Maybank starts UMS Holdings on 'buy' amid industry upturn, diversification strategy

“UMS is in the early innings of an earnings up-cycle, and has traded at such levels or higher in previous similar episodes,” recalls Lai in a Wednesday report.

In particular, the brokerage views the company’s key customer, Applied Materials (AMAT), as a key determinant in the company’s ability to ride the market recovery. Noting that AMAT alone accounts for some 90% of the group’s revenue, Lai highlights that benefits are in the pipelines.

“[AMAT] sees semiconductor equipment spending recovery in FY20E. This is driven by sustained investments from logic and foundry customers, followed by a recovery of equipment spending from memory customers in 2020 – led first by NAND, and subsequently DRAM,” says Lai.

“We see UMS as a beneficiary of AMAT’s earnings recovery as it has 70% wallet share of AMAT’s Endura wafer transfer modules, and also supplies components for AMAT’s other platforms,” adds Lai.

Looking ahead, AMAT’s contributions are unlikely to wane anytime soon, as the brokerage projects FY19-21E earnings compounded annual growth rate (CAGR) of 28% for UMS, driven by its key customer’s sustained spending in logic and foundry segments, as well as a recovery of memory spending led by NAND and DRAM.

To be sure, both companies reaffirm each other’s positive stances for the upcoming year - UMS has been seeing stable order volumes from AMAT, indicating that the semiconductor market has “bottomed out”. In turn, AMAT has stressed its confidence that a recovery for the memory capex segment is “a matter of when, not if”.

In addition to being a strategic partner to a market leader, UMS is also poised to reap handsome rewards from its diversification strategy, which is evident in the group increasing its stake in precision engineering firm JEP Holdings to 39%. This move is what Lai terms “most promising”.

Lai remains bullish on this move, as this would allow UMS to structurally increase outsourcing, and strategically diversify away from sourcing from China due to the US-China trade war.

“Through associate JEP, UMS is expanding precision metals engineering to non-semiconductor sectors such as aerospace, which sees tailwinds from outsourcing trends,” says Lai.

And with UMS CEO Andy Luong taking over the reins, JEP had registered a profit of $3.3 million in 1H19, from booking losses in the previous year. And while Lai acknowledges that UMS may require several more years to materially reduce earnings dependency from AMAT, he remains positive on the steps taken towards capitalising on synergies between both companies.

In fact, this is not the only move UMS has taken to diversify earnings. The company is also exposed to chemical engineering solutions via a 51% stake in Kalf Engineering, and has integrated part of its upstream process with a 70% stake in Starke Singapore.

Although UMS seems to be in pole position to benefit from the industry recovery, Lai cautions investors about certain risks, including the group’s reliance on a single customer, the cyclicality and seasonality of the semiconductor industry, as well as price competition for its less complex components.

In addition, while UMS diversification is positive from a business strategy standpoint, Lai is quick to note that such efforts carry risks due to the lack of familiarity in new-end markets. He expects the group’s stake in JEP to be ROE dilutive until investments such as JEP sufficiently scale up.

Yet, this is not insurmountable for the group. “We believe such risks are mitigated for JEP as a large part of Luong’s turnaround strategy for JEP appear to be capitalising on JEP’s already solid traction in the aerospace industry, and boosting its competitiveness through cost rationalisation and seeking higher value-added projects,” shares Lai.

Shares in UMS Holdings closed one cent lower, or 1.0% down, at 95 cents on Wednesday.

According to Maybank valuations, this translates to a price-to-earnings ratio of 14.5 times and a dividend yield of 3.6% for FY19E.