Early Innings of Cyclical Upturn; Initiate BUY

• UMS HOLDINGS (SGX:558) is a beneficiary of the WFE spending uptick through key customer Applied Materials (AMAT US). We project FY19-21E earnings CAGR of 28% driven by AMAT’s expectations of sustained spending in logic/ foundry, and a recovery of memory spending led by NAND, followed by DRAM. Longer-term prospects are supported by:
  1. sticky relationship with AMAT; and
  2. diversification into other markets.
• Initiate BUY with ROE-g/COE-g Target Price of SGD1.13, based on 2.2x FY20E P/B.

UMS - Corporate Information

An enduring relationship with Applied Materials

• UMS HOLDINGS (SGX:558) specialises in manufacturing high-precision front-end semiconductor modules and components. Its key customer, Applied Materials, accounts for around 90% of revenue. UMS’ manufacturing footprint is in Singapore, Malaysia (Penang) and the United States (Texas, California).
• UMS’ semiconductor segment (~90% of revenue) is divided into two main sub-segments, namely “semiconductor integrated systems” and “components sales”. In the integrated systems sub-segment, UMS assembles the wafer transfer modules for AMAT’s Endura platforms, of which it has a 70% wallet share. The Endura systems are used to deposit metal films, either via PVD (physical vapour deposition) or CVD (chemical vapour deposition) processes.
• According to AMAT’s website, a vast majority of microchips made in the past 20 years have been created using one of more than 4,500 Endura systems that have shipped across the globe to over 100 of AMAT’s customers. In components sales, UMS machines and produces components that are used across AMAT’s other platforms. The components sales also include consumables sales, to the tune of SGD20m annually. Components sales are more recurring in nature and slightly mitigate the cyclicality of inherent to UMS’ semiconductor business.
• UMS is vertically integrated and is qualified for over 50 special processes for the production of semiconductor equipment components to ensure strong product execution and short lead time. UMS was first awarded the Endura contract in 2009. The contract term is typically for a three-year term, and was recently renewed in 3Q19. Over a longer term, we see a low risk for non-renewal of the contract with AMAT, as we believe UMS is seen as a strategic outsource partner to AMAT.
• In the “Others” segment, UMS engages in the design and fabrication of electro-chlorination systems (through 51%-owned Kalf Engineering), and the supply of aluminium alloy products (through 70%-owned Starke Singapore).
• UMS has around 640,000 sf of combined space across Singapore and Penang, Malaysia. Volume production is currently carried out of its 500,000 sf site in Penang to improve cost competitiveness and due to labour availability.

Applied Materials (AMAT) profile

• Applied Materials (AMAT) is one of the world’s largest front-end semiconductor and display equipment companies. In the semiconductor fabrication space it participates in almost all key processes, with the notable exception of lithography. It is a dominant player in deposition and etch (removal) areas. AMAT prides itself as a leader in materials engineering solutions. AMAT’s etch and deposition tools have paved the way for inflections like 3D semiconductor architectures as well as multi patterning that enables leading-edge processes.
• Memory customers make up 48% of AMAT’s semiconductor revenue (NAND: 26%, DRAM: 22%), and are more cyclical than the remaining 52% of the semiconductor business, which comprises logic and foundry customers. AMAT’s customer base appears somewhat diversified. In FY18, its largest customers exceeding 10% revenue contribution were Samsung Electronics (13%, 005930KS), TSMC (11%) and Intel (11%, INTC US).

