Hi MW,
I wish to clarify that I do not consider these metrics / figures to be complicating in determining the viability of UMS as an investment - instead, I think it will be quite complicating to start sprouting figures all over a relatively short post (as this isn't a research report). However, I do welcome specific questions as it forces me to read up more about my investment and may force me to re-think my rationale behind it. I do wish to admit that my knowledge of this business cycle is weak and there are many excellent postings here from the various members about the trend/future of this industry.
Quote:Moving forward, I guess some pertinent questions I may ask about the business is – just how “niche” is it and what is the demand like for UMS’ products and/or services? If net and gross margin remains high despite economic cycles, then it can be said that there are high barriers to entry and high switching costs for customers, such that UMS can retain a measure of loyalty and pricing power.
Since 2009, UMS has evolved into a primary supplier to Applied Materials system integration needs as the latter continues to push for out-sourcing towards Asia (like its major facility in Singapore). As a result, revenue from Applied Materials soared from 58.2% of revenue in FY 2008 to 87.0% of revenue in FY 2011. Applied Materials subscribed for 6.0% stake in UMS Holdings in 2007 to cement this partnership.
UMS Gross Margins (Revenue - COGS - Change in Inventories)
FY 2005: 42.94%
FY 2006: 46.70%
FY 2007: 54.81%
FY 2008: 62.15%
FY 2009: 58.76%
FY 2010: 56.02%
FY 2011: 55.76%
This means that UMS is generally able to reap decent margins from its business with Applied Materials resulting in fairly stable gross margins exceeding 50%. However, since this business contains fixed cost - depreciation expense, labor cost, administrative expenses, utilities, rental cost etc - the net margin is a function of utilization rate. The net profit relies on the gross profit exceeding these substantial fixed cost. Hence, in a bad year, revenue will take a beating due to lower demand for its services. Despite, reporting decent margin from this lower revenue, the gross profit may not be sufficient in covering these fixed cost (including non cash items like depreciation) resulting in a net loss. This occurred in FY 2009 when its revenue and gross profits was halved and the gross profit of $27.7 million proved to be insufficient in covering these fixed costs and the impairment charges. In other words, the question isn't whether can it get good business from its clients (margins) but rather can it get enough business from them (sales).
Quote:Another point is that I feel you should be looking at Free-Cash-Flow by year rather than OCF, as FCF is essentially how much cash can be reinvested into the business or paid out as dividends after spending on M&A and maintenance capex.
UMS doesn't segregate maintenance capex from expansion capex so it is difficult to compute their free cash-flow. However, looking at their investing cash-flow for FY 2010 and FY 2011 (where no major M&A was announced), it reported $7 million cash out-flow for purchase of PPE. It is likely that this is the 'normal' maintenance capex. Since UMS has generated at least $16 million OCF (during GFC) from 2005, I don't think it has negative free cash-flow yet. Moreover, it would not be logical for UMS to maintain a net cash gearing while reducing its share float, paying annual dividends, engaging in organic growth by developing new facilities and yet failing to generate substantial free cash-flow.
This is one reason why I often liked to examine cumulative cash-flow as it gives a broader sense of where the cash is coming from and how the Company is spending it over the years. From FY 2005 to 1H 2012, its operations has generated cash earnings of $194.1 million and it received cash proceeds of $40.4 million from disposing its assets. This enabled it to easily financed $121.8 million worth of acquisitions and repurchasing $13.5 million worth of shares. The excess cash left was used to fund its $64.5 million dividends to shareholder. This was done while its balance sheet registered net cash gearing at every single year ! Hence, one can see that the operating cash-flow generated together with the disposal proceeds is more than sufficient in financing the capex, debt repayment, equity repurchase and dividends meaning that the company isn't bleeding cash.
