Write up on Sarin Technologies

Sarin Technologies (U77.SI)

Recommend to: Hold

Intrinsic value: S$1.82, Previous Closing Price: S$1.90

Main Activities

Sarin Technologies Ltd develops, manufactures, markets and sells precision technology products for the processing of diamonds and gemstones. It provides smart solutions for every stage of the rough diamond manufacturing process, from determining optimal polished gem based on true dollar value, through laser cutting and shaping to inline quality control of faceting. It has operations across India(contributing 76% revenue), Africa(8%), Europe(3%), North America(2%), Israel(5%).

Main revenue contributors are software products that assist in evaluating rough diamonds and also production and planning of unpolished diamonds into polished ones, while the company is also in progress of rolling out Sarin Light and Sarin Loupe which will help to expand the business segment into retail sector by addressing the last of the four C’s - Clarity. Sarin Light is a system that enables the automatic, consistent and quantified measurement of a polished appearance while Sarin Loupe is an imaging system which creates high quality visual imagery to both buyer and seller so that a polished diamond can be inspected virtually from multiple angles without having the polished gem physically in hand.

Key development

High barrier of entry for Planning Software:Galaxy

Sarin has rolled out and refined the planning software for scanning stones down from 2.5 carats and up to 180 carats in weight, which means that the software is able to cover the entire ranges of stone sizes that meet different customer requirement.

Sarin’s Galaxy family system is currently contributing over 25% of revenue of the group in 2012 and recurring revenue grew by approximately 50%. As there is a high barrier of entry and the manufacturer is reluctant to switch to another system once the process has been in place, we view that this is favourable for Sarin to maintain high profit margin going forward.

Penetration into retail segment

Sarine Light is currently being rolled out to enhance the consumer’s buying experience. We view that this is a positive value enhancement to the company to be involved in selling the technology products to retail sector. An initial commercial agreement with significant retail chain of diamond jewellery in Asia was concluded in early 2013 and CIMA, Japan’s leading bridal diamond jewellery chain, has rolled out Sarine Light Performance grading reports on polished diamonds in all its stores throughout Japan in early April 2013. On the other hand, Sarine Loupe is scheduled to be rolled out commercially in late 2013.

Highlight from Financial Statement 2012

Revenue increased by 10.3% to a record US$63.8m despite a significant decline in industry activity during the months of June through September. Increased in revenue mainly contributed by high rate of penetration and usage of Galaxy-related product(25% of revenue) .

Gross margin improved to 68%(up 2% YtoY) due to increased sales volume and recurring revenue contribution of Galaxy business model. Operating profit also increased to record US$24.5m representing high profit margin of 38.4%. Net profit is a record of US$20.8m(up 19.5% YtoY) while the net profit margin increased to 32.6% from 30.0%.

Cash level is healthy as seen from operating cash flow greater than net income which stands at US$23.2 mil. ROE and ROA stands out at 36.9% & 30.6% respectively. Dividend payout ratio also increased to 74.2% representing a dividend yield of 5%

Risk

1)      Drop of price of the rough diamond in 2012 but remain stable in 2013, though this will contribute positive sentiment in diamond industry, but is a key risk factor to watch out for if there is any slowdown in economy.

2)      High geographical exposure to India which is currently battered down by high inflation and current account deficit which will hinder the growth of the business if the manufacturer decided to scale down the business.

3)      Location of the company is in Israel, which remains as another geographical risk factor if there is any political instability in Middle East countries.

Valuation

Using FCFF valuation of maintaining current revenue growth rate of 11.2 % (5 years average) and a pre-tax operating margin of 72.61%(5 years average) deriving an intrinsic value of S$1.82. Remain hold.

