This is a continuation of my previous post:
Which is in turn a continuation of my initial investing thesis written way back:
In this post, I’ll aim to project what goes into Dutech Holdings’ FY16Q4 results, as well as analyze in detail their most recent acquisition.
Now, CIMB’s coverage of Dutech’s financials is pretty extensive, and although in my previous post I cross referenced their DCF with mine to illustrate some slight differences, in this and subsequent posts I won’t repeat what’s already in their report.
Cos there’s really no value in doing that.
Their analyst report is widely available and anyone can go read it. I don’t think SG TTI’s readers want to come here and read some snippets of repeated data cut and paste from somewhere else, or some superficial unsubstantiated thoughts.
Instead, here I’ll discuss some pertinent facts that as far as I can tell, nobody has recognized, brought up, dissected or discussed.
Yet these points, as you’ll see, are telling.
4. Scalability Of Dutech’s Business, Long Term Compounding Of Earnings
I separated this into a post on it’s own as it’s going to be long.
In part I, we’ve already seen how Dutech has a long term track record of profitability, increasing earnings over the years, growth both organically as well as via M&As and they’ve done this on the back of minimal debt.
Any debt that resides in Dutech’s BS currently comes from their acquired subsidiaries and are not bank loans taken up for acquisitions.
Dutech’s key man, Dr Johnny Liu, has thus far, IMO been insightful and his track record has been spotless.
I’ve also worked out the valuation in Part I by doing a peer comparison, as well as a DCF model. (Yes, I’ve received a fair bit of feedback from emails and on Investing Note that the share price has risen a bit since Part I, but I’m really talking in terms of much bigger gains than a few % points)
All these are somewhat backward looking though, and since future gains are substantially affected by what the company does in future, here I’ll attempt to do the impossible and try to peer into Dutech’s future.
Stellar FY16 results
Approximately a month from now, Dutech is scheduled to release FY16Q4 and FY16 results. I’m expecting a set of stellar results. By “stellar”, I mean at least the 2nd best set of FY earnings in the last 7 years (that’s as far back the data I’ve analyzed), and in all likelihood, record earnings by a mile.
This table shows Dutech’s long term record of EPS:
|Earnings per share (RMB cents)||18.11||10.16||11.29||28.15||40.02||33.1||29.53|
As of 9M16, Dutech’s EPS has already exceeded the full year earnings 3 years ago, and is poised to well exceed FY15.
Extraordinary Gain In FY16Q4
In FY16Q4, Dutech completed it’s acquisition of parts (most parts in fact) of the insolvent Metric Group.
I’ll spend some time discussing this Metric acquisition and it’s prospects for Dutech as there seems to be quite a bit of confusion (based on the queries I’ve received and discussions on Investing Note after my Part I post)
It’s no surprise why it’s confusing, because the names of the acquired parts are similar, and they changed the name of the holding company just recently.
1stly, it should be obvious at first glance from the announcement, that Dutech got a helluva deal by picking the carcass of an insolvent Metric Group.
Dutech paid up S$4.5mil in cash, which is a tiny chink of the S$69mil in cash and cash equivalents that the company has as of mrq.
In turn, Dutech received S$6.1mil worth of inventory, and intangible assets of S$13.8mil.
Wow. Talk about driving a hard bargain.
But that’s typical of insolvency proceedings. The administrator takes over the company, shields it temporarily from creditors, halts the business and sells off all parts as best as they could. The proceeds are then given to the creditors according to the hierarchy rights, and in all likelihood in this case, the shareholders of Metric walked away empty handed.
From the figures above, it’d also mean that Dutech is likely to recognize a one off, extraordinary gain from this M&A in FY16Q4. This is on top of it’s organic growth (see EPS table above).
Which is why I said I’m expecting stellar results.
Exactly how stellar is this extraordinary gain going to be? Well, I can’t tell exactly, cos that depends on how much of the goodwill Dutech’s accountants decide to write off.
But assuming they recognise the full sum above, Dutech will recognize a total gain of S$15.5mil, which works out to be.. <gasp> about 21 RMB cents more!
I had to rework my figures a few times to make sure I got it right.
If that’s true, that’s going to blow out the EPS for FY16 to somewhere close to 60RMB cents, which is record EPS by a mile.
Even if Dutech decides to write off some of the goodwill, I can’t see how there won’t be an additional 20 RMB cents or so added to earnings come FY16Q4 from this acquisition.
Again, bear in mind this extraordinary gain, is on top of the current large jump in earnings in FY16.
Fact: In every quarter of FY16 (Q1, Q2 & Q3) thus far, Dutech’s earnings has exceeded the same period in the preceding year by approximately 20%.
One of the ways to understand this metric acquisition, is to understand Dutech’s past track record of acquisitions. And here, we have plenty of material to work with, seeing that Dutech is not exactly a virgin in the M&A field.
In FY15Q4, Dutech acquired Krauth by paying 200K euros for it’s shares, and another 250K for know how and patents etc.
“The net tangible asset of Krauth was €220,000 as at 31 August, 2015.”
OK, so Dutech paid 200K euros for something that’s assessed to be worth 220K euros. So… they should recognize a gain on acquisition of 20K euros right? Nothing to shout about.
20K euros, based on an exchange rate of 1 euro = 7.3 RMB, should be = 146,000 RMB
But check out FY16Q1 results:
Oh boy, I was surprised to see a gain of 2,547,000 RMB as opposed to just 146,000 RMB.
And what’s the given explanation?
