The company
Ultra Clean Holdings Inc. (UCTT, Financial), manufactures and supplies production tools, modules, and subsystems for the semiconductor capital equipment industry.
Industries served: Semiconductor, Display, Medical Devices, Industrial Production and Research
Products & Services: Engineering, New Product Introduction, Supply Chain Management, Chemical & Gas Delivery, Metal Fabrication, Precision Machining, System Integration, Thermal Control, 3D Printing
Ultra Clean Holdings recently acquired Quantum Global Technologies LLC (QGT) for $342 million. Quantum Global is a provider of ultra-high purity outsourced parts cleaning, process tool part recoating, surface treatment and analytical services to the semiconductor and related industries. Ultra Clean Holdings management expects the acquisition to be accretive to Ultra Clean Holdings’s net income on a non-GAAP basis in fourth quarter 2018.
Ticker: UCTT
Share Price: $11.06
EV/Share: $9.14
Net Current Asset Value/Share: $7.21
Shares Outstanding: 39,297,000
Market Cap: $445,635,91
Altman Score: 4.52
EPS (TTM): $2.31
FCF/Share (TTM): -$0.02
History
1991: Mitsubishi Corporation Metal’s division started UCTT to bring ultraclean manufacturing techniques to the semiconductor equipment industry.
2002: Management, led by Clarence Granger, bought out the company from Mitsubishi.
2004: IPO trading on the NASDAQ
2005: Opened manufacturing site in Shanghai, China for gas panel production and assembly.
2006: Acquisition of Sieger Engineering. The company complemented UCTT’s expertise in gas delivery system design, manufacturing, and assembly.
2009: Opened manufacturing site in Singapore for assembly and testing capabilities.
2012: Acquisition of American Integration Technologies, AIT, to expand complex system integration capabilities of machining, framing and sheet metal.
2014: UCTT launches 3D printing for industrial prototyping.
2015: Acquisition of Marchi Thermal and Miconex. Marchi Thermal added complex thermal solutions to UCTT's product & services capabilities. Acquisition of Miconex, added processing steps like cleaning, chemical mechanical polishing and electrochemical deposition for precision machining, welding, assembly and integration of high-performing plastics.
2018: Acquisition of QGT adds capabilities in the Sub10nm semi-equipment cleaning market.
Management
CEO: Jim Scholhamer
Jim Scholhamer joined UCTT January 2015.
He worked at Applied Materials for just over 10 years and left Applied Materials as Corporate Vice President and General Manager of the Components and Systems Group.
He also worked at Applied Films Corporation for just over six years and left as Vice President of Operations, Engineering, and Research & Development.
Under Mr. Scholhamer's leadership at UCTT, revenue has grown on average 25% annually through December 2017 and 43% through June 2018. Earnings has grown on average 215% through December 2017 and 40% through June 2018.
CFO: Sheri Savage
Sheri Savage joined UCTT April 2009. She became CFO July 2016.
She worked at Credence Systems Corporation for almost three years and left as Corporate Controller and VP of Finance.
Savage also worked at Protiviti, KLA-Tencor, and Arthur Anderson LLP.
Insider ownership
Total insider ownership is 7.17% or 2.78 million shares. CEO Jim Scholhamer and Vice President Sheri Savage are the two largest insider owners with each owning less than 1% of outstanding shares.
The top fund holder is Paradigm Capital Management, owning 3.07% of outstanding shares. While institutional ownership is 85.06%, there is no significant concentration of a single institution.
CORRECTION: As of 9/30/2018: The top fund holder is BlackRock Fund Advisors, owning 13.37% of outstanding shares.
Financial overview (strengths and weaknesses)
Revenues are concentrated to the semiconductor industry, and it has enjoyed a significant increase in recent revenues due to the semiconductor industry’s upturn. Revenues can be cyclical, and the company has a concentration of sales to two customers, Lam Research at 61.9% and Applied Materials at 21.6%. These two customers represent 83.5% of total sales. However, Ultra Clean has a 16-year relationship with Lam Research and a 20-year relationship with Applied Materials, providing some neutralization to risk.
