The first major issue that was raised was the debt level of Aztech. This was pointed out to me before by grandmaster89 of CNA forums too, so it was on my mind when I looked through Aztech's past company's announcements.
My initial investigations show that the debt levels only increase in 2008.
Aztech Debt Level
2006: $20 mil
2007: $28 mil
2008: $69 mil
2009: $49 mil
So my initial thoughts were, these debts were likely to be used for their expansion program because Aztech started the program in 2008.
And thus, I went through the 2008 Annual Report strategically with my search button and discovered that, the extra debts were indeed used for funding their construction and purchases of vessels for their new subsidiaries. The management also mentioned that they see no issue with Aztech being able to repay its debts when they are due.
From 2008 to 2009, we also see a reduction in the debt level from $69 mil to $49 mil, showing that the management is indeed actively managing their debt level and reducing it to pre-2007 levels. In addition, Aztech had a 1 for 5 rights issue in 2009, further strengthening their cash position, putting them in better stead to reduce the debt and continue expanding. We did see that in their newest subsidiary Aztech E-lite.
It would be interesting to see how much debt would be left by the end of 2010.
************
The next issue was about Aztech's recent expansion into sectors not related to their electronics arm. Could a $100mil cap company be so diversified? Why would they want to expand into a different area?
The reasons for expansion could be found in Aztech's 2007 Annual Report:
As part of our long-term growth strategy to enhance shareholder value leveraging on our strong cash flow and balance sheet, the Board and management of Aztech is constantly on a look out for new business opportunities to fuel growth and enhance returns.Sounds good so far. And they did prove themselves so far by being profitable in their first two years of business with the new subsidiaries. Afterall, it was to leverage on their strong cashflow for greater returns.
.
.
.
We believe the above expansion strategies will provide the impetus for a greater growth beyond
what is currently generated by our core business, which will remain our key focus. Aztech will exercise prudent stewardship over our financial resources as we continue to explore other business opportunities to enhance shareholder value.
Aztech might be slowly morphing from a pure manufacturing company into a multi-industry one when they branch into construction materials supply and marine logistics. But as of now, they are still concentrating on their core business, again as seen by their lateral expansion to the LED market.
************
The next thing which I made a mistake in the previous post is to use Earnings Per Share to estimate if the dividend payout is sustainable. In fact, free cash flow should be used.
From the cash flow statement,
Cash Flow From Operations (Operating Cash)
- Capital Expenditure
---------------------------
= Free Cash Flow
| Year | Cash from Operations ('000) | Capex ('000) | Free Cash Flow ('000) |
| 2009 | 37273 | 22803 | 14470 |
| 2008 | 18547 | 52379 | -33832 |
| 2007 | 28198 | 18606 | 9592 |
| 2006 | 23132 | 18220 | 4912 |
| 2005 | 4548 | 13441 | -8893 |
Indeed, the free cash flow isn't very stable, but I would say Capex was rather consistent from 2006 to 2007. The capex spike in 2008 was due to the expansion into new businesses, and in 2009, it was "back to normal". In fact, the free cash flow per share after rights is 2.8 cents per share. If this free cash flow level could be maintained (which I believe it will), the dividends level should also be maintained.
************
Another concern is the margins of the construction and LED subsidiaries. I dare not say I'm sure of the construction industry, but I'm pretty sure for the LED industry. For LED, it's a lateral expansion of the electronics sector, and complements the core business of Aztech. However, being in the semi-con industry myself, I can safely say that net margins for semi-con are generally very high. Something that costs perhaps 30 cents to make overall can sell for over 20 to 30 bucks... After all, sand, where silicon is extracted from, is cheap. The margin wouldn't be too bad in terms on the manufacturing side. It's the marketing side that I wouldn't be sure of.
This concludes my part 2.
Aztech was the first stock I ever purchased when I was still in Uni. Then, they had that big court case with Creative etc. Downhill, it went. I got out of it with a loss. I was a "know nothing" investor in those days.
ReplyDeletehttp://singaporeanstocksinvestor.blogspot.com/2010/02/excuse-me-are-you-investor.html
I have not looked at Aztech since. Maybe, I should take a look again.
Hi AK71,
ReplyDeleteto me, I like Aztech because it is doing what I would do if I were in their shoes in terms of expansion plans.
In summary, form a strong base, make it strong and profitable, then use the profits buffer to extend my reach for increased profits. In a way, Aztech formed a base at the Electronics sector, made it profitable for quite a few years, before finally leveraging on some debts to pursue their expansion plans. Of course, they have reduced some of their debts, and I expect them to continue reducing the debts as time goes on, till the debt level is the same as before. By then, with new businesses, they will be even more profitable then now.... that is, if they continue with their present progress...
Hi JW,
ReplyDeleteThanks for taking the time to do a "Part 2" to address the issues I brought up under Comments in Part 1 of your Aztech analysis. Really appreciate that.
I think for debt levels, it's good that you looked at it over the last 4 years, but perhaps gearing (debt and net debt as a % of equity) might be a better gauge. I understand Management did a rights issue of 1-for-5, so this helped to increase the denominator and reduce gearing, at the expense of dilution in EPS and DPS. Also, it pays to look at their Annual Report and see the interest rates they are paying on the loan, and how much of it is ST and LT loans. Interest expenses can also be scrutinized to see the impact on P&L, and also any cash-flow impact? If minimal, then I would say the debt is manageable.
