A Current AIM Program Small Cap Equity Holding: KMG Chemicals, Inc. (KMG) by: Cole Froemming. "Cabot Wait to Merge"

KMG Chemicals, Inc. (KMG, $76.43): “Cabot Wait to Merge!”

By: Cole Froemming, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

 Summary:

• KMG Chemicals, Inc. (NYSE:KMG) Produces and distributes specialty chemicals and performance materials for the semiconductor, pipeline, and industrial wood preservation markets.

• KMG entered into a merger agreement with Cabot Microelectronics (CCMP) on August 14^th, 2018, resulting in the acquisition of KMG by Cabot for 1.6 billion in cash and stock.

• This company operates internationally, with 55.5% of revenues from the Americas and 43.3% coming from Europe.

• In FY2018, net sales in the performance materials segment increased 187.9%, largely due to the recent acquisitions of Flowchem and Sealweld.

• Demand for high purity electronic chemicals, such as those manufactured by KMG, has been driven by a 9% CAGR in semiconductor units worldwide.   

Key points: 

KMG entered into a merger agreement with Cabot Microelectronics that will result in the acquisition of KMG by Cabot. The deal is expected to close near year end and is valued at $1.6 billion in cash and stock. This strategic acquisition is synergistic with CCMP and their existing product line of chemical mechanical planarization slurries and pads, which are also used in the manufacturing of semiconductors.

For FY18, KMG experienced record results, with growth in both operating segments. Income from operations in the electronic chemicals segment, which primarily supplies the semiconductor market, increased 32.0% from FY17. This growth is also due to increased volume globally, and increased operating efficiencies after the restructuring of their electronic chemicals segment in Asia. The performance materials segment faired even better, with income from operations increasing 298.6% in FY18 over FY17. This was largely due to contributions from the recent acquisitions of Flowchem, in June of 2017, and Sealweld in February of 2017, but was also attributable to their legacy businesses within the segment.

In October of 2017, KMG completed a public offering of ~3.5 million shares of common stock priced at $54 per share. KMG used all of the proceeds to pay down their outstanding $550 million term loan that was taken out in the acquisition of Flowchem. This equity offering took their D/E ratio from 3.56 in FY17 to .96 in FY18, a much more manageable level of leverage for KMG.

What has the stock done lately?

One day prior to the announcement of the merger with Cabot, KMG was trading at $66.84. Once announced, KMG quickly jumped to $76.97. This was on target as shares of MKG will have the right to receive $56.65 in cash plus .200 shares of Cabot common stock. This equated to an implied value of $78.65 based of CCMP’s closing price that day. Since then, the stock has hovered right around $76. It is important to note that the .200 ratio is fixed for the stock portion of the merger and that the market price of CCMP will continue to fluctuate until the completed merger date.

Past Year Performance: 

Today, the stock is trading at $24 more than a year ago to date. Prior to the merger announcement, KMG was on the rise, with large spikes after both Q2 and Q3 earnings reports. We saw a spike of ~$8 from $61.92 to $70.04 after Q2 earnings were announced and a spike of ~$9 from $70.51 to $79.26 when Q3 was released.
These spikes of more than 10% post earnings are largely standard as a small cap stock.

Source: FactSet

My Takeaway:

The merger agreement with Cabot Microelectronics confirms that KMG is a solid player in the specialty chemicals and performance materials space. With the semiconductor industry booming, KMG benefited from the continued increase in demand for their electronic chemicals used in the manufacturing process. The acquisition makes sense for Cabot as they will further increase their semiconductor product offering and establish themselves as a leader in the industry. KMG receives a “hold” as the acquisition is expected to close near year end.

Source: FactSet

A Current AIM Program International Equity Holding: Taiwan Semiconductor Manufacturing Co. Ltd. (TSM) by: Gregory Glaab. "Giants Can Still Grow"

Taiwan Semiconductor Manufacturing Co. Ltd. (TSM, $40.96): “Giants Can Still Grow”

By: Gregory Glaab, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

 Summary:

• Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE: TSM) is the largest foundry in the world, manufacturing integrated circuits and wafer semiconductor devices for some of the top technology companies. The company was founded by Chung Mou Chang on February 21, 1987 and is headquartered in Hsinchu, Taiwan.