Ultra Clean has enjoyed a 20.26% average five-year revenue growth rate and has been actively growing through acquisitions to create size and vertical integration. The recent acquisition of Quantum will help reduce revenue exposure to its top two customers by about 11% of total revenue. The acquisition will also help open Ultra Clean’s exposure to other customers and promote customer diversification opportunities to integrated device manufacturers. Quantum’s customer base is more diversified than Ultra Clean's pre-acquisition customer base.
With the QGT acquisition, the combined company is now more balanced between Wafer Fab Equipment manufacturers and Integrated Device Manufacturers.
Sales by geography:
| Â | Three Months Ended June 29,2018 | % | Three Months Ended June 29,2017 | % | Six Months Ended June 29,2018 | % | Six Months Ended June 30,2017 | % |
| United States | $ 159,187 | 54.85% | $ 129,349 | 56.67% | $ 343,962 | 56.85% | $ 233,705 | 53.99% |
| China | 16,812 | 5.79% | 5,166 | 2.26% | 18,978 | 3.14% | 18,113 | 4.18% |
| Singapore | 82,904 | 28.57% | 73,810 | 32.34% | 185,537 | 30.66% | 134,050 | 30.97% |
| Austria | 16,393 | 5.65% | 8,491 | 3.72% | 29,929 | 4.95% | 19,712 | 4.55% |
| Other | 14,917 | 5.14% | 11,445 | 5.01% | 26,649 | 4.40% | 27,275 | 6.30% |
| Total | $ 290,213 | 100.00% | $ 228,261 | 100.00% | $ 605,055 | 100.00% | $ 432,855 | 100.00% |
In the last 10 years, Ultra Clean realized seven years of positive earnings. Earnings have had a five-year average growth rate of 151.49%. There is volatility in earnings; however, earnings volatility should decrease as Ultra Clean continues focusing on customer diversification and product and services diversification.
Gross and net margins are low. The five-year average gross margin is 15.62%, and the five-year average net margin is 2.54%. The five-year average growth in the gross margin is 5.87%, and the five-year average growth in the net margin is 81.45%. What this means is that Ultra Clean has aggressively grown its low-margin businesses.
However, Quantum’s 2017 gross profit margin was 59%. Ebitda was $50.5 million, and free cash flow was $24.8 million. Quantum’s revenue represents about 23.5% of Ultra Clean’s revenue. Its adjusted Ebitda is 46.3% of Ultra Clean’s adjusted Ebitda, and its net income is 29.3% of Ultra Clean’s net income. This recent acquisition will help improve Ultra Clean’s gross and net profit margins. Based on June 2018 combined pro-forma revenue and net income figures, Ultra Clean’s net profit margin improved to 7.91%.
Ultra Clean has a five-year average free cash flow of 55 cents per share.
The trailing 12-month debt-equity ratio is 13%, and the five-year average debt-equity ratio is 29%. Ultra Clean has not overly levered itself in the past and has a trailing 12-month interest coverage ratio of 79 and a trailing 12-month quick ratio of 1.35.
The acquisition of Quantum prompted Ultra Clean to restructure its debt holdings. Ultra Clean has secured $350 million in term loans with a 1.5% original issue discount that will accrue interest at LIBOR plus 4.50%. Ultra Clean also secured a $65 million revolving credit facility. The term loan matures Aug. 27, 2025. This size of debt will be its largest to date. While the actual impact to the balance sheet is unknown to date, debt-equity is expected to exceed Ultra Clean’s average debt-equity ratio. While this increased amount of leverage adds risk, I believe Ultra Clean’s current profitability, secondary revolver and improving diversification helps mitigate this increased risk.
