• 3Q18 revenue and PATMI fell short of our expectations. We are trimming our earnings forecast by 10% for FY18e.
• Margins were hurt by higher cost in capacity expansion and accounting changes.
• In line with our lower earnings forecast, our target price is lowered to S$2.30 (previously S$2.50). We are upgrading to BUY after the recent share price correction.

Results at a glance

The Positives

+ Front-end semiconductor tools (or USA) sales grew almost 30%. This segment will be the next phase of growth for Micro-Mechanics (MMH). In 3Q18, USA revenues were up almost 30% YoY and now represent the 2nd largest market by geography and the fastest growing. We were surprised that the turnaround in USA did not yield high gross margins for the group. We can only deduce the current back-end business is encountering stiffer selling price pressure.

The Negatives

– Upfront investment hurt near-term. Capital expenditure will double in FY18e to S$10mn and production headcount has increased 7% YoY to 329 in 3Q18. We believe these upfront cost to expand production capacity is hurting gross margins.

– Growth slower than anticipated. We had modeled in 20% revenue growth for FY18e, consistent with global semiconductor sales. MMH has trended around 18% but at a decelerating pace. We have lowered our revenue forecast to rise 17% in FY18e.

Outlook

We are still upbeat on the outlook for MMH. We were too aggressive on their ability to price up their services and margins. Unit volume growth in semiconductors remain the core revenue driver for MMH. Expectations are for semiconductor volumes to expand 7% CAGR for next five years. Growth drivers will shift from smartphone to new applications such as consumer products, smart speakers, NAND flash, lighting and auto.

Upgrade to BUY but with lower target px of S$2.30 (previously S$2.50)

We view MMH as a low beta proxy to the secular growth in semiconductors. Semiconductors are penetrating into more non-traditional applications from electric vehicles to IOT devices. MMH earnings are more recurrent and less volatile as the majority of their income is from the sale of semiconductor consumables. Financial metrics for MMH remain attractive with ROE of >30%, ~58% GP margins, net cash of $18mn and 4% dividend yield. Our target is 17x FY18e PE, in line with back-end semiconductor supply chain valuations.

The report is produced by Phillip Securities Research under the ‘SGX StockFacts Research Programme’ (administered by SGX) and has received monetary compensation for the production of the report from the entity mentioned in the report.