Friday, 13 February 2015

Avi-Tech Electronics Update - 30% Unrealized Gain in 2-3 Months & Half-year Earnings Report

In my analysis on Avi Tech Electronics (See Avi-Tech Electronics - Is Quick Profit Possible?), I highlighted the reasons both quantitatively and qualitatively, why I feel the company is undervalued and that the various ongoing corporate actions may serve as a catalyst to drive up the price towards its true value. Since my initial post about it on 30 December, the price has risen from S$0.074 to S$0.091 - a reasonable gain of >22% in about one and a half months. My own average price of S$0.699 would mean a 30% gain since around 2-3 months back at November. With the release of the half-yearly results yesterday, this post is just an update about how the story unfolds so far and my intended actions.
Avi Tech logo

Much Improved Continuing Operations - Industry or Management Actions?
Avi Tech Electronics Half year 2015 Financial Summary
Table 1: Avi Tech Electronics 1H15 Financial Summary (Continuing Operations)


As seen clearly from the Table 1 above, revenue, gross profit and net income show marked improvements. Similar growth may be observed in its operating cash flows (you can find out more from the company's latest earnings release).

Avi-Tech Results Including Disposal Group
Table 2: Avi-Tech Results Including & Excluding Disposal Group
I've extracted Table 2 from my previous post on Avi Tech. Here, you'll notice that the company has been loss making for many years. Also, despite cleaning up the effects of the subsidaries (they are contributing the bulk of losses for the past few years) that are in the midst of being discontinued, the core operations still show slight negative results from 2012 to 2014. Since 1Q2015, it is clear that not only did the disposal of subsidiaries help stem further losses, the improvements in core business have contributed to profitability as well. All in all, the results in 1H2015 represents a significant turnaround transition from loss-making to profitability.

Avi Tech Quarterly and Half Yearly Results
Table 3: Avi Tech Quarter-Quarter & Half Year Results (Continuing Operations)
I believe it is important to pinpoint whether the improvements in core operations are the result of improvement in trends of the industry or due to specific actions undertaken by the management. From the announcement, the management mentioned that the semi-conductor industry as a whole appears to be in an uptrend recovery and they 'remain optimistic of continued improving performance if this uptrend continues'. With improved results seen across all business segments, it is pretty clear that the industry recovery did play a large part in the increase in revenue for the past few quarters.

However, I argue that the management played a significant role in retaining these revenues especially since the company's inclusion into the SGX watchlist in 4Q14. The gross profit margin has grown from 11.3% in 4Q14 to 22.6% in 2Q15 and this is, to quote the management, 'partly the result of  effectiveness of the ongoing cost control measures and the enhancement in productivity across all business segments'. This is made clearer if we observe the drop of COGS as a percentage of revenue from 88.7% in 4Q14 to 77.4% in 2Q15. Another factor that plays a part is the significant decline of its operating expenses as a percentage of revenue from 18.9% to 9.9%. Although we do not have much information about the specifics of operating expenses, in the typical case such expenses should not provide future economic benefits to the company and thus such cost-cutting measures usually will not have serious undesirable consequences.

To sum it all up, an investor of the company should be heartened to see that the better set of results are not solely due to general improvements in the semi-conductor industry but also due to active steps taken by the management to ensure that more money flows into the bottom line.

Bonus: Cash from Discontinued Operations

I just want to highlight the fact that the discontinued operations did contribute a decent amount to the bottom line in the past 2 quarters. Although non-recurring in nature, its always good to know that its disposal will continue to throw in some amounts of cash for the company. The net asset value of this group under disposal currently stands at about $966,000.

Interim Dividends - 1st Time Since 2011

Another positive note is the resumption of dividend payments after a hiatus of more than 3 years. Coupled with the purchase of shares by directors in the past 6 months, the interim dividends declared is a clear show of confidence from management that they believe that the company has indeed turned around. The interim dividends of $0.3 cents per share represents about 3.3% dividend yield at current market prices (4.3% based on my own purchase price).

Valuation

In my previous article about Avi-Tech, I estimated that the liquidation value to be about S$0.094 per share. Using the same method alluded in that post, the new liquidation value should be S$0.099. I continue to believe that this is the minimum valuation that should be afforded to the company, especially considering that the continued improvement of business operations should provide further support to its intrinsic worth. This new valuation excludes the proceeds that Avi-Tech could have received in the future from the disposal of its subsidiaries.

Avi Tech Electronics Pro Formal Financial Results
Table 4: Avi Tech Electronics Pro-Forma Financial Results
Another reasonable way of checking the valuation would be the use of pro-forma statements as shown above. The main assumption here is that management is able to continue to keep Cost of Sales and Operating Expenses at 79.9% and 10.7% of revenue, as per 1H15 results. Finance costs and Operating income have been pretty stable over the years and should not venture too far away from $0.100M and $1M respectively.

