• Upgrade UMS (SGX:558) to BUY with higher Target Price of S$0.87 as we turn positive on semiconductor.
• Strong recovery in semiconductor sales after every major crisis.
• Bottoming out in Singapore manufacturing.
• Optimistic on the renewal of contract with key customer AMAT.

Upgrade to BUY From Fully Valued With Higher Target Price of S$0.87

• Our upgrade call is premised on the resumption of the growth in semiconductor equipment sales in 2020. SEMI forecasts the equipment market to jump 11.6% in 2020. The recovery is on the strength of memory spending and new projects in China. More upside is likely if the macro economy improves and trade tensions subside in 2020. Near term, we are expecting monthly semiconductor sales to stabilise at slightly above the US$30bn level.
• At the company level, our channel checks show that UMS is beginning to see a pick-up in semiconductor sales, which should be reflected in its coming quarters’ results. Our earnings forecasts for FY19F and FY20F are raised by 10% and 30% respectively.
• Upgrade to BUY with a higher Target Price of S$0.87 (previously S$0.49), pegged to smaller peers’ (e.g. AEM (SGX:AWX), COHU) average of 12x. Bigger peers (e.g. TSMC, ASM) are trading at about 20x on average. See UMS Holdings Share Price; UMS Holdings Dividend History.

Semiconductor Stabilising; Expect Strong Recovery in 2020

• Expect recovery in semiconductor sales in 2020 after a weak 2019. According to World Semiconductor Trade Statistics (WSTS) organisation, worldwide sales of semiconductor registered a 15.9% y-o-y drop for the month of August 2019. But on a m-o-m basis, August sales registered a 2.5% gain, which also marked the second consecutive month of global sales increase. On a 3-month moving average basis, sales for June/July/August saw a 3.5% gain, vs the March/April/May period. Thus, the data is suggesting some signs of stabilisation and a turnaround for the industry could be due soon.

SEMI expects recovery in semiconductor industry in 2020.

• According to SEMI, global sales of semiconductor manufacturing equipment by original equipment manufacturers (OEMs) are projected to decline by 18.4% in 2019 from last year’s historic high. Growth in equipment sales is expected to resume in 2020, with an 11.6% y-o-y jump on the strength of memory spending and new projects in China, while equipment sales in Japan should surge 46.4%.

Normalisation of semiconductor shipment.

• From the chart in attached PDF report, the global semiconductor shipment started to decline from end-December 2018, mainly on the back of the trade war and the global economic slowdown, which continues into 2019. In the last few months, the shipments seemed to have stabilised at slightly above the US$30bn level. This level coincides with the normalised long-term growth trend (represented by the black dotted line) of global semi-conductor shipments.

Strong recovery after every major crisis.

• In terms of y-o-y change, the historical semiconductor shipment data showed a steep rebound after each major crisis, including the Asian Financial Crisis in 1997/1998, the dot.com crisis in 2000/2001, the global financial crisis in 2008/2009 and now the trade war crisis. The current 15.9% y-o-y drop in August 2019 is one of the steepest since 1992. A normalisation of the shipment trend should lead to an improvement in y-o-y growth.
• However, given the prolonged trade war whereby no meaningful conclusion is in sight and the global economy is still showing tepid growth, the risk is that we may only see a more decisive turn when there is better visibility on the trade front and a healthier economy.

Bottoming out in Singapore manufacturing.

• In Singapore, our economist is of the view that the manufacturing sector could be bottoming out. On the surface, the manufacturing sector reported a headline contraction of 3.5% y-o-y. However, that is partly caused by the high base in the same period last year. Sequentially, the sector has recovered to register a marginal decline of 0.4% q-o-q saar, a marked improvement from - 4.2% previously. He reckons that the worst of the manufacturing cycle could be over, but cautions that growth in this sector will remain lacklustre amid weak global demand and uncertainties around the ongoing trade talks between the US and China.

Improving outlook for UMS.

• For UMS, the 2H19 outlook for the semiconductor business remains challenging, but our channel checks show that the group is seeing an improvement in business order volumes from its semiconductor segment. Its non-semiconductor businesses, which accounted for 8.9% of 1H19 total revenue, are also making good progress.
• Other key players in the semiconductor space, including TSMC, also guided for higher capex spending on the back of the stronger outlook for 5G deployment next year while ASML continues to see 2019 as a rowth year.

