MLCC Price Erosion Limited on Solid Auto Demand; Yageo Shares Undervalued

We have mixed feelings about Yageo’s 2327 results for the quarter that ended in December. On the positive side, the reported results were largely in line with our expectations and the company’s guidance, except for operating and net income margins, which were below our forecasts due to one-time factors. On the negative side, the March quarter’s guidance numbers and management’s outlook for the first half of the year were slightly weaker than expected. Meanwhile, based on management’s comments and industry data, multilayer ceramic capacitor price erosion is likely to be much lower than in the past downturns, which is supporting our view that the MLCC industry is much more disciplined than in the past. We will update our earnings forecasts as well as our fair value estimate after speaking with the company, but we maintain our view that Yageo’s shares are undervalued.

Yageo’s revenue in the December quarter was 6.4% down sequentially and gross margin declined to 36.5% from 38.5% in the September quarter, both in line with our expectations. Operating margin of 20.6% was 4.3 percentage points lower than the previous quarter and below our expectation of 22.1%, due to one-time expenses related to two acquisitions announced by the company last year. We believe that the decline in gross margin is due to a lower utilization rate to reduce inventory and not due to price erosion. In fact, Yageo’s inventory is 6.4% lower than three months ago. We estimate that the utilization rate for commoditized components fell from 55% in the September quarter to less than 50% in the December quarter, but the relatively high utilization rate for premium components (70%-80%) supports the resilient gross margin, in our view.