Business Model of Micro-Mechanics
Micro-Mechanics (Holdings) Ltd designs, manufactures and markets high precision tools, parts and assemblies for the semiconductor, medical and aerospace industries and is listed on the Singapore Stock Exchange. Broadly, its business can be segmented into Semiconductor Tooling and Custom Machining and Assembly (CMA). Since Semiconductor Tooling accounts for over 85% of Group revenue, it is important that we understand this value chain.
A typical chip fabrication process can be summarized in the following sequence:
Micro-Mechanics operates in the Assembly and Testing space by designing and manufacturing precision tools, parts and consumable products. It derives a steady recurring income from supplying consumable products such as wire-bonding and die-attach as these require regular replacement and hence are less susceptible to cyclical swings in the capital expenditures of its customers.
It has a huge and diverse pool of customers who are typically the Integrated Device Manufacturers (IDM) and Outsourced Semiconductor Assembly and Testing (OSAT).
Let’s see how Micro-Mechanics fare in Heartland Boy’s Fundamental Analysis Criteria.
Investment Merits of Micro-Mechanics
Solid Track Record of Increasing Revenue, Profit and Cashflow
Micro Mechanics has been consistently growing its revenue, profits and net operating cashflow since 2012. It has also demonstrated a capability to fund its capital expenditure, whether for maintenance or investments, entirely from its cash flow.
Table 1: Increasing Revenue, Net Profit, Net Operating Cashflow of Micro-Mechanics
Superior Gross and Net Margins
Micro-Mechanics has consistently increased its gross and net profit margins for the past 4 fiscal years. Much of this can be attributed to machining initiatives to improve productivity and quality.
High and Growing Return on Equity
Micro-Mechanics has consistently exceeded 12% ROE for the past 3 years.
Table 2: Increasing Gross Margin, Net Profit Margin and Return on Equity of Micro-Mechanics
In an increasing interest rate environment, Micro-Mechanics is in an enviable position of having zero debt. As at 28 Oct 2015, it also has a cash pile that translates to $0.13 cents per share or roughly 16% of the current share price.
High Dividend Yield
At a stock price of $0.84, it sports a dividend yield of 5.9%. Recently, it also institutionalized a formal dividend payout ratio of 40% from its consolidated net profit. If the Management of Micro-Mechanics choose to pay only the minimum as per its dividend policy, this would still translate into a decent 4.4% dividend yield.
Frederic Louis Borch bought 14,300 shares at approximately $0.85 per share on 14 Dec 2015. On 1 Dec 2014, Borch also bought 20,000 shares at $0.60 per share.
Good Corporate Governance and High Transparency
Micro-Mechanics won sixth consecutive “Best Investor Relations Award” and also bagged 2 “Best Managed Board” awards at the Singapore Corporate Awards. In the wake of the Noble and Singpost’s corporate governance saga in 2015, which saw their shares prices tumbled to 52-week lows, this aspect is extremely reassuring to shareholders.
Sustainable Competitive Advantage
Micro-Mechanics’s proprietary designs and manufacturing know-how create significant barriers to entry for new entrants. In addition, Micro-Mechanics established the MMUniversity to continually educate its staff at all levels. This puts the company in good stead to meet industrial trends where its customers are increasingly demanding for higher precision, smaller feature sizes and shorter delivery lead time.
Good Growth Story
Supplying consumable products used in the chip assembly and testing process of the semiconductor industry, Micro-Mechanics is dependent on the demand for consumer electronics. With a growing consumer class in China and Taiwan, semiconductor sales in these countries are projected to grow due to strong demand for tablets and smartphones. For Micro-Mechanics, sales to China have increased 38% in FY2015.
Investment Risks of Micro-Mechanics
- Semiconductor is a cyclical industry that is tethered to the world’s economic growth. Heartland Boy advises readers to read the reports from Semiconductor Industry Association (SIA) regularly to stay updated on the health of the industry. There are signs that the semiconductor industry could be slowing down in its growth after 2 years of record growth.
- Custom Machining & Assembly (CMA), the other business segment of Micro-Mechanics, has yet to turn a profit. It recorded a net loss of S$1.05 million in FY 2015 and also impaired a loan made to this business division. The management understands that this is a serious area of concern and reassures shareholders that the situation should improve with the last initiative of the 24/7 machining line to be implemented in December 2015.
- Due to zero coverage from stock brokerages, Micro-Mechanics generates little stock market news. Therefore, its shares are very illiquid. Getting access and disposing its shares can severely test your patience!
Conclusion for Micro-Mechanics
Heartland Boy has a personal price target of $1.05 for Micro-Mechanics. In the current tepid Singapore stock exchange climate, this is a good stock to buy now as both a growth and a dividend stock.
Vested at 69 cents since April 2015
This article was written on 26 December 2015.
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