UMS Holdings

[l0nEr]

Hmmm your revenue tracker seems quite accurate... but margins fell and outlook revised downwards (similar to Applied Materials).
• UMS’ 2Q2012 revenue grew by 12% to S$36.6 million as pick-up in
business activities continued into 2Q2012 from 4Q2011
• UMS’ net profit grew by 8% to S$7.6 million while generating free cash
flow of S$10.4 million for 2Q2012
• Proposed interim dividend of 1.00 Singapore cent
• Short-term outlook revised downwards on the back of continuing European financial crisis

I tried to track the revenue of UMS to that of Silicon System Group (SSG) from 2009 to 1Q2012, and they are so closely correlated, in good time and bad time, incredible! See attached Excel. File for detail (Please correct me if there is any mistake)

Ratio of revenue of UMS to SSG:

1.9% (2009)

1.9% (2010)

1.7% (2011)

1.9% (1Q-2012)

Can one rely on this relationship to predict 2Q-2012 revenue for UMS, given that the revenue of SSG for 2Q-2012 is already known? Not likely, I guess !

Seems like the plan to restart its oil and gas arm might be true, with the CEM division recording a 50% revenue growth in Q2 2012 (although it still remains small), against flat in Q1 2012.
Was thinking that shrewed sale of IMT-USA might be due to the expected decrease in contribution from the US business. And it seems like the "acquisition" failed to bring in any visible revenue/profit growth. It wasnt even discussed if the acquisition brought benefits in any way.

[Nick]

UMS RECORDS NET PROFIT OF S$7.6 MILLION FOR 2Q2012 AND PROPOSES DIVIDEND OF 1.00 SINGAPORE CENT

http://info.sgx.com/webcoranncatth.nsf/V...40029CAA8/$file/UMS-Results-Announcement-Q2FY2012.pdf?openelement [SGX Announcement]

http://info.sgx.com/webcoranncatth.nsf/V...40029CAA8/$file/UMS-PressRelease-Q2FY2012.pdf?openelement [Press Release]

UMS has reported fairly stable earnings in 1H 2012 due to the slight recovery in semiconductor capex spending over the past 9 months. However, in light of growing economic weakness in the West and potential China slow-down, Applied Materials have revised their outlook downwards and this will impact UMS revenue and profitability in 2H 2012. During this period, UMS intends to continue its transfer of operations to its Penang facility to tap on lower operating cost and its pioneer tax benefits.

I remain impressed with UMS cash generating ability and it continues to remain in a net cash position despite boosting its dividend payout and acquiring IMT Group in 1Q 2012. A lot has been mentioned about semiconductor companies being poor cash earnings in general however I would like to think that UMS has a niche service and also an excellent partnership with the market leader. A quick look at its cummulative cash-flow profile over the past 7 years shows strong cash earning is typical within UMS.

Cummulative Cash-Flow from FY 2005 to 1H 2012

Net Ops Cash-Flow: $194.1 million (Ops Cash - Net Interest Exp - Finance Lease)
Disposal Proceeds: $40.4 million
Total: $234.5 million

Acquisitions + Capex: $121.8 million
Net Debt Repaid: $5.5 million
Net Shares Repurchased: $13.5 million
Dividends Paid: $64.5 million
Total: $205.3 million

I do not dispute that the semiconductor or the airline industry is inherently high capex driven. However, there are small / med size niche players that thrive inside and generate substantial cash-flow from the services they provide to a few giants. Within the airline industry, SIA is certainly a giant and its profits is very volatile yet there is a certain SIAEC providing a very niche service (through itself and its JVs) generating substantial cash-flow annually. I am not equating UMS (or other semiconductor service provider) with a blue chip like SIAEC but just highlighting that even the bleakest of industry would contain a few niche players with pretty decent business. Naturally, my understanding of UMS might be flawed and I may have over-estimated its 'niche' or its ability to survive a sustained downturn in the semiconductor industry.

