Micro-Mechanics Holdings - FY11 earnings slightly below expectations (OCBC)

Downgrade to HOLD

Previous Rating: BUY

Current Price: S$0.45

Fair Value: S$0.50

FY11 earnings slightly below expectations. Micro-Mechanics' (MMH) reported FY11 revenue were in-line with our expectations although net profit fell slightly short due to an apparent slowdown in 4QFY11 conditions. Revenue rose 10.6% to S$45.3m, or 3.1% below our forecast. Net profit jumped 43.0% to S$6.8m but this was below our projections by 7.7%. MMH's performance was partly affected by the weakening USD against SGD, as 48% of its sales were invoiced in USD. Although its Semiconductor Tooling (SET) segment and Custom Machining and Assembly (CMA) segment registered positive revenue growth for FY11, we note that both divisions suffered a YoY decline in revenue for 4QFY11. A final dividend of 2.0 S cents was declared, bringing total declared dividends for FY11 to 3.0 S cents. This translates into a healthy dividend yield of 6.7%.

Weakening gross margins offset by effective cost controls. MMH's gross profit margin declined by 1.6 ppt to 45.9% in FY11 due to higher salary costs from an increase in headcount and higher depreciation expenses. Its SET division showed a gradual decline in gross margins since 1QFY11 due to pricing pressures and the depreciation of the USD against SGD. Neverthless we are encouraged by the strong pick-up in gross margins and continuous operational improvements in its CMA division (although still in the red). Coupled with effective cost control measures and improving operational efficiencies, MMH managed to increase overall net margin for FY11 from 11.7% to 15.1%.

Focus on improving efficiency. MMH's key focus moving forward would be to improve the cycle-time of its manufacturing process. This would increase its competitive advantage given the cloudy near term environment which amplifies the importance of being able to supply components and parts in an efficient manner on shorter notice. In order to achieve this goal, MMH highlighted that it would be increasing its capex to enhance its automation process and increase its operational efficiency.

Downgrade to HOLD on muted outlook. We understand that some of MMH's customers have turned more cautious given the lack of visibility in the near-term macroeconomic landscape. We are expecting MMH to grow at a more moderated pace in FY12, and also lower our valuation peg on the group to 10x FY12F EPS (previously 12x blended FY11/FY12 EPS) due to subdued macroeconomic and industry conditions. Hence we derive a lower fair value estimate of S$0.50 (from S$0.67). We are downgrading MMH to HOLD, given more muted earnings growth and pressures arising from continued USD weakness. However, we continue to like MMH for its strong management, healthy balance sheet and prospective dividend yield of 6.7%.