Unisem - Feverish Chengdu

Timely expansion in China combined with global demand recovery ensure an impressive CAGR of 90% for 2009-11. Catalysts are above-consensus earnings, IPO-worthy Unisem Chengdu and cheap valuations. Initiate with BUY Initiating coverage with a BUY call and a target price of RM2.26, based on a three-year historical average PE of 9.0x (which encompasses a full business cycle from its peak in 2007 to the trough in 4Q08 and 1Q09). This implies a target P/BV of 1.4x, which is also the midpoint between the average P/BV of 1.8x during the 2003-04 recovery and the average P/BV of 1.0x in 2007’s mini-upcycle.

Explosive earnings recovery, led by global demand recovery and the doubling of capacity at Unisem Chengdu by 4Q09. Unisem’s net profit is set to jump 186% and 110% in 2010 and 2011 to RM119m and RM153m respectively. Meanwhile, 3Q09 earnings could present a pleasant surprise – jumping 16% qoq to RM28m - as utilisation rates could reach 85%, up from 75% in 2Q09 and 50% in 1Q09. Operating margins should widen with better utilisation and favourable product mix (higher sales of BGAs and QFN packages).

IPO-worthy Unisem Chengdu a key earnings driver. Unisem Chengdu’s EBIT contribution is set to rise to an equivalent of RM65m in 2010, driven by the potential tripling of capacity by end-10 from early-09, to account for about 50% of Unisem’s 2010 earnings. Currently, Unisem China’s EBIT margin is already matching that of Unisem’s much more mature Ipoh plant, and benefits directly from highly generous support and incentives at the Chengdu Hi-Tech Zone, which houses established MNCs like Intel, Motorola and Ericsson.

Less susceptible to global semiconductor cycles, ... We estimate over 50% of Unisem’s sales in Chengdu are destined for domestic customers and 75% of Unisem Chengdu’s end products are consumed in the region, which is less susceptible to weaker consumer spending in developed markets.

… although recovery is on the way. Meanwhile, global semiconductor chip sales recovered significantly in 2Q09, and should move up another notch in 3Q09, partially led by Asia Pacific. Interestingly, our study of Unisem’s top key customers in 2Q09 reveals that they have registered top-line growth of 8- 32% and their inventories to sales ratio has been declining and is slightly above historical means, suggesting that inventories will have to increase by the same magnitude in subsequent quarters.

Cheap for emerging Malaysian IC assembly and test bellwether. Unisem trades at 6.3x and 0.7x PE and P/B respectively, well below its regional peers (refer overleaf) and the average after Y2K and the Asian financial crisis (sixyear historical average of 16.9x forward PE and 1.1x forward P/B). Unisem has rallied before to 2.6x P/B in the 2003-04 upcycle and 1.3x P/B in 2007. A hypothetical IPO of Unisem Chengdu could lift valuations to RM2.65.