A bumper financial performance had been well flagged in a pre-close trading update in July and in the event Pure Wafer delivered underlying pre-tax profits in line with analyst estimates of $3.9m (£2.4m) for the 12 months to end June 2014, up from $3.1m in the previous year. Restructuring costs of $260,000 held back the reported figures slightly, but on an adjusted basis EPS was 14.5¢, or 9p at current exchange rates. That was essentially flat due to a full-year's impact on the average shares in issue resulting from a share placing the previous financial year.
Given the lack of revenue growth the profit surge was largely driven by a $476,000 reduction in administration costs and a $1m lower depreciation charge following a review of the company's depreciation policy earlier this year. Importantly, tight cost control helped offset adverse currency movements and resulted in operating margins rising by 240 basis points to just shy of 11 per cent.
Robust cash flow and positive outlook
Pure Wafer's cash performance also caught the eye: cash flow of $5.5m from operating activities was almost 50 per cent higher than operating profit of $3.9m. The latter figure is calculated after accounting for a $2.2m non-cash depreciation charge. As a result, the company ended the financial year with net funds of $1.5m - a $3m positive swing on 12 months earlier, even though Pure Wafer invested $3.5m in plant and equipment in the period. In turn, this has enabled the board to declare a maiden dividend of 0.43p a share. For the current fiscal year to end-June 2015, analyst Eric Burns at broking house WH Ireland is forecasting a raised payout of 0.63p a share, implying a prospective yield close to 1 per cent. That seems a sensible prediction to make given that the major investment in Pure Wafer's facilities in Swansea and Prescott, Arizona is now complete and capital expenditure is set to drop to between $1.6m and $1.8m.
The outlook statement was also positive, with news that the pricing pressure the company faced from Japanese competitors, which have been benefiting from favourable exchange rate movements, has now stabilised. Sterling has fallen by 3.3 per cent against the Japanese yen in the past three weeks, so undermining the pricing power of Japanese rivals. In addition, Pure Wafer's cost per wafer is running at an all-time low.
The industry backdrop is also favourable as demand for integrated chips is predicted to grow by low double digits in 2015 and 2016, which is supportive of demand for 'test wafer' silicon chips. This demand is primarily being fuelled by an increasing requirement for DRAM (dynamic random-access memory); the strong automotive market in the US and Asia (an average car uses around 1,060 chips); growth in wireless chips due to strong demand for handheld devices; and growth in internet-capable digital TVs and home appliances that interact via the internet.
Earnings expectations
Factoring in this positive industry backdrop, WH Ireland believes that Pure Wafer should be able to maintain pre-tax profits at $3.9m in the current financial year after factoring in 4 per cent growth in revenues to $37.5m. On this basis, expect EPS of 12.3c, or 7.7p at current exchange rates. True, that is a downgrade on previous revenue estimates of $40m, which would have generated $4.3m of profit. But I feel the brokerage is being too cautious as a trading update confirmed that demand for wafer reclaim has remained strong in the 14 weeks since the financial year-end, reflecting demand from customers that have been investing heavily in additional capacity. Guidance is for "further progress" in the current financial year.
But even if Pure Wafer only reports flat profits as WH Ireland now predicts, then its shares still look too lowly rated on 7.5 times historic post-tax earnings. Pure Wafer's market capitalisation of £19m is only five times annual cash profits of $6m (£3.8m). It's also worth noting that the company has an unrecognised $6.2m deferred tax asset relating to previous tax losses in the UK business which can be used to offset future tax liabilities. Last year a tax credit of $112,000 flattered EPS, whereas WH Ireland's current-year EPS estimate implies a tax charge of $400,000, albeit there are no unrecognised tax losses in the US, a region which accounted for two-thirds of Pure Wafer's operating profit last year.
It's also worth flagging up the pullback in sterling in the past three months against the rampant US dollar. That's because last year the strength of the pound against the greenback contributed to a $200,000 profit hit. Sterling has since fallen from £1:US$1.71 at the end of June 2014 to around £1:US$1.60, and so has reversed all of its gains this year.
In the circumstances, I am happy with a fair value target price of 100p-105p, significantly higher than Pure Wafer's current share price. Medium-term buy.
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
