• Uchi Technologies is the leading producer of coffee odules in the world. These coffee modules are the control centres of coffee machines. The sales of these modules accounts for some 80% of the group’s revenue. Uchi makes control modules for almost all the major coffee makers like Jura (Swiss), Krups (German), AEG (German), Bosch (German), Siemens (German) and Nestle (Swiss). The remaining 20% is attributed to sales from biotech devices which include weighing machines control modules, centrifuge and pipette.

• Below expectations. Uchi’s annualised 1H07 earnings missed our forecast by 8% and were 12% short of consensus. 2Q net profit edged up just 2.1% yoy and 2.5% qoq because of revenue growth of only 4% yoy and 3.1% qoq. While we acknowledge that 3Q is the peak earnings period due to higher billings for coffee makers ahead of the 4Q festive season, we believe that full-year earnings will fall short of our estimate. As expected, the company did not declare any dividends.

• Currency effects? We believe the strengthening ringgit was behind the revenue shortfall as 100% of its sales are denominated in US$ and only 30% of its purchases are transacted in that currency. Similarly, our contention is that the currency effect took a toll on EBITDA margins which shrank from 53.5% in 2Q06 to 48.8% in 2Q07. Note that the ringgit appreciated by 2.1% qoq and 6% yoy in 2Q07.

• Still a defensive play. Despite the disappointing 2Q07 results, Uchi still offers investors a safe haven, especially in the current environment of global market volatility and worries over subprime lending. With one of the highest dividend yields (10.3-12.7% for FY07-09) in our universe and the market, Uchi’s defensiveness is a key selling point. This, together with its solid business model and cash-generative abilities, makes for a potent brew. The stock has corrected 6.8% since our last report, giving investors an opportunity to snap up the shares.

• Reiterate OUTPERFORM call but with lower target and forecasts. We cut FY07-09 earnings by 4.5-8.6% as we factor in stronger ringgit and lower pretax margin assumptions which are partially offset by higher ASP for its new products and a natural hedge as 30% of costs are denominated in US$. This results in a lower target price of RM4.00 (RM4.30 previously). We continue to tag a 15x forward multiple, a discount of 17% to our market target P/E of 18x but a premium of 11% over Uchi’s average 2-year historical rolling P/E. The multiple is justified by: 1) its reasonable EPS growth of 7-12% in FY07-09, and 2) relatively strong FCF yields of 6-9%. Factors that could trigger a re-rating of the stock include: 1) rising demand for high-end coffee machines in Europe and the US, 2) revenue contributions from new products in the pipeline, and 3) expansion of its China operations which will help to lower costs and provide ample engineering talent.

Core business still enjoying a good time.

Uchi is confident of achieving 10% revenue growth in 2007 despite a weaker 2Q results underpinned by improved capacity utilization and stronger year end demand for consumer electronics. Uchi should post yet another set of good results on the back of better product mix by focusing more on fully-automated modules which offers higher margin and the rising ASP trend for coffee control modules.

Expansion in China.

As discussed with the management, the facility in Dongguan would only be completed by early of 2008, a slight delay from the original completion plan by year end. Uchi expects to only commence operations during the 1st quarter of 2008. With the plant, Uchi could benefit from the lower labour cost and capable of enlarging its capacity by 100%. We do not foresee any problem for Uchi in scaling up its production right now as any additional orders would be outsourced to its contractors. Management expects to spend around RM28m for capex this year mainly on the China plant and the refurbishment of its local machineries.

Earnings boost from new products and customer acquisition.

The new growth areas would come from the group’s water hardness detector devices, which will be incorporated into all its fully automated modules if there is a big demand for it. One of its major customer, Jura, has already placed a 10k units order for that product. On top of that, Uchi has forayed into the bathroom fitting segment as it is at an advance stage to secure contracts to provide LED lighting control modules for a customer which is a market leader in the world bathroom fitting business. Given the realised deal, Management anticipate to take in approximately US$2-3m sales.

Uchi is a buy at target price of RM3.58

We highlight that the weakening of USD against Ringgit would have an impact of Uchi’s earnings as 100% of its sales are denominated in USD. However we believe this effect will be partially offset by the higher ASP for its products as well as a natural hedge from its 30% USD denominated costs.

Nonetheless we like Uchi for i) strong earnings growth ii) its position as market leader and iii) its attractive ROE and dividend yield. Hence we call a BUY on the stock with target price of RM3.58 based on 1-year forward PER of 14x FY08 EPS, which is a premium to its technology peers like Unisem, MPI and Globetronics. We believe the premium is justified due to i) better earnings visibility ii) Uchi position as a major player in a niche market.

• The management of a company is always for closer to its assets than its shareholders. And without even breaking any laws, there are number of ways that the management can benefit themselves and their families at the expense of the minority shareholders, for example employing their relatives, buy-and-selling of properties between relatives at above market rates or the issuing common stock options.

Last edited on Sun Oct 21st, 2007 12:35 by sinch