Published by Bob Ciura on March 20th, 2017
Value and income investors should get to know Seth Klarman.
Seth Klarman is the Chief Executive Officer and Portfolio Manager of the Baupost Group, an investment management firm with an $8 billion equity portfolio.
He invests similarly to Warren Buffett, with a focus on value investing principles.
Among Seth Klarman’s top five high-yield dividend stock holdings is ChipMOS Technologies, Inc. (IMOS).
Since the stock is not in the S&P 500, ChipMOS is not a member of the Dividend Aristocrats, a group of stocks with 25+ straight years of dividend increases.
At the end of last year, Baupost was the company’s biggest institutional shareholder, with a nearly 8% stake in the company. This investment was worth $49.5 million as of December 31, 2016.
This article will provide an overview of ChipMOS’s business model, and why it is one of Seth Klarman’s biggest stock holdings.
ChipMOS is an international semiconductor company, based in Taiwan. It is a small-cap stock, with a market capitalization of approximately $742 million.
It provides back-end testing and assembly services for chips and processors used in a variety of applications, including memory, as well as LCD and OLED displays.
The company has a diversified group of customers. It services a wide variety of end markets, including consumer electronics, personal computers, and communications equipment.
Its product breakdown is as follows:
Source: 4Q Earnings Presentation, page 9
ChipMOS operates in four core segments, which are:
- Testing (27% of revenue)
- Assembly (32% of revenue)
- LCD Driver (24% of revenue)
- Bumping (17% of revenue)
2016 was a difficult year for ChipMOS, due to a decline in demand from certain core end markets.
Revenue declined 2.4% for the year, while earnings-per-share declined 30%.
The good news is that the company’s performance improved substantially toward the end of the year.
ChipMOS had a very strong fourth quarter.
Revenue and adjusted earnings-per-share increased 4.2% and 42%, respectively, versus the fourth quarter of 2015.
The biggest boost for the company was greater stability in the memory business, which helped ChipMOS return to revenue growth.
In addition, the company saw stronger demand in handsets and computing.
And, the company experienced lower depreciation expenses and capital expenditures, which helped increase profitability.
Source: 4Q Earnings Presentation, page 12
Capital expenditures were cut by 14% in 2016.
Return on equity expanded by 530 basis points in the fourth quarter, to 14.6%.
Going forward, the most attractive growth catalysts for ChipMOS are services provided to new markets, including drones, virtual reality and assisted reality.
Growth from these new areas will supplement the progress being made in ChipMOS’s core businesses. The company saw strong results in memory services last year, led by DRAM and flash.
Another growth initiative for ChipMOS is to keep up with shifting trends in the marketplace. For example, in display, demand is moving away from LCD, toward newer technologies like OLED.
Demand and utilization have slipped in LCD over the past year, but this is being offset by significant capacity additions in testing services.
Utilization increased for the fourth quarter and full year, particularly on the testing side of the business. This could establish a strong tailwind for 2017.
Source: 4Q Earnings Presentation, page 13
ChipMOS is investing to keep up with the changing landscape, and the company hopes to see meaningful results in 2017 and beyond.
Finally, the company’s future growth will be aided by its massive restructuring last year.
At the company’s 2016 annual meeting, shareholders approved a vote to consolidate the operating company, known as ChipMOS Taiwan, with the ChipMOS Bermuda holding company.
Previously, ChipMOS Bermuda held 60% of ChipMOS Taiwan.
The biggest benefit of the consolidation is that the company now operates under a much simpler financial structure.
For example, before the merger, ChipMOS Taiwan had to pay a 20% “upstream tax” penalty to the Bermuda holding company.
In addition, it is highly possible the market will award the combined entity with a higher valuation, now that there are fewer moving parts. One single company is much easier for investors and analysts to value.
The benefits of these growth initiatives are likely not going to be felt until the second quarter of the year.
ChipMOS unveiled its forecast for the first quarter of 2017, and the company expects consolidated revenue will decline 4%-8% from the fourth quarter.
As a result, investors will need to exercise patience, as the company’s turnaround remains a work in progress.
ChipMOS pays an annual dividend. Its most recent distribution was $1.027 per American depositary share, paid on December 27.
Based on its current share price, the stock has a dividend yield of 6%.
This is a very attractive payout—its dividend yield is roughly three times the average dividend yield in the S&P 500 Index.
However, it’s also important to assess whether a company’s dividend is sustainable. High dividend yields can be risky bets, if the company is in financial trouble.
Investors should keep in mind that ChipMOS has a higher amount of risk than U.S. blue chip stocks. It is headquartered overseas, which exposes investors to currency risk.
In addition, ChipMOS is a small-cap stock, which means its financial results could be more volatile than large-caps that investors are usually more familiar with.
The heightened level of risk means that the company’s dividend is far from guaranteed.
One advantage that helps ChipMOS secure the dividend is a strong balance sheet.
At the end of 2016, the company had a current ratio of more than 3.6, which indicates the company has more than three times as much current assets as current liabilities.
This implies ChipMOS has excellent short-term liquidity.
In addition, the company is also without a burdensome level of long term debt. At the end of 2016, it held a net-debt-to-equity ratio of just 19.8%.
Not only does the company have a solid balance sheet, it continues to generate enough earnings to sustain its dividend.
Last year, the company generated earnings-per-share of $1.10, which covered its recently-declared dividend of $1.027.
Last year was a challenging one for the semiconductor industry more broadly, and ChipMOS was not immune.
Fortunately, the company’s huge merger went smoothly, and it is employing cost controls that should help earnings stay afloat.
But it will likely be another two or three quarters before the turnaround materializes. Risk-averse investors have plenty of safer dividend stocks to choose from in the U.S. tech industry.
For investors with a high level of risk tolerance, ChipMOS and its 6% dividend yield could be compelling for value and income.