Write up on Maxi-Cash

Maxi-Cash Financial Services Corp Ltd (5UF.SI)

Recommend to: Reduce Exposure

Intrinsic value: S$0.31, Previous Closing Price: S$0.40

Main Activities

Maxi-Cash offers financial services in the form of pawn-broking which acts like collateralised micro-loan to customers on short term time frame with redemption period up to 6 months. It also engages in retail and trading of pre-owned jewellery and watches through retail outlet.

Incorporated in 2008 and wholly owned by Aspial(a listed company in SGX retailing under the brand of Aspial and Lee-Wah), it now has pawnshops and retail outlets at 28 locations, most of them are in strategic locations(near to bus interchanges and MRT station) across the island. Its market share in pawn-broking business is approximately 13% in terms of number of licensed pawnbrokers incorporated in Singapore. The company successfully raised an IPO in June 2012 which raised about S$16m in cash proceeds. This will serve as a capital to expand the business operations by increasing the number of pawnshops and through strategic acquisition, joint ventures or strategic alliances.

Key development

Overcrowded for Pawn-brokering Business

According to Singapore Registry of Pawnbrokers, the number of pawnshop outlets increased to 200 in 2013 from 127 in 2009(Up 57.5%), this is partly due to the opening of the 2 integrated resorts and people seeking more short term financing to deal with the liquidity issues. However judging from the increased in IPO activities for pawn brokering busineses(ValueMax has just been listed in SGX), means that there will be a fierce competition among the 3 dominant players(ValueMax, MoneyMax and Maxi-Cash) to grab the market shares. Given the low interest rate in the market and Pawnbrokers Act that the business cannot charge more than 1.5% a month, we view that there is a limited upside to the interest income that the company can earn going forward.

Lower gold price contributing to lower gross margin

The recent slump in gold price(from average price USD1800 per ounce in 2012 to current price of USD1300 per ounce) also drives down the gross margin for the company. This is due to the fact that the pawn-brokering business have distributed a higher loan amount to the customer when the gold price was higher than the current price. Current potential customers might also not willing to trade giving the low sentiments of the gold price, therefore there is a possibility that revenue might not grow from here if the gold price remain side way for the near term.

New proposed regulation might reduce ROC

Currently the government is looking to make several amendments to the Pawnbrokers Act to tighten regulations and further professionalise the industry. One of the changes being proposed is an increase in the security deposit for each pawnbroking outlet to S$100K from S$20K currently. We foresee this will increase the capital required to setup new outlet and further reduce the return on capital if the amendment pass through.

Highlight from Financial Statement 2012

Revenue increased by 14.6% to a record $100.5m from $87.7m. Increased in revenue mainly contributed by higher interest income from providing collateral loan services(up 84.5% YtoY). Revenue from retail and trading of pre-owned jewellery increased 6.5% to S$78.2m from S$73.4m

Pretax profit for pawnbrokering business increased more than 300% from S$1.5m to S$6.2m due to operating cost not increasing within the segment despite of higher net interest income. However for retail and trading of jewellery business, there is a pre tax loss of S$0.1m due to lower gross margin and higher operation expenses.

High P/E > 30 also seemed to be on the high side of the valuation. Currently the company is not generating a positive cash flow from operation due to cash being used for working capital such as loan issued to customers

ROE and ROA stands at 6.53% and 2.12% respectively, which indicates that there is a rivalry between the competitors and thus not able to earn a higher return of equity. We foresee the ROE will remain flat at this level.

Valuation

Using a single stage residual income model and the current ROE of 6.6%, we drive the intrinsic value of SGD0.31 which is lower than the current price of SGD0.40. Reduce exposure for this counter

Parodox of wealth and the effect on expected return

William J Bernstein's article on "paradox of wealth" http://www.cfainstitute.org/learning/products/publications/faj/Pages/faj.v69.n5.1.aspx highlights an important investment rule implying that the expected return is inversely related to the wealth level created. Key points to taken from this article:

Rapid technology development is a destroyer of return(decreased return) by

1) Increasing societal wealth but decreasing cost of capital since there is an abundance of capital if the society get richer

2) Encouraging enthusiasm from gullible investors, meaning they are more willing to invest more capital therefore reducing cost of capital

3) Diluting shares as increase in share issuance required to capitalize new forms of technology and rapidly growing economies

So what's the implication for investor in the future? I think it is prudent not to assume a high return on equity in the future. This has also implied that the aggregate P/E of the companies in the future will be higher than the present level due to technological advancement and wealth creation effect. 

