Friday, August 18, 2006

Small is Beautiful

As the title of this post suggests, the counter being introduced is a small capitalisation company. In fact, its market capitalisation is about S$65 million. Interestingly, its name connotes a link to the sub-micron kingdom too.

Micro-Mechanics (MMH SP) designs and manufactures a wide range of precision tools, parts and consumable products which are used by semiconductor firms to assemble and test chips.

MMH's primary focus is on the die attach and wire bonding processes. It is currently extending its capabilities to include custom machining and assembly, and consumable products for the encapsulation process. In order to serve its wide international customer base (over 300), MMH has five manufacturing facilities located in Asia, namely, Singapore, Malaysia, China, Thailand and the Philippines.

Being a site associated with the value style of investing, it may come as a surprise to introduce a firm related to the cyclical semiconductor industry. Whilst statistics from the international industry association, Semiconductor Equipment and Materials International point to the industry holding up well, skeptics about MMH should examine its financials to see how resilient its earnings has been despite being in the volatile industry. Since listing in 2003, it has consistently maintained a gross profit margin in excess of 60%! In the same vein, its net profit margin is a healthy 20%. Eyeballing its balance sheet also reveals that it has no long term debt. In addition, MMH has been able to manage its capital expenditure with internally generated cash flow. In fact, its cash flows have remained healthy despite one major capital expenditure exercise in FY2005 to build a new plant in China and improve the Singapore and Malaysian factories. Its management has also been willing to fork out any excess cash to reward shareholders.

We also rank MMH’s management highly. Founder and President Chris Borsh has over 20 years in the industry and he communicates candidly to his shareholders. He also demonstrates alignment of his personal interest by continuing to hold over 30% of MMH's shares after listing.

Investors who stare at charts are likely to be deceived by its relatively flat price movement. In order to appreciate the full extent of its historical price, one needs to factor in its several capital structure changes. For example, it issued an extra one share for every four held last year. The willingness for a company to issue new shares (a move which will dilute per share measures such as EPS unless the earnings increase at a faster rate than the increase in number of shares) speaks volumes of the confidence that its management has in its prospects.

Going forward, MMH is seeking to diversify into the precision manufacturing business. Since starting its Custom Machining and Assembly division in 2005, it has received orders from customers from the medical, instrumentation and high tech equipment fields.

Indeed, MMH’s prospects are looking rosy in the near term too. We expect MMH to report record FY2006 earnings soon and register at least 25% YOY earnings growth. The current historical P/E is approximately 11x. Should our earnings forecast materialize and its P/E holds up, MMH's fair value is north of S$0.58.

MMH closed at S$0.48 today.



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