Furthermore, while the semiconductor industry remains cyclical, the industry should experience lower troughs as demand for chips increases with the expansion of the Internet of Things (IOT), artificial intelligence (AI), robotics, data analytics, self-driving technology, memory capacity needs, media/ video/gaming, crypto-currency and space travel.
Operational performance
| ROA – 5-year average | 4.58% |
| ROE – 5- year average | 8.21% |
| ROIC – 5-year average | 8.30% |
| WACC – 5-year average | 10.33% |
Ultra Clean has a low five-year average return on assets due to a low operating income to revenue, which is attributed to a low gross profit margin. Operating expenses seem to be well managed. Ultra Clean, however has done quite well at generating revenue as a percentage of assets.
Ultra Clean has a low five-year average return on equity due to a low earnings level and a relatively low amount of debt financing over the last fiev years.
Valuation
Based on a discounted cash flow analysis, I believe the estimated value of Ultra Clean should be $23.66. I assume continued revenue growth of 20.26% for five years with a gradual declining growth rate over another five years, ending with a 10-year terminal growth rate of 3.08%.
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Value based on a multiple of earnings
The average 10-year price-earnings multiple for Ultra Clean is 10. The next four quarters of earnings are estimated at $1.72 per share. Based solely on this multiple, Ultra Clean should be trading at $17.20. This methodology is only provided as a benchmark for verifying the DCF methodology.
Ultra Clean does not pay dividends. However, if we assume that free cashflow could be used as a substitute for dividends, since in theory it is available for distribution like a dividend, then we can calculate a payout ratio equal to the calculation below.
- Five-year average free cashflow to earnings ratio = .55/.928 = 59.3%
- PE ratio implied by current FCF/Earnings ratio = (FCF/Earnings Ratio * Growth)/(Cost of Capital – Growth)
- Calculation: (59.3% * 102%) / (11% - 2.00%) = 60.48%/9% = 6.72 implied PE multiple
- Next four-quarter EPS = 1.72 * 6.72 = $11.56
| 5-year average free cashflow/Share | 0.55 |
| 5-year average EPS | 0.928 |
| 10 Year Terminal cost of capital | 11% |
| Free cashflow growth | 2.0% |
Based on the implied calculated PE multiple and next 4-quarters of EPS, I believe Ultra Clean is trading at the very bottom of its trading range. Ultra Clean’s stock price could experience an increase in value between $17.20 and $23.63 over the next 12 months from this analysis. Tip Ranks publishes a two-person (Walls Street analysts) average price target of $23.00 for the next 12 months.
Risks
Risks to valuation can occur if revenue, earnings, free cash flow or discount rates do not materialize as assumed.
Outlook
Ultra Clean is a small growing company that is generating meager but average positive earnings and free cash flow. The company has a significant concentration of revenue in its customer base but is implementing measures to diversify through the acquisition of Quantum.
The merger with Quantum is positive because it provides Ultra Clean access to a more diverse customer base and opens the door to expand revenue through these new relationships. Also, Quantum is a higher margin business which should help improve earnings performance and volatility. While Ultra Clean does have high potential for growth and increased share price values, the company has an immoderate amount of risk. The risk-reward trade off is within reason, making Ultra Clean a good value option over then next year.
Target price (one year): ($23.63+$17.20)/2 = $20.42
Current price (10/11/2018) = $11.06
Estimated one-year return: ($20.42-$11.06)/$11.06 = 84.63%
Estimated one-year risk: Extremely low since Ultra Clean is trading below the implied price of $11.56. A significant downward revision of earnings is needed for the stock to fall much further. If we assume an extreme, worst-case scenario equal to its five-year average earnings per share of $0.928 * 6.72 implied price-earnings ratio, share price of $6.24. Current price of $11.06 - $6.24 equals $4.82 potential loss in share price value. Risk value equals $4.82/$11.06 = 43.58%
Risk/Reward Ratio = 43.58/84.63 = 0.51 times
Reward/Risk Ratio = 84.63/43.58 = 1.94 times
I am long the stock and trade in and out of it frequently.
