SUMCO Corporation: Reasonable valuation despite strong growth prospects

SUMCO Composite Valuation Indicator

Main Points

  • Earnings growth is strong and the semiconductor industry remains healthy with strong demand and prices
  • Attractive valuations despite strong growth
  • Greatly improved financial condition
  • Improving ROE

General Information

Name of Company Country of Origin/ Exchange Traded Sector Stock Price Target Price
SUMCO CORP Japan/
TSE
Technology – Semiconductors – Semiconductor Equipment & Materials JPY2400.00 JPY3186.87
@ 31 Jul 2018
COMPANY PROFILE SUMCO Corp is a Japan-based company that manufactures and supplies silicon products for the semiconductors industry, ranging from single crystal silicon ingots to polished, epitaxial and SOI wafers.

SUMCO Corp is a Japan-based company that manufactures and distributes high-quality silicon wafers that cater to the semiconductor industry. The firm uses specialized processing techniques to produce annealed wafers, epitaxial wafers, junction isolated wafers, and silicon-on-insulator wafers. The firm’s wafers are made from high-purity monocrystalline silicon ingots, which are sliced to produce high-quality wafers. The firm’s products are used in the manufacture of memory products and micro-processing units.

Stock Code 3436
Annual Dividend Yield 1.9%
Market Capitalization JPY703.87 billion
SUMMARY
Valuation Based on the Composite Valuation Indicator, the stock has a Target Price of JPY3186.87 within a 12-month period. Our Target Price represents upside of 32.8% based on stock price of JPY2400 as at 31 Jul 2018.
Growth EPS Growth for the company is very positive.
Financial Condition The company’s financial condition is strong.
Quality of Earnings The quality of the company’s earnings is high.
Operational Efficiency The company’s operational efficiency is very high.

SUMCO Overview

Since 2010, EPS has been on an uptrend. For the next few years, analysts are expecting the strong earnings growth to continue.

Silicon prices has recovered significantly in the last few years and analysts are expecting prices to continue to improve. Demand is expected to come from smart phones, data centers and electric vehicles, include automated driving cars. In the next two years, there are no large impending capacity increases among the silicon wafer companies which means that a supply glut is unlikely.

Since 2012 when the company experienced a crisis, it has aimed to become the world’s best in wafer technology and this drive has enabled it to win supplier awards from Intel, Taiwan Semiconductor and Samsung Electronics. This emphasis on higher-end wafers means there is less competition and price pressures.

SUMCO EPS

Despite the strong growth, valuations are not demanding.

Valuation

ProThinker believes in using a combination of valuation methods to arrive at a suitable valuation for the stock. This is because while each valuation method has its benefits, it also has its shortcomings. Price to Earnings and Price to Cash Flow Ratios are meaningless when the comany has negative earnings or cash flows. Price to Sales Ratio is more stable because sales are never negative. However, this does not tell us whether the company is able to sell profitably. Price to Book Ratio gives us an indication as to how much we are paying for the company’s assets but it is not directly related to the company’s profitability.
While it is important to value stocks based on multiple indicators, they sometimes lead to differing views on valuation. That is why we use our proprietary Composite Valuation Indicator, which gives you one conclusion based on the best combination of the different indicators, to tell you whether a stock is under or over valued. The graphical format allows you to determine whether or not the composite valuation accurately values the stock and gives you confidence to act on the decision.
In addition, we go all the way back 20 years (or as much as information is available) to give you a meaning “average” valuation of the company that takes extreme periods of the dot.com bubble and global financial crisis. Without this long a period, you won’t know the extreme highs and lows and therefore will not be able to determine the norm.

SUMCO PE Ratio

The Price Earnings (PE) Ratio is the most frequently used valuation indicator for a stock. However, there are times when this ratio cannot be used e.g. when the company reports a loss or profit is so minimal that it results in an abnormally high PE Ratio. Or Net Profit After Tax may be volatile and it is better to use Earnings Before Interest and Tax (EBIT) to value the company. We use the PE Band or Market Cap/EBIT Band to show whether a stock is overvalued or undervalued based on its historical valuation.
At the price of JPY2383.00 as at 01 Aug 2018, Sumco Corp is trading at a PE Ratio of 15.2 times last 12 months earnings.  This is a 36.5% discount to its historical average Price to Earnings Ratio of 24.0 times. (Price based on the historical average PE of the company is indicated by the red line.)

