• 4Q19 revenue and PATMI were below our expectations. Gross margins suffered from weaker volumes and the higher fixed operating cost than a year ago.
• Final dividends were maintained at 6 cents in 4Q19. FY19 DPU is S$0.10. Free-cash flow is at a record high despite the decline in earnings.
• We marginally lowered our target price to S$1.60 (previously S$1.63). Our FY20e earnings have been reduced by 5%. We peg our valuations to 15x FY20e PE, in-line with back-end semiconductor supply chain valuations. The downturn in back-end semiconductor volumes is at the late stage. Based on the past cycles, a rebound should be materialising from the December quarter onwards. Investors are paid a 6% yield as they wait for the recovery. Our NEUTRAL recommendation is unchanged.

The Positives

+ Dividend per share was maintained. MMH maintained the final dividend per share of 6 cents (final 5 cents, special 1 cent). Full-year dividend per share was 10 cents and a 107% payout ratio.

+ Record free-cash flows. Despite the weaker earnings, free cash flow in FY19 was a record high of S$15.8mn. Capex in FY19 was $3mn, a major reversal from last year’s S$12.1mn.

The Negatives

– Gross margin was sluggish. GP margins for MMH are still attractive at above 50% and representative of the value add vis-à-vis material costs. Excluding the prior quarter, 4Q19 GP margins stood at 52.3%, the lowest in five years.  Weakness is due to lower utilisation of 58% (4Q18: 60%). MMH is still experiencing a higher fixed cost structure after FY18 spike in capex of S$12mn.

– The revenue decline is accelerating. 4Q19 revenue missed our estimates by 9%. Of concern is that the contraction on YoY basis is accelerating, albeit modestly.  

Outlook

There is a high correlation between the growth of MMH sales and Taiwan IC packaging volumes (Figure 1). MMH revenue is more dependent on volumes than semiconductor prices.

Semiconductor backend volumes are highly cyclical. When we used historical data of Taiwan IC packaging volumes (Figure 2), the longest period of contraction has been 13 months since the 1980s. The average was 10 months (Figure 3). The current downturn is already on its 11^th consecutive month.  We are in the late stages of the decline. The worry is that the trade war between US-China will exacerbate the downturn longer.

The company highlighted that its competitive position has not been affected by the downturn. On the contrary, it is becoming harder for competitors to meet the exacting standards required by customers. Some of the barriers include cleanliness on the production facilities to avoid contamination, parts become smaller and flatter in geometry and more advanced material science to reduce electrostatic discharge. Higher capex is also required for more automated and complex machines such as machines that measure the precision of the parts from one micron in the past to now 0.30 to 0.70-micron accuracy.

Recommendation

We marginally lowered our target price to S$1.60 (previously S$1.63). Our FY20e earnings have been reduced by 5%. We peg our valuations to 15x FY20e PE, in-line with back-end semiconductor supply chain valuations. The downturn in back-end semiconductor volumes is at the late stage. Based on the past cycles, a rebound should be materialising from the December quarter onwards. Investors are paid a 6% yield as they wait for the recovery. Our NEUTRAL recommendation is unchanged. MMH still enjoys some of the best operating and balance sheet metrics in the industry such as >50% gross margins, a dividend yield of 6.3%, ROE of 22% and net cash of S$21.9mn