As for FCF, it seems Aztech did not have FCF for 2 out of 5 financial years. Capex also seems rather high for FY 2009 compared to FY 2006-FY 2007. Perhaps it can be attributed to their expansion into other businesses. However, unless Management has prior experience in these unrelated fields (construction and LED), the startups are likely to incur losses and be cash-flow negative for the first 1-2 years. One can see how each business segment is doing under Segmental Analysis in the Annual Report. I think it will also be good to look at the net margins for each division. Is any particular division dragging down the rest? Or is any division requiring high forseeable capex? There is a NOTE in the Annual Report which provides Capex Commitment numbers. That will be good to review too.
I am an accountant by training, hence I do not know the semi-con industry very well. But by looking at Chartered, one wonders why they made so much losses even though as you say semi-con has very high gross margins? Could it be the operating costs and overheads eating into the business? Maybe you can shed some light on this?
Thanks!
Musicwhiz
Hi MusicWhiz,
ReplyDeleteAs the debt was only taken up in 2008, the interest rates weren't very high. Offhand, I remember the debts ranging from 1.5% to 5.5% for FY2009. The management is confident of managing the debt, and from the cash balance available, Aztech definitely has the capability to pare down its debt in FY2010.
In terms of experience in construction industry, I have to admit I have not checked if they had prior experience. However, they did show profitability in 2008 and 2009, and their first contract runs till 2010.
In terms of the LED market, I would say they definitely have the experience. Some considerations in my mind were that LED were already used in their modems (blinking lights), etc. To me, they are merely repacking the LEDs to move into a different market segment that has high potential, especially when LEDs are part of the Green technology revolution.
As for Chartered, it has minimal R&D and its wafers were still in the 200mm era I believe. That was the case when I did my FYP and used their services. The 300mm technology nowadays will reduce expenses by a lot more, but it wasn't used by them. Furthermore, Chartered has no specific moats to protect itself.
Hi JW,
ReplyDeleteAlso wondering what competitive moat does Aztech have to protect itself? While moving into complementary businesses is a sign of the Company wanting to expand and diversify, hopefully they are not spreading their resources tooo thinly. How can Aztech ensure that it does not suffer from competitive attacks from entrenched competitors in the construction industry which may cause them to net lower margins?
Thanks,
Musicwhiz
Hi MW,
ReplyDeleteIn terms of products, Aztech has received a number of awards. The competitive moat would be their R&D and modem technology, and the high capex and technology required for new comers into the market. Semi-con and electronics industry has matured to the point where newcomers who play on a smaller scale would find it rather expensive to continue in the market, simply because there's no economies of scale for them.
In terms of marine logistics and construction material supply, the initial capex is very high, and it's not like any Tom Dick Harry can easily start buying a vessel to charter out, very unlike the buying of condos and HDBs to rent out.
The concern about netting lower margins is valid, but Aztech believes that this leverage on their cashflow will give shareholders more bang for the buck, than perhaps simply leaving the money in the bank. It then boils down to whether you believe in their management's capability to pull this through.
Finally, I did think about whether they spread their resources too thinly, but I'm willing to take the risk for this, and give more attention to the reports by this company.
Overall, I would say that Aztech behaves a little like me in a number of ways... it sort of resonates with what I think and would agree... It's unlike the other stocks I own, with the exception of Breadtalk.
hmm, they are not exactly semi con isnt it? why the reference to semi con?
ReplyDeletethey are more like r&d and marketers rather than semi con. if you think about a good solution, people copy your idea there, no moat but they can still earn normal profits.
not vested just joining in an interesting discussion.
Hi Gosu Warrior,
ReplyDeleteyou made an interesting point. I raised semi-con because LED is part of semi-con (or so I thought).
In terms of semi-con, the moat is rather big in terms of the start up cost of a fabrication plant. So to me, their main competitors would be those already in the same industry....
The potential for LED lights isn't small. Look at our traffic lights. Imagine if all the lights at the bottom of HDBs are changed to LED... All the break lights or signal lights in cars are changed to LED (already quite a number)... The possible drawback is that LED is extremely long lasting, so customers won't come back for replacements so fast :p
This is very nice article to read.
ReplyDeleteBut electronics is a high margin sector ? I don't think so. I am an Engineering Manager and have enough exposure to tell you these:
1. a silicon wafer is selling for less than a frisbee of the same size.
2. you can't compare raw material cost to final product cost because there is always high RnD cost, plant / equipment maintenance / upgrade cost, product becoming obsolete etc.
3. top managements like to say "enhance shareholders' value" etc. Perhaps if there is no chance for organic growth, the management should distribute the cash as dividends or buy back shares, instead of expanding into unfamiliar area. Construction & marine are not within Mun's circle of competence.
Hi FQ101,
ReplyDeletethanks for visiting and commenting!
You are indeed right. I failed to consider the things you mentioned :(
However, on hindsight and 2nd thoughts, a lower margin coupled with higher start up costs would provide a nice competitive moat to newcomers!
1) Very true. But to Aztech, that should be part of their cost price right? Afterall, they are not a fabrication plant.
2) Spot on again. The capex is indeed high. Hopefully this will ensure the competitive moat against newcomers into the industry.
3) True again. I'm banking on the management for this. Afterall, Mun is a businessman, and the most important thing is foresight and choosing the right people to manage the company. Hopefully he can do a repeat performance in start ups.
In short, I didn't really consider the points you mentioned. Thanks!
Hi JW,
ReplyDeleteToday, Aztech announced they are going into the F&B business as part of their "diversification strategy". I wonder if it's "diworsifiction"? How is food related to Electronics and Construction? Are margins even attractive? Are they spreading themselves too thin? Why not focus on a CORE business instead? They are far from being a conglomerate like SembCorp or Keppel, so why so many multiple, disparate business units?
Your comments on this are appreciated. :)
Regards,
Musicwhiz
Hi MW,
ReplyDeleteI won't be defending the company, but I'm finding their actions very interesting.
The behaviour is a bit like me... Shall try to get a post out on this...