SUMCO Price to Sales

The Price to Sales Ratio is another commonly used valuation indicator for a stock. It overcomes some of the limitations of the Price Earnings Ratio in that it can be used even when the company is not making a profit or only making minimal profits. However, it should not be used by itself because a company may be achieving sales but not profits.
At the price of JPY2383.00 as at 01 Aug 2018, Sumco Corp is trading at a Price to Sales Ratio of 2.3 times last 12 months sales.  This is a 56.0% premium to its historical average Price to Sales Ratio of 1.3 times.

SUMCO Price to Cash Flow

Price to Cash Flow is an alternative method to value shares. This is because accounting profits can be subject to manipulation. Therefore, some investors prefer to value a company based on cash flows generated by the operating activities of the company. It also acts as a reality check to valuation measures such as Price to Earnings and Price to Sales. If a company generates high profits and sales but not operating cash flows, it could be heading for trouble because it is cash that pays the operating expenses. However, the Price to Cash Flow ratio of most firms are volatile and should not be used in isolation to determine the valuation of the stock.
At the price of JPY2383.00 as at 01 Aug 2018, Sumco Corp is trading at a Price to Cash Flow Ratio of 10.7 times last 12 months cash flow.  This is a 4.0% premium to its historical average Price to Cash Flow Ratio of 10.3 times.

SUMCO Price to Book

Price to Earnings, Price to Sales and Price to Cash Flow ratios all value a company based on what it is generating (i.e. profits, sales or cash flow). Price to Book ratio is different in that it values a company based on what it owns (i.e. its net assets). This is usually a suitable valuation indicator for a financial institution, which frequently revalues its assets and liabilities, or a company with huge asset base e.g. utilities company.
At the price of JPY2383.00 as at 01 Aug 2018, Sumco Corp is trading at a Price to Book Ratio of 2.5 times current book value.  This is a 65% premium to its historical average Price to Book Ratio of 1.5 times.

SUMCO Dividend Yield

For stocks that have a history of paying meaningful dividends, the stock price is often dependent on how much dividend the company pays.
At the price of JPY2383.00 as at 01 Aug 2018, SUMCO Corp is trading at a Dividend Yield of 2.0%. This is a 9.5% discount to its historical average Dividend Yield of 1.8%.  (Note: The lower/higher the dividend yield, the more expensive/cheaper the stock is.)

SUMCO Composite Valuation Indicator

The Composite Valuation Indicator is derived using our proprietary method to put all the valuation indicators in a way that explains the stock price best. It recognizes that looking at a single indicator is dangerous and inadequate. It also overcomes the difficulty of different indicators pointing giving different signals and difficult to act upon if you do not have a composite valuation. Our Composite Valuation Indicator does not assume that valuation stays constant at the average level. If the growth of the company slows down, it will adjust the valuation downwards to reflect the slower growth. Please note, however, that the Composite Valuation Indicator does not account for situations when the market is willing to pay a much higher price for the stock because of an anticipated takeover or some other special event. It is also possible that investors are now attributing a lower valuation to the stock because the stock or sector’s long-term prospects are poor.
Based on the Composite Valuation Indicator, the stock has a Target Price of JPY3330.19 within a 12-month period. Our Target Price represents upside of 39.7% based on stock price of JPY2383 as at 01 Aug 2018. We recommend that investors start to take profit after a rise of 20%.
The target price takes into account the appropriate valuation of the company and analysts estimates for profit, sales, cash flow, book value, dividends, etc. as well as other factors such as financial condition, quality of earnings, growth prospects and ROE.

 

Financial Condition

SUMCO emerged from a financially distressed situation into a company that is now financially strong. Having learnt the lesson, it has now stated as a Vision Statement to be deficit-resistant even during economic downturns. From 2012 onward, the company saw improvements in all metrics that contribute towards financial health. Sales Turnover, Retained Earnings, Return on Asset, Working Capital all improved and Total Liabilities declined.

