We are initiating coverage on Unisem with an OUTPERFORM rating and a Target Price of RM1.86, based on a targeted FY13 P/forward BV of 1.1x. The group is shifting its focus to high-margin, highgrowth products and this transformation of its business model should see gross margins rising higher to more than 50% in the next 2 years. This comes very timely with the rebound in the global semiconductor industry, which should see an up-cycle lasting at least 2 years. In tandem with the industry cycle upturn, we forecast Unisem's net earnings to rebound a strong 2-year CAGR of 94% by FY13 (from RM19.7m to RM74.2m), albeit from  a lower base. With the ongoing management initiative to refocus the business, we believe Unisem is well positioned to ride the current rebound in the semiconductor industry. Our OUTPERFORM rating is premised on the stock offering a total returns of 34.4% (30% capital upside with a 3.4% dividend yield) to our TP.  

Business model shifting to high-margin, high-growth products. Unisem is now concentrating on high growth products such as QFN, WLCSP, Flip chip and wafer bumping, which should see growths of 10%-30% annually over the next few years. Essentially, the company's business model is changing from the previous high-volume based sales products  to the new high-margin, high-growth based sales products in the next two to three years. This should lift its gross profit margin to more than 50% in the next 2 years as the transformation kicks in. 

Industry sales rebounding.  The industry's book-to-bill ratio, which reflects the industry sales and orders, dipped to 0.71x in Sep 2011, which was below the normal range of 0.80x-1.00x, due to the global economic uncertainty as a result of the US and Eurozone debt crisis. However, the ratio has since risen back to 1.13x in Mar 2012. We believe the current recovery should be strong enough to bring the ratio back to 1.00x-1.20x in 2012/2013, supported by increasing demand from consumer electronics. With a parity of 1.0x, the ratio always moves in the range of 1.0-1.2x with the highest point of 1.5x in 2000 and the lowest point of 0.4x in 2001 and 2009.

Earnings to follow suit, 2-year CAGR of 94%.  In tandem with the industry's rebound, we are forecasting Unisem's net earnings to rebound by a strong 2-year CAGR of 94% by FY13 (from RM19.7m to  RM74.2m for FY11-FY13), albeit from a lower base. The jump is due mainly to a jump in revenue as well as an enhancement of its profit margins. We are looking at revenue rising a 2-year CAGR of 6.4% for the same period (FY11-FY13) while net margin will improve from just 1.7% in FY11 to 5.6% in FY13.

Balance sheet still firm, 3.4% dividend yield.  Unisem's gearing level is still manageable at around 0.4x. With capex likely to be maintained at around RM200m in the near term, as its profits rebound, we expect the net gearing to improve to 0.25x by FY13. We are estimating FY12-FY13E net dividend per share of 5.0 sen and 7.5 sen, translating to a 3.4% and 5.2% yield. The immediate term risk to earnings is foreign currency exchange rate due to the conversion from USD to RM of its payables and receivables, although this should be manageable.

Initiating with a OUTPERFORM. We are initiating coverage on Unisem with an OUTPERFORM rating and a Target Price of RM1.86 based on 1.1x P/fwd BV (+0.5 SD above its 3-year mean) to its FY13E BV/share of RM1.69. Our target price implies a PER of 26.5x and 16.9x for FY12 and FY13 respectively. In comparison, we have used a targeted FY13 P/forward BV of a 1.0x (or implied a targeted CY13 P/forward BV of 0.9x) that derived from a lower -2 standard deviation for MPI as it has a more volatile earnings cycle and its future growth rates are also likely to be lower than Unisem.

Source: Kenanga