Locally-listed UMS Holdings (UMS) recently announced the third quarter results ended 30 September 2018. Despite the slump in 2both revenues and earnings, there remains one bright spot which was the steady gross margin of 59 percent achieved in both the current quarter.

The latest earnings results from UMS also brought into attention its close partnership with US-listed Applied Materials (AMAT), and whether there are any synergistic outcomes from the partnership. Back in mid-September 2017, some analysts from MayBank Kim Eng (MKE) indicated that under the joint partnership, UMS manufactured wafer transfer modules used in AMAT’s Endura deposition system and precision components for other equipment. Gartner, a renowned consulting firm noted that UMS supplies 70 percent of wafer transfer modules for Endura. The sizeable exposure to AMAT’s business does raise some concerns over UMS’s risk management initiatives, and whether UMS was well diversified in terms of its supplier-customer relationships.

Partnership At Risk Of Fallout

AMAT itself has also reported dismal fourth quarter and full-year results. During the fourth quarter ended 30 September 2018, AMAT’s net sales rose slightly to US$4 billion, while net profit fell 11 percent year-on-year to US$876 million. For the full-year FY18, AMAT’s net sales rose 19 percent to US$17.3 billion, while net profit fell 4 percent to US$3.3 billion.

The Company said its 1Q19 net sales are expected to be in the range of US$3.6 billion to US$3.9 billion, and adjusted earnings per share (EPS) is expected to be in the range of US$0.75 to US$0.83. Analysts have forecasted EPS of US$0.92 per share, and total revenue of US$3.9 billion for the next quarter.

The slowdown in AMAT’s earnings brought to question of whether UMS might also be negatively impacted given its sizeable earnings exposure to the American chip maker.

Impact On Valuations Of UMS Holdings

Using the discounted cash flow (DCF) method, we came up with a per share of $0.90. The counter closed at the end of the market trading day on 23 November 2018 at S$0.595 per share.

The following table is our base case assumptions and DCF valuation summary:

Assumptions
Risk-free rate 2.2%
Beta 89.8%
Market Return 10.0%
Cost of Equity 9.2%
Cost of Debt 1.2%
Tax Rate 17.0%
WACC 8.5%
Terminal growth rate 0.0%

Source: Company reports, and our assumptions

DCF Valuation Summary of UMS Holdings

DCF
All figures are in S$’000, unless otherwise stated
2018A 2019F 2020F 2021F 2022F 2023F 2024F
PAT             52,037     44,506     45,396     46,304     47,230        48,174      49,138
YoY Growth (%) -14.5% 2.0% 2.0% 2.0% 2.0% 2.0%
Adjustment to Free Cash Flows           (23,378)     (9,851)   (10,048)   (10,249)   (10,454)      (10,663)    (10,876)
Free Cash Flow (PAT + Adj. to FCF)             28,659     34,655     35,348     36,055     36,776        37,512      38,262
Terminal Value      450,083
FCF             28,659     34,655     35,348     36,055     36,776      487,595
YoY Growth (%)

20.9%

2.0%

2.0% 2.0%

2.0%

NPV           440,985
Less: Debt             19,001
Plus: Cash and Cash Equivalents             59,571
FCF due to shareholders (S$)      481,554.92
Weighted average shares outstanding           536,430
FCF per share (S$/share) 0.90

Source: Company reports, and our assumptions

In our base case assumptions, we assume a five-year revenue growth of 2 percent, along with zero terminal growth, and a weighted average cost of capital (WACC) of 8.5 percent. At the current price of $0.595 per share, UMS’s relative valuations look fairly reasonable with twelve-months historical price-earnings (P/E) multiple of 6.7 times, and dividend yield of 7.6 percent.

However, if we were to take into consideration an extreme scenario where AMAT were to drastically reduce its demand of the wafer transfer modules supplied by UMS and used in its Endura deposition system and precision components, and assigned a 50 percent reduction to our fair price assumption, this will work out to be $0.45 per share. Although, a 50 percent reduction to the fair price assumption sounds drastic, we cannot rule out such possibilities due to the size of earnings exposure UMS has with AMAT currently.

In conclusion, we think that at current valuations, both relative and DCF valuations have all pointed towards a potential undervaluation in the stock price. However, the risks of a global semiconductor slowdown cannot be ruled out in 2019. AMAT has already tempered its expectations of flourishing growth in their earnings, and we think investors should also take measured approaches and stay diversified as they go about managing their investment portfolios.

Shares Investment is not a financial advisory firm licensed by the Monetary Authority of Singapore. The above article entails some arithmetic guesswork, only to express the writer’s own opinion on the stock and its current valuation.  We do not make any trading calls and readers should consult with their own financial advisors before making any investment decisions. 

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