Semiconductor Riding on the Wave of the AI and Data-driven Growth Surge

• The semiconductor industry continues to expand, driven by the massive growth of interconnected devices and heavy demand for processing power and storage. Growing demand can be seen in areas such as high-performance computing, data storage, artificial intelligence (AI), cloud computing, and automotive, which are driving spending growth in the semiconductor industry. The expected 5G roll-out in more locations in 2020 should also drive demand further. Gartner expects good long-term growth CAGR (2017-2022) of 5.1%, outpacing 2011-2016 CAGR of 2.6%.

Optimistic on the Renewal of Contract With Key Customer AMAT

• UMS has had a long-standing manufacturing partnership with AMAT for more than 10 years in the manufacture of components for various semiconductor equipment, and as the main manufacturer and sub-assembler of AMAT’s flagship Endura deposition system. Its contract with AMAT is due for renewal at the end of December 2019. We are optimistic that the contract will be renewed, given its entrenched relationship with AMAT.

Dependence on AMAT’s Performance

• Historically, 90% of UMS’s revenues were attributed to AMAT. Thus, naturally, UMS would depend on AMAT’s performance. AMAT’s customers include chipmakers like Samsung, Intel, TSMC and Micron Technology. Based on consensus estimates, AMAT is projected to register a 15% y-o-y drop in earnings for FY October 2019 (which is an improvement from the 40% drop projection in August 2019) and to rebound 9% in FY20F followed by 18% in FY21F.

Strong Balance Sheet Supported by Attractive Dividend Yield

• UMS has a healthy cash level despite investing S$6.9m to raise its equity stake in JEP HOLDINGS (SGX:1J4) from 29% to 39% in 2Q19 and paying dividends of S$10.7m. The group’s net cash rose to S$6.0m as of end-2Q19, reversing from a net debt of S$1.4m as at end-4Q18.
• Current dividend yield of 5% is still attractive, despite the cut in FY18 and assuming lower dividend per share (DPS) going forward. DPS had fallen to 4.5 Scts in FY18, from an average of 6 Scts paid over the last five years. However, going forward, we would not rule out the possibility of a lower dividend payout, as the group preserves cash for M&A opportunities. We are projecting a 3.5-Sct DPS for FY19F-21F. See UMS Holdings Dividend History.

Diversifying From the Cyclical Semiconductor Segment

• To diversify from the exposure to the cyclical semiconductor industry, UMS in recent years has invested in several companies. The group acquired a 70% stake in Starke Singapore, a non-ferrous metal alloy specialist, in March 2018. It has also invested in JEP Holdings, which is in the precision engineering business, since January 2018 and has recently increased its stake to 40%. With this stronger material sourcing and distribution network, UMS can improve operational synergies as well as tap into growth opportunities in new markets.
• In 2017, UMS acquired a 51% stake in water and chemical engineering solutions company, Kalf Engineering. And in 2016, the group diversified into aerospace components via a 10% stake in All Star Fortress Sdn Bhd.
• These investments should provide the group with alternative growth opportunities in the medium-to-long term and provide diversification away from the cyclical semiconductor business.

Plants Outside China; No Direct Impact From Trade War

• Both of UMS’s manufacturing plants are located outside of China. UMS has about 640,000 sqft of combined space in Singapore and Penang, Malaysia to meet new demand and customers’ requirements. It has relocated most of its production from Singapore to Malaysia which has a lower-cost infrastructure in order to improve cost competitiveness and labour availability. Thus, there is no direct impact of additional tax for goods out of China into the US. UMS also has a procurement and purchasing centre in the US.

Upgrade to BUY, Raised Earnings and TP

• We upgrade UMS to BUY as we turn positive on semiconductor. Our earnings forecasts for FY19F and FY20F are raised by 10% and 30% respectively.
• Our higher Target Price of S$0.87 (Prev S$0.49), is pegged to smaller peers’ (e.g. AEM, COHU) average of 12x on FY20F earnings. Bigger peers (e.g. TSMC, ASM) are trading at about 20x on average.

Where We Differ

• We are more positive on the semiconductor outlook and expect UMS to trade in line with its smaller peers’ PE of 12x on FY20F earnings.

Source: DBS Research - 24 Oct 2019