UMS Holdings announced their fully year result yesterday.
Its been sometime since I bought this stock, sold this stock, then bought back again.
So here is my brief look at the business
Share Price: $0.67
Outstanding Number of Shares: 429 mil
Dividend per share: $0.06 (8.9% Dividend Yield)
Cash Flow required to pay dividend per share: $25 mil
Cash Flow Analysis
The net profit for the year was $22 mil versus $34 mil in the previous year, a 34% drop. The absolute profit swing was -12 mil.
A look at individual line item revealed that the biggest swing was from other expenses and changes in inventory.
CEO Andy have always create the narrative that they are very good at controlling cost, to that they could generate some good margins. In this full year result, as well as the quarterly results, we can see this result of this from the reduction in raw material and sub contracting charges, employee benefits and other expenses. However, Raw material charges and employee benefits are up in the fourth quarter.
It turns out that the old acquisition of CEO Andy’s Interest Party Transaction (IPT), Integrated Manufacturing Technologies (IMT-US) is not working out as it should, and the company is writing the value down. This together with part of the inventory written down.
Both these are non-cash items and in the cash flow statements you will see that their cash flow is much higher than their net profit.
Based on their net profit of $22 mil, they are paying more out of profit than they should, when they pay out $0.06 of dividends for the full year.
However, if we measure up the amount of cash flow require to pay the $0.06 dividend, against the 2016 free cash flow of $31.2 mil (take net cash generated from operating activities – purchase of plant and equipment), that is prudent. the free cash flow payout ratio is 80%. FY2015’s operating cash flow is better.
Notice the mismatch between Depreciation expense and Purchase of plant and equipment. We will come back to this later.
The general narrative I get from the revenue fall and the short 1 year profit profile is that semi conductor is currently in a challenging scenario. This is inline with what I am observing while reviewing semi-conductor based business such as Micro-Mech, Global Testing and AEM Holdings. The latter with more of a change in profit profile. Micro-Mech and Global Testing do not have any change in their narratives, and what I observe is similar challenging situations.
My thought is that if they can operate in a period that are not doing so well, and still generate good dividends, then when there is a surge, the cash flow would have good upside. The caveat for this is that, things could get worse, cash flow can look worse, and dividends could be cut. I am forecasting where we are in the business cycle, but forecasting is not a good sport to be in. I am likely not to get it very correct.
UMS Holdings after a few years have cleared their debts. Their change in inventory and receivables match well with their short term working capital financing through payable.
Property, plant and equipment was:
- 2010: 65.5 mil
- 2011: 59.4 mil
- 2012: 50 mil
- 2013: 43 mil
- 2014: don’t have the data and lazy
- 2015: 34.8 mil
- 2016: 31.7 mil
The mismatch in spending the same amount of dollar in maintenance capital expenditure to meet depreciation is what allows a better cash flow to pay the dividends.
Some companies aggressively depreciation their assets, but the assets could last longer than their tenure of depreciation. To a certain extent, UMS capex requirements is determine very much by their key customer’s requirements. This is an area where yearly, it is best to get the management to shed light.
While the cash is building up, I would be conservative to think that a part of this amount would be spent on future major capital expenditure.
Acquisition of Klaf Engineering
This acquisition is small at less than $1 mil (compare this against their FCF). It seeks to diversify away from the semi conductor industry. This seems to be similar to their previous move to another industry.
I am not going to pretend I am familiar with this new segment, but putting the word maintenance out there seems to be a good buzzword as people will think its recurring. We shall see.
If it is a vital component in these installation, or can create tremendous value add, then we should see good profitability and hopefully growth. However, if majority of their clientele is offshore industry, when their clients are squeezed, they get squeezed or the clients reduce the purchases of things that could save them money.
Other than their great pivot to work with Applied Materials, the IPT acquisitions for IMT-US didn’t result in significant value to shareholders.
I am not very optimistic about these ventures.
UMS share price have moved up from $0.60 to $0.67. The move seem to be in anticipation of a good dividend. Getting 3 cent looks justifiable for the share price move.
I would be surprised if the share price further jumps today.
There is a numerator and the denominator in Price Earnings Multiple. The numerator (Price) have moved further up. The denominator (Earnings) based on FY2016 got worse due to the impairments and change in inventory. It is 12.7 times PE or 7.8% earnings yield.
Usually this is a cheap valuation and an attractive one, if we see the business as recurring for 10 or 15 years.
UMS reliance on a key customer based on 4-6 years contract makes me think that we demand more return, in a shorter time to have margin of safety. We also note that earnings and cash flow in this industry can fluctuate.
If what I am right, that the demand and supply for semi conductor products are in a cautious state, and potentially future outlook might be better, than this might balance things up and current price is a fair value.
It would look a great bargain if its 8 times PE or 12.5% earnings yield.
If we take out the $0.097 per share in cash from the share price, this would make UMS look very attractive. However, as I said, somewhere down the line, UMS may require some bigger capex, and this cash looks to cater for that, so deducting this cash out looks like a dangerous way to value (which is why its important to find out the future capital expenditure picture)
Questions to Ask in AGM
If a shareholder is going to the AGM, there are some things we need to seek clarification.
Could management shed light on the renewal of the contract to Applied Materials? Users tend to squeeze contractors and the last renewal, UMS have to shift its manufacturing to Penang to control its costs. The terms of 3 + 3 looks different from 5 years.
Could management shed light on the future capital expenditure requirements? UMS could pay good dividends because of the mismatch between depreciation and maintenance capital expenditure. The last time a large capital expenditure took place was around 2009 to 2010. Its been like 7 to 8 years since then. Have customers requirements changed that there is a need for new capex?
How would they fund the capital expenditure when required? Would it be through cash holding?
Why choose to diversify? UMS seem to be the vehicle for CEO Andy to pass on his experiments into. Is UMS bailing him and his partners out? If we observe, every time they tried to diversify or take the business in other segments, they pale in comparison to what Applied Materials can provide. Business for listed precision engineering business is tough. So what makes this purchase of Klaf Engineering and their move into a new segment in previous reporting worthwhile, instead of focusing their efforts?
Could management shed some light on the current state of the semi-conductor industry?
A segment of my articles are about my musings on listed business prospecting such as this. I do not tell you this is a good buy or you are suppose to sell. I put out the information in the hope that, you can contrast the way you prospect these business with how I do it, and perhaps can help you improve the way you prospect. I bear no responsibility if the investment turn out good or bad. We should all take responsibility for our investment decisions. One of the biggest way to improve as an investor is not to blame this or someone but to take ownership of your decision to buy, sell, stay away or hold.