Ultra Clean Holdings, Inc.: A tidy outlook
A third-quarter earnings miss last month left some investors ready to clean up their portfolios by sweeping out their shares of Ultra Clean Holdings, Inc. (Nasdaq: UCTT).
Ultra Clean isn’t a Northern California janitorial service. The small cap makes subsystems that keep critical manufacturing operations in the semiconductor and electronics device maker industries free of foreign matter that could play havoc with the fabrication processes.
While the 8% earnings miss was troublesome, it didn’t trigger a drastic change in the long-term outlook of most analysts who follow Ultra Clean. Analysts appear to see Ultra Clean’s results playing off of the overall slackening of growth in the semiconductor industry. Of five analysts polled by Thomson Financial, two have Ultra Clean rated at “strong buy,” two at “buy” and one at the equivalent of “hold.”
After listening to a webcast presentation by Ultra Clean’s management at the JPMorgan “Think Big, Buy Small” small- and mid-cap conference last week, Stanford Group analyst Tim Summers said he didn’t pick up any signals of a sentiment change in the two weeks since the company reported its third-quarter results.
“It’s a great story that’s in an industry that’s crummy right now,” said Summers, who has had a “buy” rating on Ultra Clean, along with a $20 price target, since July. “The semiconductor industry is highly cyclical and historically the stocks will do poorly until investors have the confidence that the industry is coming back.”
While Summers said that the sector still appears to be going down, the decline is slowing, and there is growing evidence that a reversal is coming in the months ahead. In his Oct. 23 post-earnings update note to clients, Summers wrote that Ultra Clean’s “opportunity for growth in the next several years is unsurpassed by any other company in our research universe” and that despite the weakening share price because of the results, “this is a stock we believe investors should own for upside cyclical leverage.”
Founded in 1991 by Mitsubishi to bring ultra-clean manufacturing technology to California’s Silicon Valley, Ultra Clean Holdings was acquired by Francisco Partners in 2002. The company went public two years later.
Most of the company’s manufacturing facilities are in the San Francisco Bay area, but it also has operations in Austin, Texas, Portland, Ore. and Shanghai.
Shares hit an all-time high of $19.99 on April 23, but since then have backed down amid the U.S. economy’s turbulence that has made Ultra Clean’s customers reluctant to committing on major capital upgrades. The 52-week low is $11.47, established Dec. 21.
For investors, the fallout from the third-quarter report has been a déjà vu experience, mirroring what happened following the release of the first-quarter financials. Ultra Clean’s stock hit that all-time high ahead of its Q1 report, then crashed 17% when earnings per share missed the consensus estimate of analysts surveyed by Thomson Financial by $0.03. Still, profits more than doubled to $5.2 million, with EPS doubling to $0.24, while revenue nearly doubled to $110 million.
The legendary volatility of small caps was demonstrated when Ultra Clean’s second-quarter results were released in July, which showed $0.23 EPS that met analysts’ expectations. Shares climbed 15%, to help keep Ultra Clean’s stock on track for a nice comeback.
In that July 23 second-quarter release, Ultra Clean Holdings did forecast third-quarter earnings of $0.16 to $0.22 a share, on revenue of $95 million to $103 million. The problem was that while the quarter hit guidance, it was at the low end of both ranges. Ultra Clean’s shares again tumbled 17% on Oct. 23, the day after the company issued gloomy third-quarter results.
For the quarter ended Sept. 28, revenue fell 8% from the same quarter the year before, to $95.5 million. Net income dropped to $3.5 million, for $0.16 earnings per share, compared with $5.6 million, or $0.25 per share, in the year-ago quarter. Gross margin also slipped, to 14% from 14.8% last year.
“The third quarter of 2007 was a challenging period for the industry in which we saw a progressive softening of demand from nearly all of our customers,” said Clarence Granger, the company’s chairman and chief executive, on an Oct. 22 conference call with analysts.
Granger said on the call that the company projects a further decline in industry demand.
“We expect revenue for the fourth quarter of 2007 to range between $87 million and $95 million and net income per share to range between $0.08 and $0.14,” Granger said.
In the 2006 quarter, revenue was $107.5 million, with earnings per share of $0.22. The group of analysts polled by Thomson Financial currently expects the company to report fourth-quarter earnings per share of $0.14, a 35% drop from the 2006 quarter, on revenue of $91 million, which would be a 15% decline. The median Thomson price target is $21.50.
Despite the downbeat Ultra Clean forecast, analysts still favor the stock, but most trimmed their earnings and revenue expectations on the company’s outlook.
Piper Jaffray analyst Jesse Pichel did cut his rating on Ultra Clean Holdings to “market perform” from “outperform,” keeping his price target at $15. He wrote in a research note that while its fourth-quarter revenue guidance “was 11% below Street consensus on the slowdown in the semi-cap market, we do not believe that UCTT is losing market share.” He continues to view the stock “as a value-oriented play.”
Analyst Jay Deahna at JPMorgan Securities reiterated an “overweight” rating on Ultra Clean, the latest quarterly results doing little to sway his outlook.
“Bottom line,” he wrote to investors, “we see UCTT as a superior story and recommend buying the stock on any near-term weakness for a cyclical and/or secular investment.”
Deahna, who upgraded Ultra Clean from “neutral” in February, calls the stock his “top small cap” and has it on the firm’s U.S. Equity Analyst Focus List. His February 2008 stock price target is $23.
Similarly, Argus Research analyst Kevin Calabrese reiterated his “buy” rating on Ultra Clean, but cut his 12-month price target to $17 from $18. He wrote to clients that “the shares … offer strong long-term growth prospects and carry an average risk profile for the industry,” noting that the company “is set to reap improved efficiencies from new facilities and improved utilization rates next year,” but not before mid-2008.
Ultra Clean is not standing still. In August, the company announced that Leonard Mezhvinsky, president of the company since June 2006, would resign at year-end and has launched a search for his replacement.
On its third-quarter conference call CEO Granger also reported that Ultra Clean had signed a lease to move its headquarters to a larger facility and expects to save money by unifying its Silicon Valley assembly operations under one roof. The company has opened a second China facility as well, as it ramps up operations there.
Stanford Group’s Summers noted that the company continues to win new business, despite the retrenchment in the semiconductor industry overall.
“When the industry turns around and begins to show growth, it is the kind of stock that would tend to outperform some of the others,” he said in an interview with SmallCapInvestor.com. “Even if we go into a flat to down industry environment, it is possible that UCTT will continue to show growth.”
