Sunday, April 2, 2017

Why buy Micro Mechanics?



Started in 1983, Micromechanics design and manufactures high precision parts and tools used in testing and assembly of semiconductors, mainly focused in die attach, wire bonding and encapsulation. 

The business can be broken down to 2 main segments: Semiconductor Tooling and Custom Machining and Assembly (CMA). As the former accounts for 85% group revenue (average Yr 2012- Yr 2016), it’s overall earnings can be quite dependant on the outlook of the semiconductor industry. 

Semiconductor Tooling

It forms the bulk of the revenue which does designing and manufacturing equipment used for semiconductor device fabrication, mainly focused in die attach, wire bonding and encapsulation.

1. Die Attach is the process of attaching the silicon die of a semiconductor device to substrate and it requires various precision tools to carry out. This video illustrates it well: https://www.youtube.com/watch?v=1U0-Km305zM

Hence Micro-Mechanics manufactures die attach tools used to mount a die to a substrate. For instance, they design different sizes of rubber tips (pick up tool) which is used for the die attach process to handle the die.  Products include rubber tips, high temperature plastic tools, dispense Nozzle and Epoxy Stamping Tools.

2. Wire Bonding is the method of making interconnections between the die and the substrate. The tools manufactured are wire clamps and anvils.

3. Encapsulation is also known as integrated circuit packaging. It’s the final Stages of semiconductor wafer fabrication, where the semiconductor material is covered with a case to protect against mechanical effects and corrosion. Hence, the tools manufactured such as dispensing nozzle is used to for flip chip underfill and package encapsulation applications.

 Currently, their main bulk of earnings comes from 6 countries: China, Malaysia, USA, Taiwan, Philippines and Singapore.


CMA

It stands for Custom Manufacturing & Assembly which manufactured precision tools and equipment on a contract basis tier one companies in aerospace, medical, instrumentation, and water fabrication industries.

It operates under Micro-Mechanics Inc (MMUS) and in 2008, it bought over assets of AMP3 i.e equipment, inventory and intellectual property from AMP III LLC for USD1.85mil (SGD2.52mil) so they could manufacture precision components for wider range of industries such as medical, aircraft, bioscience and semiconductor.

This division started in Malaysia, Penang with the intention to grow a business that goes beyond semiconductor. It has been undergoing a stable growth through organically-driven initiatives which contributes total of 10% of total revenue. Hence the purpose of this acquisition is to accelerate the growth of this division through access to new skills.  

As of Yr 2015, it has yet to make a profit and reported a loss of $1.05mil and $1.7mil in 2016. Their main sales market is to the USA and hence the recent strengthening of US dollar against SGD will have a positive impact on revenue and earnings. 

These years, there have been efforts to build a separate plant to construct a separate CMA division for manufacturing parts for equipment makers in semiconductor, aerospace, laser and other high technology.  Moving forward, they will cease diversification attempt and focus on semiconductor/water fabrication industry after considering the investment and engineering requirements.




As 85% of it’s revenue is generated from semiconductor, it’s important to look at the Semiconductor forecasts to have a better idea of its outlook. The below chart is extracted from http://www.wsts.org/
and it seems to suggest an uptrend since it’s downfall in mid-2016. As it has no debt and generates FCF I am happy if they can just maintain the earnings. 



Simple Business

One of the Berkshire Hathaway acquisition criteria is a business that is simple and easy to understand. For instance, Warren Buffett’s $28b acquisition of Heinz in 2012 tells a lot about his investing habits: plain and simple like ketchup. 

Likewise, I personally find Micro Mechanics’ business easy to understand and they do not have much subsidiaries and they are very focused on what they are good at.

As I m buying this purely for dividends, and growing dividends, I will be focusing more on the cashflow.

Let’s dive into the numbers...



Year
2012
2013
2014
2015
2016
FCF/share
$0.02
$0.04
$0.04
$0.07
$0.09
Dividends paid/share
$0.03
$0.03
$0.03
$0.05
$0.06
  


I have extracted the numbers from the annual report 2011 to 2015 and it shows that they have been consistently generating free cashflow which is more than adequate to pay dividends. Even in times when there’s a softer demand for semiconductor 2015 and 2016, they even managed to grow their free cashflow.

Like SATS, they have been dealing with cost pressures effectively over the past 3 years despite rising slowing growth and rising manpower costs, resulting higher FCF.
 

Good ROE with no debt

More than just a net cash company, they have no debt. So there are not much affected by the rising interest rate environment.

They also consistently exceed ROE of 10% for the past 5 years and growing. There was a decline in last year’s net profit partly due to currency losses in depreciation of Ringgit and Renminbi, as both markets accounted for 50% of the sales. However, the ROE calculation was based on profit for the year/Total Equity instead of the Comprehensive income. So the decline in ROE is much attributed to the softer demand in semiconductor industry. As I am buying this for dividends, I won't set expectations on their growth.



High Dividend Yield

A dividend policy was established in 2015, which is to distribute 40% of the audited net profit. Assuming earnings stays the same for 2017, expected dividends would be $11,883,409*0.4/$139,331,081= $0.034/share

Dividend yield= $0.034/$1.035= 3.3%

However, based on past years they have been generously paying 57.8% and 70.2%, of the net profit, and with FCF of $0.09/share in 2016, I am hoping for a 5% yield at price of $1.035.



Points to Note

Currency Risks- As 94% of the revenue is derived from overseas, it faces foreign exchange risk if SGD continue to strengthen. If the ringgit continues to weaken against SGD, it will continue to impact the earnings as Malaysia market accounts for 21% of sales. On the positive side, the strengthening of USD could soften the impact of foreign exchange loss. 

Cyclical- If there is only one take away for semiconductor investors, it is that semiconductor industry is highly cyclical. The sales is dependent on end-product demands such as laptops, mobile phones. On a positive note, it is comforting to note that in bad times market will turn at some point for the better as it’s not a sunset industry.

Vested with 5000 shares at $1.035 as of writing.

p/s I read from some analyst reports that they have a wide clientele base with major chip manufacturers/assembly and test companies such as Texas and Intel. It would be a plus point for Micro Mechanics but I couldn't find this information in the website or annual reports.