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Micro-Mechanics (Holdings) Ltd’s First Quarter Profit Falls, But Investors Should Focus on the Long-Term Instead

Yesterday, Micro-Mechanics (Holdings) Ltd (SGX: 5DD) announced its financial results for the first quarter of its fiscal year ending 30 June 2019 (FY2019). The reporting period was for the the three months ended 30 September 2018.

As a quick introduction for better context later, Micro-Mechanics designs, manufactures, and markets high precision parts and tools used in the semiconductor industry. It may not be a pleasing set of results overall, but that’s just the short-term. The long-term fundamentals of the company are still intact. Let’s find out more.

Show me the money

Revenue for the reporting quarter came in at S$16.9 million, down 4.6% from S$17.7 million a year ago. The decline was mainly due to lower sales contributions from Singapore and Malaysia. Singapore’s contribution, in particular, plunged 43% while Malaysia’s fell 11%.

Micro-Mechanics’ gross profit fell 6.8% year-on-year to S$10.0 million, because its gross profit margin inched down from 60.9% in the first quarter of FY2018 to 59.5% in the reporting quarter. The lower gross profit was mostly due to an increase in the company’s production headcount, and higher depreciation expenses for machines purchased in FY2018. On a quarter-on-quarter basis, however, the company’s gross profit margin improved by 4.9 percentage points from 54.6%.

Ultimately, Micro-Mecahanics’ net profit declined by 12.9% year-on-year from S$5.2 million to S$4.5 million. As a result, the company’s earnings per share fell from 3.72 cents to 3.24 cents.

As of 30 September 2018, Micro-Mechanics had S$23.9 million in cash and no debt, an improvement from the net cash position of S$21.1 million as of the end of June 2018.

Cash flow from operations for the reporting quarter fell by 10.8% year-on-year to S$3.9 million. However, free cash flow (operating cash flow minus capital expenditure) climbed 44.7% to S$3.2 million. In FY2018, Micro-Mechanics spent S$12.1 million on capital expenditures while it expects to spend around S$6.0 million in the current financial year. The company has spent S$0.7 million of the projected S$6.0 million thus far for FY2019.

Looking ahead

Chip sales growth is expected to slow down in the coming months. The World Semiconductor Trade Statistics foresees chip sales growth of about 15.7% for the whole of 2018, implying a slower industry growth rate of around 9% for the final four months of the year.

However, short-term variations are a norm in the semiconductor industry. As investors, we should focus on the long-term trends of the industry instead. Micro-Mechanics commented in its latest earnings update:

“As such cyclicality is typical for the semiconductor industry, we prefer to focus on the industry’s long term trends and try not to get side-tracked by short-term variations. We continue to believe the semiconductor industry is poised for a prolonged period of solid growth as chips are becoming increasingly embedded in nearly every aspect of modern life, from today’s smart phones to tomorrow’s driverless cars. Hence, the key to the Group’s success lies in our continuing ability to seize long-term opportunities and correctly identify the initiatives and investments that bring value to our customers.”

The chip industry is moving into device geometries of below 10 nanometres, and into increasingly challenging processing methods (for context, the thickness of a human hair is 100,000 nanometres). Micro-Mechanics is not resting on its laurels and is also focusing its engineering efforts into these extremely small device geometries. On the one hand, the “nano” world poses manufacturing challenges. But on the other hand, the extreme precision required keeps competitors at bay, due to the capital and engineering resources needed. And this bodes well for Micro-Mechanics.

The Foolish takeaway

The slowdown in the semiconductor industry has affected Micro-Mechanics’ FY2019 first quarter revenue and earnings. However, the company possesses a strong balance sheet, which should allow it to tide through any tough times, and it is also focused on long-term industry growth trends. Any short-term share price weakness could be an opportunity to buy more of the company’s shares.

At the time of writing, Micro-Mechanics shares are trading at S$1.76 apiece, giving the company a trailing price-to-earnings ratio of 14.9 and a dividend yield of 5.1% (excluding any special dividend).

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of Micro-Mechanics. Motley Fool Singapore contributor Sudhan P owns shares in Micro-Mechanics.