OK so basically the company is saying, after paying 200K euros for what is assessed to be 220K worth of assets as of August 2015, this 220K euros worth of assets is actually worth (200K euros + 2,547,000 RMB = 550K euros) in March 2016.
The next question that pops into my mind is, what accounts for this additional difference? Is it cold hard assets/inventory? Or is it in the form of goodwill?
Since the statements are audited, if the difference is in the form of inventory, I’d feel much more comforted. Goodwill is, well, arbitrary. It’s as good as what you want it to be.
This is an important point to investigate, because if management has a long term track record of arbitrarily raising goodwill in M&As and recognizing that as an extraordinary item to earnings… well I’m liquidating my stake and I’m outta here before anyone else. Good luck to the bag holders still hanging around.
So how did I investigate? Bear with me as I go into the micro-specifics just this once. (Won’t do it here for all the other acquisitions. Math is not meant to be done on a laptop)
Here we can see as of FY15Q4, Dutech carried 10,037,000 RMB of intangible assets. In the Krauth acquisition above, they also paid 250,000 euros (1,825,000 RMB) for knowhow, and that’s added to this intangible assets.
In FY16Q1 though, they amortised 1,365,000 RMB worth of intangibles.
This means that as of FY16Q1, the BS should have (10,037,000 + 1,825,000 – 1,365,000) RMB worth of intangibles. = 10,497,000 RMB
As we can see in the BS above, as of FY16Q1, the intangibles amount carried in the BS is 10,859,000 RMB, which is not too far from the 10,497,000 RMB. Part of the difference can be explained by rounding errors and partly by differences in the forex rates used for the calculation.
What I’m trying to illustrate here, is that most of the (extra) extraordinary gain, if not all, came from Krauth’s inventory.
Dutech didn’t explain in greater detail how this extra extraordinary gain came about, but as long as it’s not some imaginary goodwill/intangibles figure, I’m happy with it.
On a related note, in the earlier Tom Gayner video I referenced:
I remember someone in the audience asked how can a retail investor with no real access to management, judge whether the management is capable and has integrity.
Well, I think my above teardown on the accounting specifics, will be one of the nuances that hint at the integrity of the management. Sure, a single example may not be adequate. But do this enough times and along various aspects, and you’d get a pretty good picture over time.
By digging deep and looking at the details, one can glean precious information about how the management conducts itself. Another simple example: even the consistent 1,365,000 RMB in amortization every quarter, tells me a lot about how conservative the management is and the management’s attitude towards intangibles.
Dutech’s Value Proposition For Metric Group’s Operations
To assess the merits of the acquisition, and to see how Dutech can turn around Metric, of course we’ll need to have some in depth knowledge of Metric Group.
This is Metric’s FY results, up to FY15:
Lost money in 4 of the past 5 years, with -ve CFO in 3 of the past 5 years. Is it any wonder that they’re insolvent?
But wait! There is a silver lining. EBITDA is actually positive in 2015. Part of the reason for the losses comes from non cash items like D&A, and of course cash items such as all the administrative and finance costs, taxes etc.
What’s cause for some optimism, is the CFO. Regular readers of SG TTI would know I personally love CFs. 6.7mil Euros from CFO is a massive improvement.
Metric Group’s main business units are divided into a “Public Transport” unit, a “Retail & Logistics” unit (Both located in Hanover) as well as a car park ticketing unit, under a subsidiary Metric UK (Based in UK).
The Public Transport and Retail & Logistics units do not have their own manufacturing plant for their products. It’s obvious that Dutech is going to use what has worked marvelously in their previous acquisitions: Apply Dutech’s lean, efficient and low cost production chains in Shanghai to support these 2 metric units.
Metric UK has it’s own manufacturing plant, but I like this unit a lot. Mainly because it provides recurring income for Dutech. Every car park ticketing machine sold has attached maintenance contracts, and this provides a constant recurring income for Dutech.
Metric UK is the ONLY car park ticketing machine manufacturer in UK.
Their latest ticketing machines have features such as video displays for advertising, and this potentially may generate a new income stream for their clients.
My understanding is that Metric UK intends to use this as a selling point for their clients to replace their older ticketing machines with these new ones, which would in turn, generate maintenance contracts for Metric UK.
Also, newer ticketing machines have features like wireless payment:
In fact, as of Nov 2016, the city of Cardiff in Wales has decided to adopt Metric UK’s ticketing machine and is in the midst of rolling it out city wide.
All in all, I don’t think Dutech is going to reinvent the wheel here. They’ve successfully executed this before, and this is going to be a replay of what they’ve done previously. The previous turnaround of DTMT took much faster than I expected, and I don’t think it’ll be different this time around.
FY17 would likely see an increase in administrative expenses due to integration costs, similar to in FY15 when Dutech was integrating DTMT.
This acquisition though, also does mean that Dutech’s exposure to Forex is now increased further as Metric UK’s operating currency is in pounds.
Some of you (on Investing Note) seem to have trouble getting the relevant financials for Metric in English, so here it is.
(Again, don’t ask me where I got these from. I honestly don’t remember, it’s been at least a couple of months)
(Grrr all that is taking up a lot of my allocated free data space so quickly save it. I might delete them when this post gets old and nobody reads it)
I really intended for this Dutech update to be a 2 part post… but that’s too ambitious I guess. This is way too long so there will be a 3rd part afterall.
All mega blockbuster movies these days come in trilogies anyway right?
P.S. The math above and basically this entire post is written by a very tired TTI at 3am in the morning. So if you spot any errors, pls feel free to embarrass me.