating cash-flow consistently so that makes it a little easier to value. In terrible GFC period of 2008 and 2009, it generated operating cash-flow (including finance expenses) of $16.1 million and $18.8 million respectively. Even if we strip the finance lease income, the operating cash-flow was $13.3 million and $13.4 million respectively. The average operating cash-flow in FY 2010 - FY 2012 was $31.0 million or 9 cents per share. We know that it has been investing heavily in 2006 - 2008 to beef up its capabilities by purchasing industrial buildings in Changi and setting up its huge Penang facility from scratch. Yet, in this same period, it could still maintain its earnings, kept its balance sheet in net cash mode while significantly reducing its outstanding share float from a peak of 410 million to 343 million shares. Naturally, since late 2009, it has decided to channel the cash generated towards dividend payment. This isn't the hallmark of a typical boom to bust company.
(09-05-2013, 10:43 PM)Musicwhiz Wrote: [ -> ]Finally, if the Company is indeed in a cyclical industry, why won't it retain more cash to buffer against bad times instead of maintaining a high dividend payout policy? Is the Company retaining enough for growth and expansion? Has capex traditionally been purely maintenance or a combination of both expansionary/acquisitive capex cum maintenance capex?
I think the Management has been balancing this issue delicately. For instance, it purchased IMT Group in Feb 2012 for $28 million and it contributed $6 million to the Group bottom-line. It partially financed the acquisition with debt - in 1Q 2012, it had $28.8 million cash and $15.1 million debt. Four quarters later, it would have paid out 5 cents of dividends and redeemed its US$3.5 million structured deposit and yet, its cash is maintained at $28.4 million with debt significantly reduced to $2.0 million. I would actually consider this to be prudent and hence the payout ratio isn't as high as it would seem (though higher than the usual company in the tech sector). It survived GFC with $11.8 million net cash and currently it has built a net cash hoard exceeding $25 million. As such, I would think it has retained sufficient capital to buffer bad times. The bulk of the capex incurred previously was one-off since there is no need to develop another Penang facility or buy more industrial buildings. Replacing machines will be the key capex in the medium term but judging from the recent quarters, I think capex will continue to be low. Management did mention that capex is unlikely to be high this year since they incurred much of it a few years ago. Of course, nothing is certain and if there is a massively huge ramp up in demand, I can imagine expansion would curtail dividends going forward.
Personally, while it would be nice to create a second division catering to another industry like O&G or Solar, the management track record in diversifying has not been great. I guess when capacity is limited and you have a great customer providing nice margins, it makes little sense to still devote production lines to another customer. Previously, it tried to cater to the solar industry but the weak customer profiles made receivables an issue. In other words, diversification should result in the reduction of risk while maintaining returns - any other outcome, isn't really diversifying so I guess until the Management finds a job with similar returns, it makes little sense to expend capital on it. The acquisition of IMT Group would imply that the Management is more keen on building up its core competency than venturing into a new sector for now. Again, potential investors will have to decide whether is this the right approach.
In short, investors must recognize that the results will be lumpy and the dividends are by no means guaranteed. I would be surprised if they even paid a dividend in a traditional poor year. The lack of diversified product offerings is another element of risk that investors will have to bear. The past solid cash-flow generated are definitely not guaranteed to be continued in 2013 onwards. I like to think that is the reason why it has traded at 10 - 15% yield in the past 12 months. I try my best to be objective. Again, I wish to stress (to any reader) that I am not recommending a buy or sell here.
(Vested)