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.