What 3 Investors Like About Amazon, Tencent, and Singapore-Listed Micro-Mechanics
At the end of April, I had the chance to be featured, together with my investing buddies Stanley Lim and Chong Ser Jing, at Stanley’s Value Invest Asia webinar.
Both Stanley and Ser Jing were my colleagues when I was with The Motley Fool Singapore, before joining Seedly. Now, Ser Jing runs his own investment blog at The Good Investors, together with another ex-colleague of mine from Fool Singapore, Jeremy Chia.
During the webinar, Stanley, Ser Jing, and I discussed our favourite stock ideas, on top of answering questions from viewers.
You can view the video below (video lags for the first 10 minutes though):
The stocks we covered were:
- Amazon.com (NASDAQ: AMZN): 7:23 minute mark (by Ser Jing)
- Tencent Holdings (SEHK: 700): 33:00 minute mark (by Stanley)
- Micro-Mechanics (Holdings) (SGX: 5DD): 53:41 minute mark (by me)
We touched on the following points (thanks to Ser Jing for compiling the list):
- Amazon’s future growth drivers
- Amazon’s valuation
- Different valuation tool kits investors can use
- Tencent’s biggest risk, and the risk of its VIE (variable interest entity) structure
- Is Tencent still hampered by the Chinese government’s refusal to approve online games?
- Tencent’s growth rate
- Risk of fraud for China-based companies, such as what happened to Luckin Coffee (NASDAQ: LK)
- How to handle fraud cases when investing in stocks
- Tencent’s market share
- COVID-19’s impact on Micro-Mechanics’ business
- The risk of Micro-Mechanics cutting its dividend
- Micro-Mechanics’ economic moat
- The cyclicality of Micro-Mechanics’ business and of the semiconductor industry
- Finding the courage to start investing
- Are we too early to bottom fish?
- Should we be concerned about the small differences in our purchase prices for stocks?
Right here, I’ll be covering the company I talked about during the webinar, Micro-Mechanics. For the rest of the companies and the question-and-answer segment, do jump in from the video links above.
What’s Micro-Mechanics’ Business About?
Micro-Mechanics is a company that was established 37 years ago in Singapore to mainly serve the semiconductor industry.
Micro-Mechanics produces precision consumable tools and parts (read: recurring revenue) used by numerous machines installed around the world that assemble and test semiconductors.
The company serves over 600 customers from its five manufacturing facilities located in Singapore, Malaysia, China, the Philippines and the US. Micro-Mechanics’ customers include nearly all of the American, European, Japanese and Asian semiconductor makers.
Micro-Mechanics’ Revenue Breakdown
Micro-Mechanics has a financial year that ends on 30 June each year.
The majority of Micro-Mechanics’ FY2019 revenue came from China (29% of the year’s sales), followed by the US (21%), and Malaysia (19%).
The company’s factory in China, located in Suzhou, largely serves the domestic market and not the export market. Therefore, Micro-Mechanics’ China sales remained relatively steady for FY2019 despite the US-China trade tensions.
What’s To Like About Micro-Mechanics?
There are five main traits I like about Micro-Mechanics.
Firstly, the company’s revenue and net profit have grown over the years.
From FY2015 to FY2018, revenue grew from S$52.2 million to S$65.1 million. Meanwhile, net profit rose from S$12.0 million to S$17.1 million.
In FY2019, however, revenue declined by 7.3% to S$60.3 million, due to a slowdown in the global semiconductor industry. With that, earnings fell 24.5% to S$12.9 million.
Micro-Mechanics’ business looks to be turning around since the first quarter of FY2020.
For its FY2020 first-quarter, revenue of S$15.3 million and net profit of S$3.3 million marked the first quarter-on-quarter increases since the first quarter of FY2019.
Secondly, Micro-Mechanics has strong durable competitive advantages, in my opinion.