Going forward, I expect UMS 2H results to be weaker unless Applied Materials enjoy an uptick in orders in 4Q 2012. If profits are adversely affected, the usual 1.0 cents quarterly dividend may be slashed. The CEM division registered strong quarterly growth (albeit a small base). This division was meant to diversify UMS reliance on semiconductor operations years ago. I am not sure whether future plans will succeed - we have to see how it performs in 2H 2012 especially with the expiry of an exclusive contract with an O&G player recently. The drop in US revenue is expected as Applied Materials is outsourcing towards Asia hence the rise in Singapore revenue. There is no mention about the performances of the recently acquired IMT Group and its contribution to the bottom-line. If this acquisition fails to do well, UMS might be forced to impair its goodwill on the balance sheet.

UMS closed at 39.0 cents and its 2Q 2012 dividend of 1.0 cents will be paid on 31 Oct 2012.

Boon - would value your opinion on their prospects in 2H 2012 and beyond. Thanks !

(Vested)

[Boon]

Hi Nick,

I think it is a good set of 2Q results, still maintaining its net margin and cash generating ability.

Revenue = 36.6 million
Profit after tax = 7.6 million
> Net Profit Margin = 20.8%

EPS = 3.97 cents (1H2012)
Debt = 11.2 million
Cash = 23.0 million
> Net Cash = 11.8 million

My opinion on prospects for 2H2012 and beyond is similar to that of the following quote but with a pre-condition attached

Quote from 2Q result announcement: “During the SEMIcon West Convention in July 2012, analysts and experts predicted a momentarily pause prior to a “multi-year market expansion” in the Wafer Fab Equipment (WFE) industry. There remains some optimism that recovery will happen as soon as in 4Q2012.”

Short Term: (Momentarily pause)
Things are expected to be weak in 3Q or maybe even in 4Q, but it's not going to be disastrously weak, unless the world economy is deteriorating quickly into a recession. Though revenue, profit and FCF could be down for 2H2012, but would remain in positive territory , I believe.

Long Term: (Multi-year market expansion)
The semiconductor equipment industry is highly cyclical in nature. Distinct cycles of semiconductor sales (hence equipment sales) closely mimic those of global economic. The long-term sales outlook appears positive based on broad demand trends. However, since the growth rate of global semiconductor sales (and hence equipment sales) is so strongly correlated to the growth rate of global gross domestic product (GDP), as shown in the PwC report, I believe, the “multi-year market expansion” as described above would materialize only if the global economy condition remains good.

(Vested)

[Musicwhiz]

Thanks Nick and Boon for the informative posts! High-quality analysis indeed, as I am not really familiar with this sector.

Nick, could I suggest plotting out the numbers by year instead of using cumulative? Since this is a cyclical business, perhaps you could go by half-yearly numbers (e.g. revenues, gross margins, net margins, FCF generation and dividends paid) to see if there is a trend. Since we all know on hindsight when the GFC crunch came and affected global demand, you can also deduce from the numbers whether UMS was adversely affected.

I do admit a 20% net margin is very impressive for this industry. Then again, it being inherently cyclical means that the question to ask would be - is it at the top of the cycle or probably somewhere mid-way? And how badly is it affected by the cycle? Perhaps also compute EBITDA margins and EV/EBITDA to see how this fluctuates with cycles?

Only with more clarity in the numbers can we begin to conclude if UMS is truly under-priced or not, as the valuation depends very much on how resilient it is to cycles and how well it can weather the proverbial economic storm(s).

(Not Vested)

[Nick]

Hi Boon,

I do appreciate your comments. I too believe UMS will remain profitable in 2H 2012 and possibly on par with 2H 2011 barring a major recession. UMS (and Applied Materials) business are ultimately tied to macro demand for electronic products. Hence I don't think there is much the Manager can do besides controlling cost ie shifting towards Penang. In the long run, the CEM division could play a vital role in diversifying away from the semiconductor industry. If the CEO is seriously committed in building up this division, we might see some M&A in the coming quarters to beef up its capabilities and skills in order to attract new clients. A good example would be the recent acquisition of Arena Millenium (a Malaysian precision manufacturer in the O&G and Aerospace industry) by Broadway Industrial. However, if the semiconductor returns prove to be more lucrative, I suspect the Management will continue to invest in expanding its range of services to Applied Materials. Let's wait and see.

