Uchi Technologies Berhad: A high dividend yield investing strategy

“The secret to successful investing is to figure out the value of something and then-pay a lot less”

Joel Greenblatt

Uchi paid a dividend of 10 sen last year, its lowest since more than 10 years ago, with the exception of year 2009 when the whole world was affected by the US sublime crisis. Even that year, a 6 sen dividend was paid out. At the price of RM1.33, the dividend yield is 7.3%, easily doubled what you get from fixed deposit. Uchitech seems to fit in to the high dividend investment strategy. The pertinent question is “Will this high dividend payment continue?”

Share price movement

Uchi’s share price was about RM1.20 fourteen years ago. It rose sharply up to about RM3.30 in mid 2007 before the US sublime crisis took its toll. Its share price retreated to about RM1.00 after the crisis. Since then it has been traded between the narrow ranges of RM1.00 to RM1.50 and closed at RM1.33 on 17^th October 2014.

The figure below shows the total return of Uchi compared to that of KLCI for the last 5 year.

In the last 5 years, Uchi returned only about 10%, way under-preformed the total return of 50% of the KLCI. For a long term horizon, the strategy in investing in a high dividend stock like Uchi doesn’t seem to provide excess return as envisaged (so do many high dividend paying stocks). But why do I still think it is good to invest in Uchi since its share price has dropped so substantially from its peak of RM3.30 seven years ago to RM1.33?

That is precisely my investment thesis; a great company with a beaten down price, and probable poise for a turnaround story.

Business background

Uchitech via its fully owned subsidiary company, Uchi Electronic (M) Sdn Bhd, involves in original design manufacturing and assembly of electrical components onto printed circuit boards (PCB) and trading of complete electronic module, such as that of coffee machine, and saturated paper for PCB lamination.

Another fully owned subsidiary company, Uchi Optoelectronic (M) Sdn. Bhd is involved in design, research, development and manufacturing of touch screen advance display, high precision light measurement (optoelectronic) equipments, mixed signal control system for centrifuge/laboratory equipments, mixed signal microprocessor based application and system integration products.

The Electronic Control Modules segment, particularly the Art-of-Living products (i.e. high-end consumer electrical appliances), was the highest contributor to the Group’s income at approximately 75%. Meanwhile, Biotechnology products (i.e. laboratory and industrial equipment) which contribution has been negligible in the past, have started increasing its contribution to 24% in the last financial year and set to increase further to 50% in the future. 93% of the total revenue is derived from exports to Europe.

Uchi’s past financial performance

Table 1 below shows the performance of Uchi for the last 9 years.

Table 1: Revenue and profit of Uchitech

Uchi’s revenue and net income dropped drastically from its peaks of 156.9m and 78.2m in 2007 to 83.1m and 27m in 2009 respectively due to the US sublime financial crisis. It attempted and succeeded to recover somewhat in 2010 but the recovery was stunted due to the slow recovery of the European economy. However, Uchi’s business remains highly profitable with positive earnings and good cash flow every year, including during the financial crisis. This shows the durability of its business model.

However I must say many do not  like this type of performance, especially those who don't see the so called profit growth in the last few years. It is understandable. We are talking about potential in the future though,

The secret weapon

Uchi has been paying more than 90% of its earnings as dividend each year. Its balance sheet remains healthy with more than 100m cash in bank and zero debt all these years. Cash has depleted a little the last 3 years, but it is mainly because it spent a lot of money in capital expenses improving its edge of its core business within its circle of competence, 54m in all the last three years. Where did the money come from?

Yes, the secrets lie in its margins. Uchi’s gross margin has been consistently in the high 60% every year for at least the last 10 years. That itself demonstrate the high quality o fits business.

“In business, I look for economic castles protected by unbreachable ‘moats’.”Warren Buffet (?)

Company which earns a gross margin of above 40% consistently must have an economic moat. Uchi’s net profit margin has also been consistently way above 40%.

