A rating of only eight times prospective earnings for the financial year to end June 2014 seems wholly unjustified to me considering the company looks nailed on to hit WH Ireland's profit estimate of $3.9m, having booked pre-tax profits of $2.2m in the first half. On that basis, expect earnings per share of 14.7¢, or 8.8p. True, EPS is little changed from the previous year, but that only reflects the extra shares in issue following a placing which transformed Pure Wafer's balance sheet. But a more relevant way of analysing the earnings growth is on a proforma basis, which showed that EPS would have risen by 2¢ a share in the first half alone. In any case, I much prefer to invest in cash rich highly operationally geared tech company rather than one that carries significant financial risk.
Moreover, with the benefit of robust cash generation, Pure Wafer's board intend declaring a maiden dividend at the full-year stage. Analyst Eric Burns of WH Ireland predicts a payout of 0.5p a share, doubling to 1p a share in the 2014/15 financial year. On this basis, the forward yield is 0.7 per cent, rising to 1.4 per cent.
It’s also worth pointing out that Pure Wafer's current valuation implies the company has gone ex-growth. This is clearly not the case because the business is set to increase pre-tax profits by 30 per cent to $3.9m in the 12 months to end June 2014, and by a further 10 per cent to $4.3m in the next fiscal year.
Importantly, the management team have a tight grip on the company’s capital expenditure and working capital needs. Cash inflow from operating activities increased by 12 per cent to $3.16m in the first half, enabling Pure Wafer to pay down borrowings and purchase £500,000 worth of plant and equipment. As a result, a net debt position of $1.6m (£970,000) was reversed into a net cash position of $1.3m at in the six-month period. In turn, interest charges fell dramatically. The board also have the flexibility to tap credit lines if they wish to, having refinanced facilities with HSBC just over a year ago. These include a £3.5m term loan over four years and a £1m revolving facility at 3 per cent over Libor.
So with finances sound, and the company well funded, investors can focus on the merits of the business and the opportunities for growth. On this count, the picture is promising.
The industry backdrop
To recap, global market demand for semi-conductors/silicon chips has been rising strongly which has been supporting demand for 'test wafers' silicon chips. These test wafers are needed for testing, maintenance and calibration of semi-conductor manufacturing equipment. As a result, wafer reclaim is now an essential and highly specialised industrial process enabling the multiple re-use of silicon test wafers. This is where Pure Wafer comes into its own as one of the world's leading providers of wafer reclaim services which enable semi-conductor manufacturers to gain further efficiencies through greater re-use of silicon test wafers.
Importantly, industry experts predict the global semiconductor industry will enjoy 9 per cent annual growth rates in the next three years, the majority of which will come from foundries: TMSC, Global Foundries, Samsung and UMC. All these companies are clients of Pure Wafer. Technological advancements are key as they are driving the ever increasing requirement for memory, or DRAM. For example, wireless chips have been growing at a compound annual growth rate of more than 20 per cent for the past decade, while demand for units of integrated chips are forecast to drive demand for silicon and therefore wafer reclaim.
Meeting demand
So to meet growing industry demand, primarily from Asia and the US, Pure Wafer has added capacity to its production facilities in Swansea, south Wales, and Prescott, Arizona. As the leading European and US provider of 300mm wafer reclaim services, the company’s blue-chip customer base includes most of the world's largest semi-conductor manufacturers. Intel, IBM, Texas Instruments and HD MicroSystems are all clients.
Sales from 300mm wafer reclaim services now account for over two thirds of Pure Wafer's business, having risen by 6.5 per cent in the first half of the current financial year. There is scope for market share gains too following a 40 per cent ramp up in capacity of 300mm wafer reclaim services at Pure Wafer’s Swansea facility. The capacity upgrade at the Prescott plant will be complete within eight weeks. As a result, the company should be able to reduce the unit cost per wafer reclaim and maintain its competitive pricing.
That's important because the 30 per cent depreciation of the Japanese yen versus the US dollar in the past 18 months has enabled Japanese rivals to aggressively price their business to a global customer base. That said, there has been no impact on Pure Wafer’s profits as the pricing pressures have been absorbed through cost control. It’s still my view that market growth will put a floor on reclaim pricing and protect earnings of Pure Wafer. If I am right, then a forward PE ratio of eight is too modest a valuation.
Technical set-up
The technical set-up is supportive too as the 14-day relative-strength index (RSI) reading is around 35, so there is ample scope for recovery in the share price to regain the 200-day moving average (around 77p) in advance of an assault on the mid-March highs of 97p. Beyond that the January highs around 101p and the October high of 105p are the next targets. Both look very achievable by the year-end.
Offering 45 per cent upside to my target price of 105p, I rate Pure Wafer's shares a buy on a bid-offer spread of 68p to 72p. If achieved they would still only be trading on 11 times WH Ireland’s EPS estimate of 16¢ for the financial year to June 2015.
Please note that I am working my way through a long list of companies on my watchlist that have reported results or made announcements recently including: Eros (EROS), Inland (INL), API (API), Charlemagne Capital (CCAP), Oakley Capital Investments (OCL), Pittards (PTD), Thalassa (THAL), Camkids (CAMK), Taylor Wimpey (TW.), Barratt Developments (BDEV), Bovis Homes (BVS) and Terrace Hill (THG).
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