Hi MW,

I don't wish to start throwing all kinds of figures in this post - it will complicate matters and these numbers can be derived from the past Annual Reports. The profits earned over the past 8 years has been fairly volatile - relatively decent profits pre-2008 and excellent earnings post-2009 due to the partnership with Applied Materials. The Group reported a loss in 2009 due to the anemic spending in the semiconductor division. This shows that the profits will be volatile and this isn't surprising as the underlying industry is highly cyclical. Yet, what I found astonishing was their cash generating abilities.

Net Operating Cash-flow (Ops Cash-flow - Net Interest Exp - Net Finance Lease Exp):

FY 2005: $27.97 million
FY 2006: $28.46 million
FY 2007: $27.55 million
FY 2008: $16.15 million (GFC started)
FY 2009: $18.88 million (Loss-Making)
FY 2010: $27.53 million
FY 2011: $34.59 million
1H 2012: $12.98 million

The strong operating cash-flow and disposal proceeds enabled them to (i) finance their expansion - building a US$25 million 480,000 sqft facility in Penang and a US$20 million 80,000 sqft facility in Changi and acquire IMT Group for $28 million, (ii) reduce their share float from 393.48 million shares in 2007 to 343.74 million shares today and (iii) paying 18.95 cents / share dividends to shareholder - while maintaining a net cash gearing throughout the past 7.5 years. Yet, I will not confuse this with a yield stock or a cash-cow (like SIAEC or Kingsmen). The underlying industry is still very cyclical and it will be interesting to see how 3Q profits and cash-flow will be in light of weaker orders experienced by Applied Materials.

[Musicwhiz]

Hi MW,

I don't wish to start throwing all kinds of figures in this post - it will complicate matters and these numbers can be derived from the past Annual Reports. The profits earned over the past 8 years has been fairly volatile - relatively decent profits pre-2008 and excellent earnings post-2009 due to the partnership with Applied Materials. The Group reported a loss in 2009 due to the anemic spending in the semiconductor division. This shows that the profits will be volatile and this isn't surprising as the underlying industry is highly cyclical. Yet, what I found astonishing was their cash generating abilities.

Net Operating Cash-flow (Ops Cash-flow - Net Interest Exp - Net Finance Lease Exp):

FY 2005: $27.97 million
FY 2006: $28.46 million
FY 2007: $27.55 million
FY 2008: $16.15 million (GFC started)
FY 2009: $18.88 million (Loss-Making)
FY 2010: $27.53 million
FY 2011: $34.59 million
1H 2012: $12.98 million

The strong operating cash-flow and disposal proceeds enabled them to (i) finance their expansion - building a US$25 million 480,000 sqft facility in Penang and a US$20 million 80,000 sqft facility in Changi and acquire IMT Group for $28 million, (ii) reduce their share float from 393.48 million shares in 2007 to 343.74 million shares today and (iii) paying 18.95 cents / share dividends to shareholder - while maintaining a net cash gearing throughout the past 7.5 years. Yet, I will not confuse this with a yield stock or a cash-cow (like SIAEC or Kingsmen). The underlying industry is still very cyclical and it will be interesting to see how 3Q profits and cash-flow will be in light of weaker orders experienced by Applied Materials.

Hi Nick,

I must admit I have not read UMS’ ARs as of yet, but my reasons for commenting is not to “complicate matters”, but merely to point out the necessity for year to year comparisons in order to make meaningful conclusions about the cyclicality of the business, rather than stating cumulative amounts from FY 2005 to 1H 2012.

Don’t get me wrong – this information is indeed useful, but the fact that the industry is cyclical means that in order to determine just how vulnerable the Company is (as part of comprehensive due diligence), one has to note the pattern of revenues, margins and profits; plus cash generation, capex and dividends paid. These are some of the key metrics which one should observe on a half-yearly basis, and though as you rightly pointed out the numbers can be derived from the AR, it would still be helpful to provide a summary since you’ve already done such an excellent job in summarizing so much other information. Granted, I could do the grunt work myself, but it’s nice to hear someone else’s perspective on this and your methods are seen by me as being rigorous.