SUMCO Altman Z-Score

Z-score has been improving since 2012. The main reasons for this are:
* higher working capital
* higher retained earnings as a proportion of total assets
* higher EBIT as a proportion of total assets
* lower level of borrowingsThe latest Z-Score of the company as at Dec 2017 was 3.5, which is in the safe zone.
The various components that go into the Z-Score are shown below:

SUMCO Sales Turnover

This is the Revenue Turnover ratio and it reflects the amount of revenue the company is able to generate from the use of its assets.  Companies that have difficulty generating revenue cannot generate consistent cash flow to pay its bills.
The amount of revenue generated from assets has been on an uptrend since 2012.

SUMCO Retained Earnings

The more profits are retained within the firm, the greater the buffer of reserves for the company to weather difficult times.
The level of retained earnings relative to assets has been on an uptrend since 2012. Currently, retained earnings are at 13.8% of total assets.

SUMCO ROA

This measures the ability of the company to generate EBIT (earnings before interest and taxes) from its assets.
EBIT as a % of assets has been on an uptrend since 2010. Currently, EBIT is at 7.3% of total assets.

SUMCO Total Liabilities

This is an indication of the level of borrowings of the firm. A high level of borrowings will affect survivability as it may not have enough cash flows to meet its debt obligations.
The level of borrowings of the company has been declining since 2012.

SUMCO Working Capital

Working capital is essential to the operations of the company and a low level of working capital may result in liquidity problems. Working capital relative to total assets has been on an uptrend since 2012.

Return on Equity

ROE has greatly improved since 2012 and is expected to continue to improve.

SUMCO ROE

Return on Equity (ROE) measures the amount of profit a company makes with the money that shareholders have invested. A rising ROE is an indication of improving management efficiency. It is also an indication of how fast the company can grow in future through profits that are retained and not distributed as dividends.
When analyzing ROE trends, it is important to know why ROE is going up or down. There are three main ways ROE can improve.
1. If the company is able to generate more sales per dollar of assets (what we call Asset Turnover)
2. When the company is able to improve its Net Profit Margin
3. When the company borrows more (what we call Equity Multiplier)
The first two ways are healthy ways to grow its ROE but it may be undesirable for a company to grow its ROE by borrowing more if the company’s financial condition is already weak. This is why it is so important to beyond determining whether a company’s ROE is improving to determining what the company did to improve its ROE. If the company grew its ROE by borrowing more, it is important to gauge the company’s financial condition to see if it is still healthy.
The company’s Return on Equity has been improving since 2010. During this period, Asset Turnover contributed positively, Equity Multiplier contributed negatively and Net Profit Margin contributed positively to ROE.

SUMCO Asset Turnover

Asset Turnover measures the amount of revenue a company is generating from its assets. Uptrend/downtrend indicates that the company is becoming more/less efficient in the use of its assets.
The Asset Turnover of the company has been on an uptrend since 2012. The latest ROE of the company is 49.1% for financial year ending Dec 2017.

SUMCO Equity Multiplier

Equity Multiplier measures the extend of borrowings the company has vs. its assets. Uptrend/downtrend indicates that the company is borrowing more/less. Companies borrow more to help them to leverage their operations and improve ROE.
On the other hand, companies may choose to reduce their leverage and have lower ROE.
The company’s Earnings Multiplier has been on a downtrend since 2012, which means the company is borrowing less.

SUMCO Net Profit Margin

Net Profit Margin measures the amount of money the company makes after it deducts all expenses. Uptrend/downtrend indicates that the company is more/less profitable.
The company’s Net Profit Margin has been on an uptrend since 2010

Other Considerations

Of course, in deciding whether or not a stock is attractive, it is more than determining its valuation and future fundamentals. We need to consider other aspects of the stock such as growth, financial condition, operational excellence, cash flow, technicals, etc.
It is difficult to find a stock that is attractive valued and still pass every single criterion of the investor with flying colors. At times, we need to make certain trade-offs. For a full quantitative analysis, you could refer to this report.
Source of Data: Charts are from ProThinker Stock Report. Company description, historical financial statements data and price data are from gurufocus.com. Estimates are from gurufocus and/or 4-traders.com – Thomson Reuters.
Disclaimer: This report is for information purposes only and should not be considered a solicitation to buy or sell any security. Neither ProThinker nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without the express written consent of ProThinker. Copyright(c) 2018. All rights reserved.