The high margin provide it with another secret, the high return on capital. Is it a secret, I thought I have been talking about the importance of high return on capital when we want to invest in a company? Its return on equity (ROE) was 45% in 2007 and dropped to its lowest of 21% last year, not because of the competition driving down its margin, but lower revenue due to the economic crisis in its main market in Europe. Nevertheless, the 21% ROE without any debt is still way above its cost of equity. If the European economy recovers, Uchi would be able to recover to its former glory. Yes, Uchi just need to have more business. So what is the chance that Uchi will recover and is able to continue to pay high dividend?

How does the market value Uchi?

At the close of RM1.33, and a trailing twelve month EPS of 11.5 sen as at 30^th June 2014, Uchi is trading at a PE ratio of 11.5, and an enterprise value of 10 times its earnings before interest and tax. These valuations are undemanding considering its highly efficient operations business, stable earnings and cash flows, a healthy balance sheet and high dividend yield.

What the future entails for Uchi?

“Mario Draghi, president of the European Central Bank, has finally announced that the bank plans to engage in a form of quantitative easing” Forbes Magazine

http://www.forbes.com/sites/jonhartley/2014/09/08/draghis-case-for-ecb-quantitative-easing/

Is Uchi ready for a probability of the recovery of the European economy? Below is an abstract from its 2013 annual report.

“In 2013, we continued our practice of investing substantially in R&D, further cementing our technological leadership position in the marketplace. Our successful bid for pioneer status will see our product mix expand to include touch screen advanced displays, high precision light measurement (optoelectronic) equipment and mix signal control systems for centrifuge/laboratory equipment. According to the incentive scheme, 100% of the statutory income derived from the design & development and manufacture of these products will be exempted from income tax for a period of five years commencing from the day of production.

However, arguably the most significant development, particularly in terms of environmental impact, comes from the Group’s contribution in the design and manufacture of energy-saving modules for household and office equipment which comply with European eco-design requirements… in accordance with a new directive that will take effect from January 1, 2015.

The Group continued to invest heavily in our R&D endeavours in 2013; it therefore gives us great pleasure to announce that we have expanded our R&D product lines that are scheduled to be launched in 2014/2015. In embracing green technology, aside from the new energy-saving compliant projects that will be launched under the Art- of-Living product line, we are also developing inverter technology and its extended application to further improve the energy efficiency and wake-up time of products.

Among others, our formidable R&D team is well equipped with the technology and know-how to offer practical and innovative solutions in the shortest timeframe.”

A technology company consistently spending money for research and development from its internally generated fund and yielding positive results is what is needed to be successful. If Phillip Fisher is still alive, Uchi would have got him drooling.

Second quarter report ended 30^th June 2014

Uchi reported its second quarterly report for the financial year 2014 on 19th August 2014. Its revenue still remains subdue but net profit for the two quarters has improved by about 20% to RM20.6m. One interesting thing is its capital expenses has reduced to just 204,000. So with the low capital expenses required for it near future, it would have abundant free cash flow which will continue to sustain its high dividend payout policy.

Uchi also reported a very important development that the application for the pioneer status for their new products namely touch Screen Advance Display, High Precision Light Measurement Equipment and Mix Signal Control System for Centrifuge/laboratory Equipment has been approved by MIDA. The tax saving will enhance the profitability and free cash flow of the company, and hence its divided.

Is Uchi going to reap its fruits in the near future? The future is unknowable and unpredictable. I can only base on the information I can gather and provide a novice opinion.

Conclusion

Uchi has demonstrated that it is a great company with high quality and durable business with an economic moat with its consistent high margins and high return on capital. There also seems to be a good future growth story to tell with its attaining the investment pioneer status from MIDA, and its success in Research and Development meeting stringent client and regulatory requirements, placing it ahead of its competitors. Thanks to the good capital allocation of the management. The most recent quarterly report appears to prove the plausibility of the turnaround story. Most of all, it is selling at a beaten down price and hence good value. In my opinion, investors looking for high dividend stocks may add some Uchi stocks into their portfolio.

KC Chong (19^th October 2014)