From Scenario 1, if we were to assume that revenue reverts back to its worst level seen so far in 2014 (for eg, if semi-conductor industry as a whole declines and affect sales badly), the implied P/E ratio at current price of S$0.091 is 12.7x. Do note that 2014 net earnings is negative. This difference is mainly due to management's cost cutting and productivity measures that I had highlighted above - which further shows the importance of such management actions. If we were to annualize the 1H15 results such that the revenue will at least maintain current levels (as in Scenario 2), the implied P/E becomes 11.0x. These valuations ain't that demanding at all. Of course, the P/E based on my purchase price would have been much lower at 9.8x and 8.4x respectively. (I did not include Scenario 3, which is for those who feel the improvement in the industry as a whole will contribute further to sales growth. If this does happen, valuations will obviously be more attractive.)

Conclusion

It seems that Avi-Tech Electronics has finally turned around. Although we can't be sure if these very much improved results can be sustained, we can take comfort that:
  1. The discontinued subsidiaries will not contribute any more losses to the company.
  2. Share purchase from directors in the past months and the resumption of dividends after >3 years indicate management's confidence about the prospects of the company.
  3. Management seems to be actively taking targeted measures to ensure profitability since the company was placed in the SGX Watchlist.
  4. The current market price of the company is not too excessive, both on a liquidation and earnings basis.
Having said all these and with the new estimated minimum liquidation value of $0.099 as a guide, I'll probably continue to hold on to my shareholdings until price exceeds above this or if there's any serious deterioration of fundamentals in the company that warrants my attention. Did any of you bought into Avi-Tech? Let me know your opinions!

Related Articles:
Avi Tech Electronics (CT1.SI) - Is Quick Profit Possible?
My SG Porfolio (Top Realized Gains & Losses) and Some Recent Picks

Disclosure:
Long Avi-Tech Electronics (CT1.SI)

11 comments:

  1. Hi Secret investors

    Congrats there on your wise selection.

    I think the forward looking is to look at how the management is going to grow the business or venture further. Hopefully they learnt from the lesson and dont burn cash again like they did with the last venture.

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    1. Hi B,

      Not sure if its considered a 'wise' selection. Haha.. In investing, it is always hard to identify whether gains in individual stocks is due to pure luck or due to good skill.

      Hopefully the end result will be a nice profit for me for Avi Tech :)

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  3. Great writeup! Personally, I was never too worried about the point regarding management burning cash again. If you think about it, the management would definitely probably screw up somewhere down along the road again as shown by their history of poor acquisitions. However, with the CEO willing to stake his own money this time signifies the chances of him trying to 'screw' his company up in the short run (until the company is taken off the watch list) is rather low. This was my reasoning for weighing the risk of this company.

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    1. Hi TL,

      Did you buy into Avi-Tech as well?

      Yes agree with you that if CEO does put his money into the company itself, he wouldn't want the company to do badly. The only thing that is hard to tell is whether the management is competent enough to prevent the company from burning cash carelessly. The company did buy back shares in 2012 and CEO bought back in 2013 as well.

      Fortunately, the half year results did show management's efforts to rein in costs and the dividends declared is a positive sign.

      Thanks for visiting my blog. Hope you enjoyed my articles as much as I've enjoyed reading yours :-)

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    2. We do have a stake in Avi-Tech and were accumulating it till your post got featured on NextInsights (haha!).

      Yup, I do enjoy your articles as it is more about value investing rather than the usual personal finance articles. We should meet up to talk more when I am back in Singapore after graduation?

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    3. Haha I doubt my write-up caused the price surge!

      I think it's an extremely good idea that we meet up to discuss more about investing when you're back (when is that?). In the mean time, we can share our stock ideas and thoughts via comments in our blogs or better still, through email. Can't find your email in your blog. My email address is secretinvestors@gmail.com.

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  4. net cash now stands at 70% of market cap. this is a metric I like a lot. Unfortunately boss has locked it away in FD 17m of the 24m. That kinda signals boss is not gonna share proceeds from discontinued operations with OPMI other than the expected 6%+ yield /div payout to keep share price stable. Which is kind of a turn off.

    Looks like core operations are also more prone to downturn than say more fairly valued company like UMS.

    Would definitely vest if share price goes down further and business remains profitable.

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    Replies
    1. Hi BlueKelah,

      Yes I think management has made it quite clear from the past annual reports that they feel it is 'in the interest of the company and their shareholders to invest for future returns, rather than to return cash to shareholders.' Obviously, they have proven themselves very wrong in the past. I still feel that they should distribute more of their cash horde to shareholders rather than keeping excessive cash which gives low returns.

      Although valuations wise, I thought it is still not too excessive but prices have risen quite a bit the past few months and its always good to be more careful :-)

      Good luck!

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    2. vested now, cannot tahan the big net cash position :D

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    3. Hi BlueKelah,

      I guess you still made a good entry as prices had further risen to $0.106. Latest 3rd quarter report released yesterday shows further improved earnings. Management has indicated that they are considering to distribute more dividends in 4Q and seek shareholders' approval for a share buyback mandate to facilitate 'the return of surplus cash to shareholders in an expedient and cost-efficient manner.'

      All these reinforces the case that management is confident about the company's potential and also signals current market prices are probably still undervalued.

      Congrats :)

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