I like to use China Fishery Group as another example - from FY 2004 to FY 2011, US$0.532 billion net operating cash-flow and US$0.001 billion disposal proceeds. Yet, the Management spent US$1.162 billion on acquisitions and US$0.077 billion on dividend payment to shareholders implying that the core operations cannot sustain such levels of growth alone. As a result, we can see the Management raising US$0.436 billion worth of debt (net of repayment) and issuing US$0.260 billion worth of new shares. This enables it together with the operating cash-flow to finance the major cash out-flow namely acquisitions and dividends. I use this not to gauge a Company's ability to generate FCF on an annual basis but rather to examine the business model and how it is sustaining the dividends and growth - by operations or by new debt/shares. This gives me an idea whether is it truly a cash generator or a cash guzzler.
Quote: You did mention that UMS has net cash gearing, are their loans relatively recent which means they managed to lock in favourable interest rates?
UMS has been pretty conservative with bank borrowings - it had 0 bank debt in FY 2010 and FY 2011 though it did carry small amount of finance lease liabilities ie $2.7 million in FY 2011. In 1Q 2012, it took on a short term loan of $15.1 million to partially the finance the M&A of IMT Group in Feb 2012 and it has since reduced it to $10.1 million in 2Q 2012 with finance lease liabilities of $1.8 million. Debt hasn't been a problem for UMS and its interest expense is easily covered by its cash-flow.
Quote:dividend history to see if the payout ratios have kept constant or if the absolute dividends have been maintained/raised.
While UMS paid a dividend annually (even during loss making year), the major payout only started in 4Q 2009 with quarterly dividends of 1.0 SG cents since then. The cash generated in 2005 - 2008 period was primarily spent on developing its 2 facilities. At the moment, there isn't any major new developments (besides IMT M&A) which enables substantial dividend payout. The current dividend policy is quarterly payouts with special dividends in 4Q and the amount depends on the operating profits and future capex. There is no fixed payout percentages or absolute dividend figure policy. There is no guarantee UMS will continue to pay out a significant portion of its earnings to shareholders.
Quote:Are these disposal proceeds one-off and how was the capex financed (e.g. purely 100% equity or some combination of debt and equity?).
The cumulative disposal proceeds of $40.4 million - disposal of a Chinese subsidiary in 2008, recycling business in 2006 and a leasehold property in 2011 - did partially finance the capex. I am not certain how exactly these development projects were financed but debt levels did not rise significantly from 2005 to 2009.
Quote:What year were the factories built and has UMS identified demand for their products before undertaking the construction?
They first announced plans of building the 480,000 sqft Penang facility for US$25 million in 2006 and it was fully operational in 2009. This facility came with 5 years + 5 years pioneer tax-free status from Dec 2010. UMS intends to shift production work over to this facility to take advantage of labour and lower tax. The second major capex was the building of 80,000 sqft Changi North facility for US$20 million and it was completed in 2008. This building was initially meant to diversify into the O&G, Aerospace and Solar precision parts manufacturing for its CEM division. Yet, it never really took off and it now serves Applied Materials system integration needs. Unless I am mistaken, this building is very close to Applied Materials base so it is pretty useful. The third capex was the acquisition of IMT Group in 1Q 2012 for S$28.0 million to expand its range of services to Applied Materials. Time will tell whether this acquisition is meaningful. I suspect that if UMS is serious about diversifying its customer base to other industries, future capex will come from its CEM division. This, too, will bring its own set of challenges. Moreover, the IPT deal for IMT Group and the sale of shares by the CEO (which caused the share price to plunge early this year) may be a cause for worry.
I hope this helps
Feel free to point out the errors in my thinking.
Hi BeDisciplined,
Interest Expense and repayment of finance lease obligations are found in the Financing Cash-flow while dividend income is located under the Investing Cash-flow. The huge chunk of goodwill (virtually all prior 2012) came from the 2004 merger between the listed Norelco entity and UMS Semiconductor. The recent acquisition of the IMT Group increased the goodwill by $20 million. I like to look at cash-flow as it gives an idea how the Company is generating cash and what it does with it or whether is it even sufficient to sustain its operation or growth !