Incorporated in February 1998, UCHI is principally involved in Original Design Manufacturing (“ODM”), specializing in the design and development of electronic control modules, which are eventually manufactured and assembled into semi-finished parts and control modules for its customers.

In this article, we take a closer look at UCHI’s business and its impressive track record of profitability over the past decades.

UCHI operates on two sites, with its main operating plant based in Malaysia and its assembly arm based in Guangdong, China. Details as follows:

As compared to 2018, UCHI has downsized its operation (head count was 109 in 2018) in China, as part of its plans to reduce the risk of supply chain disruption caused by a prolonged trade war.

UCHI products can be broadly segmented into 3 categories:

• Art-of-living – High-end household and professional appliances.
  UCHI designs and develops electronic control systems to serve clients producing fully automated coffee machines. Their clients include Jura (Swiss), Nestle (Swiss), Krups (German), and Bosch (German). About 75% of control modules that UCHI produces are exported to Jura. UCHI is the sole supplier of control modules to Jura.

• Biotech – Biotechnology product applications.
  UCHI develops and manufactures products for laboratory and industrial instrument applications such as precision weighing scales, deep freezers, centrifuges, and pipettes. Their clients include Sartorius Group, based in Germany (FY2019 Revenue was €1,827m), and Eppendorf, a leading life science German company.

• ODM and Original Equipment Manufacturing (“OEM”)
  UCHI involves in-house design and development of electronic control systems, manufacturing, and delivery of systems. This segment makes minimal contribution to the Group.

As of FY2019, the art-of-living category is UCHI’s main revenue contributor, 81%; followed by biotechnology at 18%, and the others at 1%.

Geographical distribution wise, the European region is UCHI’s largest export market, from where 93% of its revenue is derived.

SOLID AND IMPRESSIVE PROFITABILITY

Over the past 5 years, UCHI’s revenue grew at a compound annual growth rate (“CAGR”) of 8.6% p.a. Revenue growth in FY2019 was 11.9%.

Given the global lockdown due to the outbreak of Covid-19 in 2020, we expect UCHI’s FY2020 results to close slightly lower, within the range of RM140m – RM150m.

In terms of profitability, the Group generates superb returns with a 5-year average return of equity of 28.9% (FY2019 was 46.7%). Gross and net margins were strong and consistent, averaging at 69.0% and 47.2% respectively over the years.

In 2020, the business once again proved its resilience when its 9MFY2020 results achieved an impressive net margin of 50.4%, despite the lower revenue achieved. Reasons for the strong margins can be attributable to favorable product mix and one-off cost savings implemented during the MCO.

UCHI currently enjoys a low tax rate as they were granted an extension of income tax exemption in 2018. The extension lasts for 5 years and will expire on 31 December 2022.

UCHI generates strong and consistent cashflow from operations, producing a CFO to Net income ratio of about 1.0x over the past 5 years. Our optimism on the Group is further encouraged by the fact UCHI is able to maintain an FCF to Net income of >1.0x over the years, after taking into account distribution of dividends over the years.

A strong FCF to Net Income ratio may suggests the following:

Based on UCHI’s track record for the past decade, we opine that UCHI’s position is more of the positives. It should be noted, however, that the Group’s revenue growth has been slowing in recent years.

The Group has zero borrowings and has total cash of RM117.3m as at 30 September 2020.

RECENT KEY INITIATIVES

• The Group shifted its procurement base for some of the parts and components to reduce the risk of supply chain disruption. Simultaneously, preparations and efforts were made to reduce the production capacity in China in the event of a prolonged trade war.

• The Group continues to allocate 7% of its annual revenue (~RM11m) for R&D effort. They currently have on hand a number of projects in the pipeline, involving electronic control systems for both the art-of-living and biotechnology categories.

• The Group reviews and enhances buffer stocks scheme to mitigate the effects of material price fluctuation, supply shortages and shorten order fulfilment lead times.

• Address issues of manpower shortage by outsourcing production processes or engaging contract manufacturing services.

KEY STRENGTHS

• 20-year track record of superb profitability with an operating profit margin of not less than 40%.

• Experienced management team have helped sustain the Group’s solid financial track record. Key members of the management team have been with the Group for the last 20 years or more. Over the years, the Group has been consistent and focused on its niche target segment.