Micro-Mechanics produces consumables that are required to be replaced frequently by its customers, creating recurring revenue for the company. This key feature makes Micro-Mechanics less susceptible to the semiconductor industry cycle than an equipment supplier, for example. Usually, equipment suppliers mainly see one-off business transactions, until the equipment needs to be replaced many years down the road.
Micro-Mechanics also doesn’t have any single direct rival which competes on its full range of products and technical services in its current geographical markets. The breadth of services offered by Micro-Mechanics makes it a one-stop shop for its clients.
On top of the qualitative aspects, there are also quantitative aspects that give clues about its competitive advantage.
For FY2019, it maintained a high gross profit margin of 54%; any figure above 40% is excellent.
Return on equity (ROE) was at 22% in FY2019. Any ROE figure above 15% is high in my books. ROE is a measure of how efficiently management allocates capital.
Thirdly, Micro-Mechanics has a strong balance sheet with loads of cash and no debt (more on that later). A robust balance sheet is essential to ride through tough economic conditions, such as right now.
Fourthly, the company has great long-term prospects in the semiconductor industry. There will be a continued demand from technologies and devices that require chips, such as mobile phones, artificial intelligence (AI), and fifth-generation (5G) cellular communication.
Micro-Mechanics can also ride on the short-term demand surge due to businesses putting in business continuity plans (BCP) and employees working from home (WFH) on the back of the Covid-19 pandemic.
Lastly, I like that Micro-Mechanics’ founder and chief executive, Christopher Reid Borch, has plenty of skin in the game. As of 30 August 2019, he owned around 52% of Micro-Mechanics, either directly or indirectly.
Summary of Micro-Mechanics’ FY2020 Q3 Earnings
Micro-Mechanics released its financial results for its third quarter of FY2020 on 24 April 2020.
For the latest quarter, net profit improved 48% to S$3.9 million on the back of higher revenue of 12.9% to S$16.2 million.
Micro-Mechanics’ top-line growth was due to a broad-based sales increase across almost all its geographical markets. Sales in China increased by 14% despite the temporary closure of its Suzhou factory between 3 February to 12 February in compliance with the Chinese government’s directives to limit the spread of the coronavirus.
The company’s balance sheet remained rock-solid, with S$16.1 million in cash with no debt. On this front, Micro-Mechanics commented:
“Building a great manufacturing business without debt helps to foster a culture of resourcefulness, discipline and careful decision making. In addition, we would like to attract shareholders who share our approach to long-term investing.”
I agree with that approach and it has endeared me to the company more.
Free cash flow, however, dipped 15% to S$3.8 million, but this is nothing alarming to me as the company has a history of growing free cash flow. I’ll be monitoring the free cash flow situation going forward to see if it bounces back.
Micro-Mechanics updated that it didn’t witness “any significant impact on our business from the COVID-19 situation”, except in Malaysia due to the movement control order (MCO), which resulted in a reduced level of operations for many of its Malaysian customers.
A Look at Micro-Mechanics’ Valuation
Micro-Mechanics has a share price of S$1.74 at the time of writing. At that price, its trailing twelve months (TTM) price-to-earnings (P/E) ratio is at around 18, with a five-year average of 13.
Meanwhile, Micro-Mechanics’ dividend yield is currently at 5.7% (without FY2019 special dividend) and 6.3% (including FY2019 special dividend), which might attract income investors.
Micro-Mechanics may look expensive compared to its history. However, with its quality business, favourable long-term prospects, and a management team that’s forward-looking, I feel the company deserves a premium valuation.
I’ll end off with a telling quote from Borch (emphases from him) mentioned in Micro-Mechanics’ third-quarter FY2020 earnings release:
“When the pandemic is over, our goal is not to hope for life and business to just go back to normal. Instead, we want to absorb what we have learned, implement more fully some of the changes we made to adapt to changing circumstances, and better anticipate the challenges that lie ahead. In short, we see an incredible opportunity to go back to better.”
Want to discuss further?
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock. The writer may have a vested interest in the companies mentioned.