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. This is just one aspect I look out for.

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. You did mention that UMS has net cash gearing, are their loans relatively recent which means they managed to lock in favourable interest rates? That could push down finance costs in the interim, but the key is to watch the debt levels over the years to see if the Company has been diligently paying down debts when times are good, as well as the dividend history to see if the payout ratios have kept constant or if the absolute dividends have been maintained/raised.

You mentioned about disposal proceeds helping them to expand by building a factory in Penang. And Changi and to acquire IMT Group. Are these disposal proceeds one-off and how was the capex financed (e.g. purely 100% equity or some combination of debt and equity?). What year were the factories built and has UMS identified demand for their products before undertaking the construction? I’ve read of cases where firms in an industry expand capacity close to the peak of the cycle, leading to an over-supply situation and falling ASPs. Do you happen to have a view on which part of the cycle UMS is in? (Assuming they are building factories and ramping up production, I am guessing it could be mid-to-late cycle).

Their cash flows also helped them to buy-back shares which is definitely a positive if their shares are trading at low valuations vis-à-vis peers. Is the share trading at low valuations or significantly below NAV?

Just for clarification, I don’t view Kingsmen Creatives or SIA Engineering as yield stocks or cash cows (using the BCG Growth Share Matrix definition). To me, they do possess some measure of growth as well and at the same time, they pay out a decent dividend. My definition of cash cow companies would be akin to GRP which I used to own – large cash reserve, copious amounts of FCF but flat revenue and net profit over the years.

Regards.

[BeDisciplined]

Hi,

Net Operating Cash-flow (Ops Cash-flow - Net Interest Exp - Net Finance Lease Exp):

Is net interest expense under Op cash flow section? I notice there is interest being mentioned under Ops and Finance.

Where can I find and how do I compute net finance lease expense?

Personally, I find the goodwill of $80m very high in the context of total equity of $178m. Moreover, it has gone up to $80 from $60m which works out to be ~24 cts per share.

What is the methodology to evaluate a company based on its cash flow? Is cashflow more appropriate for a dividend stock than a growth stock?

Thanks

[Nick]

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.

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).

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.

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.

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.

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.

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 !

[KopiKat]

Despite my fears of CEO cum major shareholder (posted previously), I couldn't resist buying today... Without a strong and committed majority shareholder, I believe the share price will get attacked / pushed often by traders (just take a look at recent volume and price changes). As I think it's fundamentally ok (despite the cyclical fears), it's the kind of stock for me to make both long term and short term $$... Just have to be able to make quick decisions if cycle does suddenly take a rapid turn for the worse..

PS. The possible advantage of a not so strong and committed (my perception only) major (but not majority) shareholder is that a predator can easily come in if it's attractive enough to them...

[Boon]

Thanks Nick and Boon for the informative posts! High-quality analysis indeed, as I am not really familiar with this sector.

Nick, could I suggest plotting out the numbers by year instead of using cumulative? Since this is a cyclical business, perhaps you could go by half-yearly numbers (e.g. revenues, gross margins, net margins, FCF generation and dividends paid) to see if there is a trend. Since we all know on hindsight when the GFC crunch came and affected global demand, you can also deduce from the numbers whether UMS was adversely affected.

I do admit a 20% net margin is very impressive for this industry. Then again, it being inherently cyclical means that the question to ask would be - is it at the top of the cycle or probably somewhere mid-way? And how badly is it affected by the cycle? Perhaps also compute EBITDA margins and EV/EBITDA to see how this fluctuates with cycles?

Only with more clarity in the numbers can we begin to conclude if UMS is truly under-priced or not, as the valuation depends very much on how resilient it is to cycles and how well it can weather the proverbial economic storm(s).

(Not Vested)

Hi MW,

I have computed most data on a yearly basis from 2005 to 2011 (see attached excel file) and would appreciate your comments, and also comments from Nick and others. Please don't hesitate to correct any mistakes if there is any. Thanks.