• TSM has maintained historically high margins while enduring an industry-wide volatile summer.

• TSM’s price has fluctuated with crypto-currency prices, however this should not stay correlated long-term. 

• Analysts are optimistic due to performance of customers and complete market share of 7nm nodes; estimating double-digit earnings growth for 2019E and 2020E.

• TSM’s price could be heading for new heights due to, historically highs ratios and low valuation multiples.

Key points: 

Since TSM was added to the portfolio, TSM has endured a multitude of outside factors, negatively impacting the stock price. Since February, technology has been one of the most volatile industries. Tariffs, crypto-currency prices, and declining growth of consumer tech goods sales, have all hindered the industry’s performance. Even though these outside factors have affected the company’s price, TSM has maintained their gross and NI margins above their 5-yr averages of 47.1% and 34.5%. 

TSM saw high demand in 1H2018 for crypto-currency related products; producing its highest revenue contribution of 8.5% and 10.1% in Q1 and Q2, generating almost $16Bil in 1H2018. Crypto prices have fluctuated immensely, especially with Bitcoin and Ethereum having YTD returns of -52% and -69%. It is clear that blockchain and cryptocurrencies have not progressed as estimates had predicted. Because of this, analysts estimate crypto-currency related products to account for only 2-3% of overall revenue for next two years. By management focusing on less volatile markets, TSM will continue to see a steady revenue and cash flow stream.

Analysts are optimistic of TSM for 2019E and 2020E for two reasons; the company’s expected 100% market share in 7nm nodes by FY2019 and estimated double-digit EPS growth. GlobalFoundries, one of TSM’s biggest competitors, announced this summer that they will discontinue production of their 7nm nodes giving TSM 100% market share of this product. These products are a vital component in Apple’s iPhones and AMD’s products. Estimated EPS growth is mainly due to expected market share increases of their customers. J.P. Morgan analysts estimate, for every 5% incremental market share gain for AMD in PCs and servers, could add $616mn in revenue for TSM. AMD share price has seen a YTD return of 157.4% while the rest of US semiconductor companies have seen an average return of 6.7%. As TSM’s smaller customers continue to increase in size, TSM will continue to discover new sources of revenue.

After a volatile summer, many analysts consider TSM a value buy with strong growth potential. In September, J.P. Morgan stated TSM remains their “top large-cap pick in Asia semis, amid a maturing semis cycle”. TSM has increased their, sales, EBIT, and CF per share for the past 5 quarters while majority of their valuation multiple have remained stagnant or decreased.  

What has the stock done lately?

Just as TSM looked to be leaving its summer woes behind them, news broke on Oct 4^th, that Chinese spy chips were discovered in data center equipment used by Amazon and Apple. Along with other large cap Asian tech companies, TSM has fallen almost 7% since the report was published. No one has claimed responsibility and there is still an ongoing investigation.

Past Year Performance: 

TSM has seen a total YTD return of 7.64% and a 52-week return of 6.5%. For many of the reasons I have highlighted, the company has experienced major volatility for the first time since FY2015. With consumer tech goods growth declining and the sluggish implementation of crypto-currency, blockchain, and automated vehicles, the company has not had any catalysts since February to drive the stock to new heights.

1 Year Stock Chart vs. Benchmark

Source: FactSet

My Takeaway:

TSM has faced many uncontrollable external factors that would have caused many other companies to crack under pressure. Mark Liu and C. C. Wei have continued to show their value by guiding the company through tough times while increasing market share and maintaining favorable margins. With strong management, TSM remains a safe bet whenever the business cycle comes to a close. Until then, there is still plenty of optimism given how well they are positioned within the industry.

1 Month Stock Chart

 Source: FactSet

Marquette’s Finance Students Traveled to Chicago on Friday, November 16th and Visited Alumni at Three Financial Firms

Semi-Annual Marquette FMA Student Club Visits Included: William Blair & Company, Capital One, and Morningstar

On Friday, November 16^th Dr. David Krause and 47 Marquette finance students braved the snowy conditions to travel to Chicago to visit three financial firms located in the Loop. Departing at 6:30 am during the second snow event of the season, the bus trip to Chicago took nearly three hours. Spirits remained high and the students were treated to a wonderful day in Chicago.

