• Lower y-o-y sales, weaker margins in 1Q19; below expectations.
• Industry fundamentals remain weak in the near term.
• Cut earnings forecasts on lower margin assumptions.
• Maintain FULLY VALUED with a lower S$0.45 Target Price.

Industry Fundamentals Remain Weak in the Near Term

• The near-term outlook continues to be challenging with uncertainty in customers’ order flows as a result of the ongoing China-US trade tensions. Key customer Applied Materials (AMAT) is also guiding for a weaker outlook. Consensus is expecting a 20-30% y-o-y drop in revenue and earnings.
• The longer-term outlook however remains upbeat. SEMI expects global fab equipment spending to stage a strong recovery of 27% to set a new record in 2020, after a projected 14% contraction in 2019. The semiconductor industry is forecast to expand over the long term, driven by massive growth of interconnected devices, with heavy demand for processing power and storage.
• Given the weakening industry fundamentals in the near term, we continue to maintain our FULLY VALUED call or UMS HOLDINGS LIMITED (SGX:558).

Where We Differ

• We have assumed a lower PE of 8x (vs larger peers’ 10x) FY19F/FY20F earnings compared to consensus as UMS has higher customer concentration risk vs peers.

Potential Catalysts

• Higher demand for semiconductor equipment, client diversification, earnings-accretive M&As.

Key Risks to Our View

• Key client risk. Historically, 90% of UMS’s revenues on average can be attributed to Applied Materials. Disruptions to the relationship or weakness in Applied Materials’s end-demand could significantly weigh on UMS’s performance.

What's New - Lower Y-o-y Sales, Weaker Margins in 1Q19

Lower sales, weaker margins.

• UMS reported a 24% drop in 1Q19 revenue to S$28.6m, mainly due to weaker semiconductor business. Gross profit margins eased to 53% from 57% in 1Q18. This was due to a change in product mix and higher contribution from subsidiary company, Starke Singapore which earns lower margins from its material distribution business compared to the group's semiconductor business.
• Overall, 1Q19 revenue accounted for 24% of our FY19F forecasts and net profit a lower 19%, below expectations.

Lower DPS, in favour of M&A.

• An interim dividend of 0.5 Scts has been declared, lower than 1Q18’s 1 Sct but similar to 3Q18, when a lower DPS approached was first announced.
• The lower DPS is in line with the group’s guidance for a more balanced approach to dividend payments, in favour of M&A opportunities, especially with the pending takeover of associate company, JEP HOLDINGS LTD. (SGX:1J4). Going forward, we would not rule out the possibility of a lower dividend payout. See UMS's dividend history.

Could swing to a net debt position.

• UMS could swing to a net debt position, from a net cash position of S$9.3m as at 1Q19, depending on the level of acceptance for the acquisition of the remaining stake in JEP Holdings.

Industry fundamentals remain weak in the near term.

• The near-term outlook continues to be challenging with uncertainty in customers’ order flows as a result of the ongoing China-US trade tensions. Key customer Applied Materials (AMAT) is also guiding for a weaker outlook. Consensus is expecting a 20-30% y-o-y drop in revenue and earnings.
• The longer-term outlook however remains upbeat. SEMI expects global fab equipment spending to stage a strong recovery of 27% to set a new record in 2020, after a projected 14% contraction in 2019. The semiconductor industry is forecast to expand over the long term, driven by massive growth of interconnected devices, with heavy demand for processing power and storage.

Maintain FULLY VALUED Call With a Lower Target Price of S$0.45

• We have cut our earnings estimates by 20%/19% for FY19F and FY20F mainly on lower gross margin assumptions of 53%/54%, vs 57% previously.
• Our Target Price is reduced to S$0.45 (previously S$0.55), based on a valuation multiple of 8x FY19F/FY20F PE. See UMS's share price history.
• We maintain our FULLY VALUED call.

Source: DBS Research - 16 May 2019