UMS - Investment Thesis

Recovery of semiconductor equipment spending

• Applied Materials (AMAT), which accounts for around 90% of UMS’ revenue, 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.
• 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. The Endura deposition systems are ubiquitous across semiconductor fabs globally, and AMAT claims that a vast majority of chips in the past 20 years have been made using the Endura system.
• Our base-case scenario assumes FY20E PATMI growth of 31%, on the back of a 15% rise in revenue, driven by operating leverage. Given the nature of UMS’ revenue exposure, it is a proxy to global semiconductor equipment spending. SEMI expects global semiconductor equipment sales to rise by 11.6% in 2020 to USD58b. For comparison, global semiconductor equipment sales are expected to fall 18.4% to USD52.7b after hitting a high of USD64.5b in 2018.
• While our base-case FY20E PATMI of SGD46m is 16% higher than consensus, we believe this is still an achievable figure based on current business conditions. That said, we see both up and downsides, given the dynamic macro-environment, and because AMAT is still uncertain regarding the timing and profile of memory investment recovery. However, AMAT stresses its confidence that memory capex recovery is a matter of “when” not “if”. AMAT’s peers like KLA Corp (KLAC US) and Lam Research (LRCX US) also echo expectations for NAND spending growth in 2020.
• In our bull scenario, we assume revenue growth of 20% in FY20E. This could be driven by:
  1. earlier-than-expected recovery of memory spending;
  2. stronger-than-expected logic/ foundry investments.
• This results in ROE-g/COE-g fair value of SGD1.31, contrasting our Target Price of SGD1.13.
• On the other hand, in our bear case scenario, we assume 10% revenue growth, and earnings growth of 15% in FY20E. This may materialise if prolonged uncertainty, possibly due to the US-China trade war, delays the recovery of memory spending, and/or results in softer-than-expected logic/ foundry investments. This scenario results in ROE-g/COE-g fair value of SGD0.96, which is what share price is currently pricing in.
• The share prices of AMAT and its peers have been rallying throughout 2019. The latest bout of strength in the past 1-2 months were due to:
  1. the favourable capex outlook from TSMC (2330 TT); and
  2. the reaffirmation of a 2020 recovery in latest earnings season.
• Over the next 3-6 months, firm capex guidance from chipmakers and positive dynamics in memory prices and inventory correction are among the signs that we will watch for to reinforce our investment thesis.

Positioning for the long run

• UMS has a sticky working relationship with AMAT, and is qualified for over 50 special processes to produce components for semiconductor equipment OEMs. In turn, AMAT is a market leader in the WFE market, boasting a 19% share in 2018, according to The Information Network, a semiconductor market research provider. AMAT’s etch and deposition technologies have helped leading semiconductor manufacturers introduce important scaling inflections like 3D architectures and multi patterning.
• AMAT believes that for the data economy to take off, new chips have to be:
  1. specialised to overcome limitation of general computing chips; and
  2. more power efficient.
• To achieve this, chipmakers must explore new computing architectures through the innovative use of materials and scaling approaches to overcome increasing challenges to achieve Moore’s law scaling. AMAT believes it is well positioned to aid its leading chipmaker customers, given its strengths in materials engineering and close working relationships with these customers that span decades.
• AMAT has also launched two new Endura systems catered for emerging memories such as MRAM, PCRAM and ReRAM, aimed at edge and cloud computing. While contributions from these new systems are small relative to AMAT’s revenue size, we believe this underscores AMAT’s stickiness and relevance in helping customers drive innovation.

Investments paying off

• UMS is actively diversifying its earnings reliance from the semiconductor industry. Of several investments UMS has made in recent years, we believe the 39% stake it acquired in JEP HOLDINGS (SGX:1J4) is most promising. We expect associates’ contributions from JEP to account for 8% of UMS’ PBT in FY19E.
• Like UMS, JEP is involved in precision machining, but its end-market exposure is skewed to aerospace (>50% of revenue). JEP is optimistic of its long-term prospects in the aerospace industry as aircraft makers and tier-1 suppliers increasingly outsource non-core work to speed up production and to meet demand. To capitalise on this trend, JEP intends to grow through both existing and new customers.
• Following Mr Andy Luong’s (UMS’ founder and CEO) appointment as executive chairman and CEO of JEP, the precision machining company has turned around to SGD2.2/3.3m of PATMI in FY18/1H19 respectively from years of being lossmaking/ breaking-even. This was realized through moving up the value chain, renegotiating contract pricing, and rationalising costs.
• While we believe UMS may require at least several more years to materially reduce earnings dependency from AMAT, we are positive on the steps taken by management thus far, especially through the active realisation of synergies with JEP.

UMS - Valuation

• We use ROE-g/COE-g to value UMS to account for the cyclical nature of its business. Our Target Price of SGD1.13 is based on 2.2x FY20E P/B, in turn based on average FY20-21E ROE of 18.9%, COE of 9.5% and LTG of 2%. Our Target Price implies FY20E P/E of 13.2x, which is marginally higher than 1SD above its 4-year forward P/E mean of 10.7x.
• We believe this is warranted, as UMS is in the early innings of an earnings up-cycle, and has traded at such levels or higher in previous similar episodes. Further, the implied FY20E P/E is at a 14% discount to globally-listed AMAT suppliers trading at 15.3x.

Source: Maybank Kim Eng Research - 4 Dec 2019