This can also shown from the generic valuation formula that as the denominator required to discount the future cash flow into present value decreases, then the valuation will become more expensive in the future.

Recommended Investment Books

Throughout the investment journey, I have read lots of investment books, below highlight some of the books which I found very useful for learning investment concept:

1) Berkshire Hathaway - Letters to Shareholders 1965-2012 - Warren Buffett
http://www.amazon.com/Berkshire-Hathaway-Letters-Shareholders-Buffett/dp/1595910778

It can be downloaded from http://www.berkshirehathaway.com/letters/letters.html as well, but I always think that reading from paper is much more effective from e-book. The book categorize the topics into different financial topics such as Investing, Value, Moats and Return on Capital, Accounting and also topics on industries such as Insurance which you can go to specific pages to look at the topics that you are interested at.

However, this is not for beginner as you do need to have a strong financial or accounting knowledge to fully grasp what he means for eg topic like goodwill amortization. For me I definitely looking forward to re-read this book many times to revise and implement value investing concept from the greatest investor of all time.

2) Investment Valuation - Aswath Damodaran
http://www.amazon.com/Investment-Valuation-Techniques-Determining-Finance/dp/111801152X

Damodaran is considered one of the top valuation guru in the field, there are different topics on how to value a company using Discounted Free Cash Flow, Discounted Dividend and Relative Valuation and other valuation methodology. I was hoping to study in much detail on the methodology that he proposed, but you can also read his blog on how to value a hyped company such as Twitter, Facebook etc(http://aswathdamodaran.blogspot.sg). I believed for someone to master the art of investing, valuation is a must-to-master subject.

3)The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New - Jeremy Siegel
http://www.amazon.com/The-Future-Investors-Tried-Triumph/dp/140008198X

If you are new investor and planning to do some asset allocation on your current wealth, you can start off by just reading this book. This book provides a great detail on how to do asset allocation (on the last chapter) for a long run. The rest of the chapters also highlight the reasons why you shouldn't buy IPO or buy stocks that are over-hyped. To me, I felt that he is the one of the few professors(including Damodaran) that research investing topics that really put theory into practical perspective.

4) The Winning Investment Habits of Warren Buffett & George Soros - Mark Tier
http://www.amazon.com/Winning-Investment-Habits-Warren-Buffett/dp/0312358784

Though George Soros is a Macro-economic investor and Warren Buffett is a Micro-economic investor, they shared the same 23 investing habits. As your habit highly correlated with your your investment result, therefore it is crucial to understand what the common habits that they shared.

I particularly like the investment habits of

Habit 1: Always protect the capital
Habit 4: Has already developed the investment system(selection, buy and sell)
Habit 22: 24x7 working for investment.
Habit 23: Put his words into action, eat what he cook.

Started the blog journey

Started a new investment blog. It will help to reinforce several things:

1) Valuation - If you don't write what you are thinking, it probably means that you don't understand the matter in deeper context yet, and valuation need a concrete number to support the thesis.

2) English writing - A solid english communication is essential to convey investment ideas to target audience, whether you are buy side or sell side. However I do not expect I will be writing like a professional writer, but the bare minimum is to convey investment idea with simple and plain english.

3) Retain and Reinforce - serves as collective historical thought of my investment journey, feedback is always essential in an investment process to learn the mistakes from the past and improve going forward. Howard Marks from Oaktree Capital wrote memos to the clients, detailing how he view investment in the more philosophical way, I believed it is through sharing then a person will grow