Sarin Technologies: Glittering results but unglittering share price

Background

Sarin Technologies Limited is engaged in the development, manufacture and sale of precision technology products based mainly on automated three-dimensional geometric measurement (metrology) for the processing of diamonds and gems.

The Company’s products provide solutions for every stage and aspect of diamond design and manufacturing. In addition, it provides products for the measuring and analysis of polished diamonds and for inscribing on polished diamonds, as well as other technology that assists sales in jewelry stores.

The Company’s DiaMension and DiaVision products are used in the gemological institutes, such as the Gemological Institute of America (GIA), the American Gem Society (AGS), the International Gemological Institute (IGI), the Hoge Raad voor Diamant or the Diamond High Council (HRD), the Central Gemological Laboratory (CGL) and the European Gemological Laboratory (EGL) for the qualification and grading of a polished diamond’s cut.

Premise and current operating environment

Sarin’s share price performance have been pretty dire in this volatile market. Nothing seems to be able to bring it up. Part of the reason i feel before seeing this full year result is attributed to:

• Poor sales due to falling demand from United States, India and China.
• Supply concerns in India
• Falling USD which they are priced and paid at.

This review in operation hopes to bring to light most of these concerns.

Profit Results

• Sales grew 18.5%
• Cost of sales grew 16.6%
• Net profit was worse, decreasing 4.4%
• Net Profit Margins are decreasing from 26% to 21%
• Gross Profit Margins are increasing from 21% to 33%
• Free Cashflow after considering acquisitions and plant, property is at  USD 9 mil.

Perhaps net margins look bad, however, if we look at 2 things that caused this it becomes clear why it is worse then last year. This year the Income Tax expense is 2.5 million vs 500k last year. Selling and marketing expenses is  1.5 million higher than last year.

Of the 2, the latter is more as a function of rising sales. I don’t think there is much issue here if you look at the free cashflow. Cashflow is increasing steadily from 7.7 million to 10.7 million. I think this is a pretty fair situation to be in.

Operations and Market Conditions

Sarin’s comments on how they were and moving forward is long by any standards. They did however address a few things:

• Consumer spending will be affected by the recession, however, historically, even in years of little or no economic expansion, diamond sales in the U.S have remain surprisingly resilient and stable.
• Sarin is affected in currency fluctuations in 2 ways:
  • The strengthening of the Indian Rupee against the U.S Dollar may impaired Indian customer’s profitability  and purchasing power.
  • The strengthening of the New isreali shekel as the expenses are payed in that while earnings are in US dollars.
• Investments in automation in diamond manufacturing industry will continue, as the overall drive to increase yield and productivity remains a key concern. Emphasis remains on investing in yield and productivity enhancing tools and systems.
• As a result in african legislation and increased incentives, there will be a shift in plant being built in southern African countries, thus presenting an opportunity to  Sarin.
• Online sales of polished diamonds are growing rapidly with leading players earning record revenues. Having secured the agreement to acquire 23% of IDEX online, it will allow Sarin to market and bring innovative tools to the industry.
• For year 2008, Sarin will be introducing DiaExpert Nano system for high -throughput planning and marking of small stones. The company also plans to introduce new software upgrades and product line to address productivity problems.
• Sales and marketing is targeting the African and China customers for FY 2008 as well as Russia and Belgium.

I can’t write all out, so please take a look at the annual report for more information

Balance Sheet Strength

The balance sheet of Sarin looks like that of a tech company. Low debt flush with cash.

• No interest bearing debt
• Cash and short term investment holding is maintained at 69% of assets.
• Cash and short term investment holding is 49% of present market cap (29.5 SGD cents)
• Inventories increases 25%, almost inline with sales
• receivables remain stable.

That much pretty much says almost 14.5 SGD cents are cash, if the balance sheet is to be trusted. Definately a price i would consider the base. The low fixed assets and high cash makes this company a very nimble performer. Basically you are investing in a business that seems to have really little barriers to entry so how come there isn’t any competition to this?

Performance Indicators

Return on invested equity has really improved if you take the cash out of the equation. It improved from 216% to 263%.

The value based on current performance of operating cashflow is 417% of current enterprise value. The present market cap is 50 million and at WACC of 10% and growth of 3% going forward, return premium is at 153 million. thats almost 3 times the market cap now.

Okay, probably liquidity will be an issue in the future. If i were to use a more absurd WACC at 20% and zero growth, The return premium will be 53 million. Thats almost equal to the market cap now. So the question is which WACC is expected.

Looking at it another way. The Present Market cap is 50 million US dollars. The cash and short term investment is almost 25 million. so 50 million – 25 million worth of cash is almost 25 million. The current operating cashflow after capital expenditure is 9 million USD.

That means less the cash, based on current share price, the company can only generate 2 .7 years of annual cashflow at ZERO growth. hmm. something doesn’t seem right here.

I have 2 purchase at 36 cts and 45 cts.  In both case, based on current cashflow, the market is valuing them both at that time at 4.4 years current op cashflow and 5.7 years current opp cashflow. That to me makes my buy price looks pretty conservative.

Either my reasoning is very wrong or that market’s valuation is very wrong.

No dividend is paid out this time round. But based on my buy prices the yields are around, 6.3% and 5%.

Dividend payout last year is 77% of net profit and 60% of net operating cash flow. It is debatable where that is acceptable for a company that generates such high ROIC.

Given the choice, they can pretty much paid out a 21% dividend yield and it would not have impacted their balance sheet much.

The thing is that they probably do not need that much cash, so it makes sense to return it to share holders.

I think baring any information that is kept secret from us, this company is very undervalued now.