The first visit was at William Blair & Company - a financial services firm focusing on investment banking, investment management, and private wealth management. 

William Blair & Company

Our host, Robert Duwa, arranged for an agenda that provided the students with insights into the functions and culture of this independent and employee-owned investment bank that operates in more than 20 offices worldwide. The new headquarters building located at Wacker Driver and Randolph Street in Chicago is an amazing structure. The students enjoyed the tour of the building and the amazing views from the 46^th floor of the structure overlooking the Chicago River and Loop.

Bob Duwa

Bob Duwa, CFA, Partner, and Head of Institutional Client Relationship Management served as the event host.  Dan Niswonger (Marquette alumnus and an Associate in the Investment Banking function) provided an overview of Blair’s capabilities – he also offered excellent career advise to the freshmen, sophomores and juniors about classes they should consider taking at Marquette. 

The next speaker was Tyler Glover, Director of Consulting Services, who talked about Blair’s Private Wealth Management business.  

Corey Tobin (Partner, Research Analyst and Director of Research) talked about Blair’s Investment Management career path. He provided the students with excellent insights about where the profession is headed – with a strong emphasis on the need to understand and embrace technology.

Dave Kucera, Capital One

Bob Duwa wrapped up the morning session with further insights into a career in Investment Management along the client service and sales path. The students left with a highly favorable impression of William Blair & Company – each of the speakers emphasized the firm’s emphasis on ethics and hiring people who fit the culture of this nearly 90-year-old financial institution that is embracing the changing occurring in the global economy.

The next stop on the field trip was to Capital One where the students met Marquette alumni who oversee Capital One’s Securities Financial Institutions Group (FIG). The students heard from Dave Kucera, Head of FIG & ABS Banking, Chicago Market President – and Kevin Gibbons, Head of FIG Lender Finance, Managing Director.

Digital Lab

Capital One is one of the largest financial services firms in the U.S. with nearly 48,000 employees and revenues in excess of $27.2B – and they are the 6^th largest lender in the country. It would be unfair to think of Capital One as only a credit card company (3^rd largest) – they are the largest U.S. direct bank and 2^nd largest bank auto lender in the U.S.

Dave Kucera pointed out that Capital One is a leader in the FinTech revolution occurring within the industry. Lending by less traditional financial institutions has been growing rapidly and innovative technology-driven firms are taking share from old-style banking institutions in many sectors (i.e. Quicken Loans - Rocket Mortgage). He concluded by talking about the firm’s strong data analytics and underwriting capabilities in the non-traditional lending space – setting the stage for the students’ tour of Capital One’s Digital Lab.

Morningstar

Colin Plunkett, Morningstar

It wouldn’t be fair to describe the work environment within the product development efforts of Capital One’s Digital Lab – the students needed to experience it. The workplace setting has been created to attract and cater to the Millennial and Gen Z professionals. 

The tour was eye-opening and inspiring for many of the students who had an opportunity to see the people behind Capital One’s innovative banking and retail financial products and services. The Marquette finance students had an opportunity to see that FinTech is more than just a tag line – it is real and occurring within some of the leading financial firms in the U.S.

The third and final visit of the day took the students to another technologically innovative financial firm – Morningstar. This firm is a leader in global investment research and investment management, which has been headquartered in Chicago since it was founded by Joe Mansueto in 1982. Our host, Colin Plunkett (Marquette 2015), provided an interesting array of speakers (all Marquette alumni) to talk about various products and services Morningstar provides.

Marquette students at Morningstar

Colin Plunkett provided the students with an interesting session on the excess cash margin, a metric that he uses when evaluating the relationship between a company’s operating income and its operating cash flow.  He gave concrete examples of how the excess cash margin can provide an early warning to analysts that a company may soon experience earnings troubles. 

The students were also provided a brief tour of the facilities, which are also highly innovative and supportive of a diverse and youthful workplace.

While the trip back to campus again took nearly three hours, the students enjoyed the day and appreciated the efforts of all Marquette alumni who opened their doors. We are looking forward to our spring trip to Chicago – hopefully with better weather!