• Sole supplier to Jura, UCHI’s major customer. This creates customer stickiness and high switching costs.
  
  JURA Elektroapparate AG (“Jura”) based in Swiss, incorporated in 1931 specializes in the development of high-end household and semi-professional appliances for the office and food service sector. Jura pioneered the production of automatic coffee/espresso machines.
  In 2019, Jura sold 398,000 units of coffee machines (Revenue was CHF542m). Jura’s coffee machines price range between RM6,000 – RM32,000. Its premium pricing and target on the affluent market creates an inelastic demand for Jura’s products.

• High product quality with low customer rejection rate. UCHI has an internal target to maintain a customer rejection rate of below 0.15%. In 2019, UCHI achieved 0.11%.

KEY RISKS FOR CONSIDERATION

• Concentration risk on a single market and single customer exposure. High dependency on the European market (96% of revenue) and Jura. Nevertheless, the risk is mitigated given UCHI is the sole supplier of control modules for Jura (for the past 2 decades).

• Concentration risk on a single segment being the high-end control modules for coffee machines. Diversification to biotechnology products has so far failed to yield significant results (<20% of the Group’s revenue since 2005).

• Strengthening of RM against USD. Almost 100% of UCHI’s revenue is denominated in USD and approximately 30% of this revenue is allocated for payables in USD – natural hedge. The remaining 70% is exposed to currency fluctuation and is managed via a Forward Contract Management.

• Increased competition from mid-range automatic coffee machines i.e. Nespresso, Delonghi etc.

MAJOR SHAREHOLDERS AS AT 5 JUNE 2020

The founders, Ted Kao and Edward Kao controls the Group directly and indirectly via an investment holding company. The duo holds a total of 27.4% in the Group.

Institutional investors include Public investment (5.6%), KWAP (1.7%), AIA (1.1%), Eastspring (1.4%), CIMB (2.6%), EPF (2.0%) etc. Based on the Top 30 listings, institutional investors hold a total stake of about 24.0% in UCHI.

PEERS COMPARISON

It is unclear if there are any direct competitors that makes electronic control modules in Malaysia. However, there are a few indirect peers that may be worth considering for benchmarking against UCHI.

Table below compares UCHI to several peers within the electronic manufacturing services segment. Comparisons may / may not be relevant to UCHI.

The chart below depicts UCHI’s PE valuation range, over the past 10 years.

Taking into consideration of UCHI’s outstanding profitability, healthy dividend payout and stable demand for its products, we would value UCHI within a PE range of 13x – 18x.

Nevertheless, in the short term, Mr. Market may price UCHI on a higher PE range following the recent demand hype over technology-related stocks and the low interest rate environment. In 2017 & 2018, UCHI’s PE swinged to a high of 24x.

HOW MUCH IS UCHI WORTH?

Assumptions:
1. FY2021 Revenue assumed to grow between 5% – 10% from the base of FY2019. For the past 5 years, UCHI’s revenue grew at a CAGR of 8%. We expect growth to be above 5%, riding on the economic recovery in the European region.
2. GP margin assumed to range between 67.5% – 68.5%. UCHI’s 5-year average GP margin was 69.0%.
3. Operating cost assumed to remain stable, perhaps with only a slight increase. FY2018 & FY2019 operating cost were RM35.3m and RM32.5m respectively.
4. Investment income from placement of deposits is expected to reduce following the low interest rate environment. FY2019 and 9MFY2020 investment income was RM2.9m and RM2.1m respectively.
5. UCHI is enjoying a low tax rate as its income tax exemption status was approved for a further 5 years, up to 31 December 2022.
6. Net margin assumed to range between 47% – 48%. UCHI’s 5-year average net margin was 47.2%.

At current valuation, UCHI is considered fairly valued on its own. However, if compared to its peers or other related stocks within the technology or electronic manufacturing services segment, UCHI’s valuation remains at a discount.

Overall, we view UCHI as a favorable target for consideration if investors are looking for stable companies with healthy dividend yields. Unlike REITs and Banks that can pay similar yield in dividends, we favor UCHI for its resilience as proven during the last few financial crisis.

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