SCT - Scott Tech

[sb9]

Awesome to see the jump today, is it going to get to $4

Getting close to that magical $4 mark....can it be lower for a lil while until the DRP price is determined as I've opted for the DRP

What a quiet achiever, marching along nicely. Can't believe this my second biggest gainer in my portfolio behind ATM.

[Snoopy]

Getting close to that magical $4 mark....can it be lower for a lil while until the DRP price is determined as I've opted for the DRP

What a quiet achiever, marching along nicely. Can't believe this my second biggest gainer in my portfolio behind ATM.

Why does the DRP exist sb9? Have you thought about that?

IMV Scott Technology has far too much capital. Indeed CEO Hopkins said that if they couldn't find a good use for the capital raised as a result of bringing JBS on board, they would return capital to shareholders. So it makes no sense to me to be raising more capital at this time ......unless.....there is a really big acquisition about to be announced that management are not at liberty to reveal!

Maybe all will become clear at the AGM?

SNOOPY

[sb9]

Why does the DRP exist sb9? Have you thought about that?

IMV Scott Technology has far too much capital. Indeed CEO Hopkins said that if they couldn't find a good use for the capital raised as a result of bringing JBS on board, they would return capital to shareholders. So it makes no sense to me to be raising more capital at this time ......unless.....there is a really big acquisition about to be announced that management are not at liberty to reveal!

Maybe all will become clear at the AGM?

SNOOPY

Snoops, guess you answered your own question as per my highlighted bit in your response.

Sure management have aspirations to grow further supported by strong balance sheet. Let's wait and see what their plans are either thro' NZX releases or updates at ASM.

[Snoopy]

Sure management have aspirations to grow further supported by strong balance sheet. Let's wait and see what their plans are either thro' NZX releases or updates at ASM.

The meeting opened with around fifty shareholders attending. A strong share price rally from the JBS capital raising time in early 2016 (price then $1.39) to $3.70 today made for a positive vibe. As customary, Chairman Stuart McGlauchlan announced the recently inked contracts: $21m of new business. But one good month does not a boom year make. Perhaps more indicative of relative future prosperity is the next twelve months of foreign exchange purchases that represent ‘deals in the bag’. AR2017, section D1, shows these up 32% to $24.976m. Yet I believe the best encouragement for future business comes from those senior managers (almost all of them) not at the AGM - because they were away negotiating new deals. Alan Prince from the Christchurch Maces Road site did attend, and the banter was “he is allowed one day off.”

Over ‘after meeting eats’, I discussed with senior management the segmentation of results into ‘Australasian Manufacturing’, ‘Americas Manufacturing’ and ‘Asia and Europe Manufacturing’. The current segmentation was vigorously debated at senior management level and may not be perfect. The puzzling Asia/Europe link can be explained by following the career path of appliance line manufacturing guru Ken Snowling. From heading Maces Road Christchurch, Ken oversaw the development of Scott Technology in China. Now he may be found bedding in Scott’s new European headquarters in Germany. The latest $17.5m of appliance line jobs will be manufactured in China. Europe and New Zealand. This clearly crosses market reporting segment boundaries. But Christchurch, China and Germany have always been associated with Appliance Line Production work. So the linking Asia and Europe is not such a surprise.

The AGM presentation publicity photo (slide 14) shows a smiling Cathy Smart, Scott’s first Chinese born (?) head, leading a train of happy employees. Two children holding the Scott’s banner at the head of the train are extended family. Chairman McLauchlan was quick to point out that Scott’s support family values, not child labour!

Further in the ‘post match discussion’, I asked about the absent director Andre Noguiera, who only attended two of the six board meetings held. Being head of JBS USA, Andre obviously has wide JBS group responsibilities. But the real benefit of having Andre on the board is the direct connection to JBS operations in the Americas. Having managed JBS Australia for a year on his way up in 2012, Andre is very aware of the detail of the day to day detail of running the Australasian division.

The Dunedin Kaikouri valley base will be doubled in size with earthworks starting early in CY2018. Construction will be managed by now unretired pensioner Graham Batts, a former managing director of Scotts and most recently a retired non executive director. Jobs for the boys? It was Graham who planned the move to Kaikouri valley in earlier years (completed in 2008) and had the foresight to build the new HQ such that future expansion was possible. There is no-one better qualified to fulfill the ultimate expansion plan. Dunedin is where most of the meat industry robotics systems have been built.

Eleven lamb boning systems have been delivered throughout Australasia. Ireland is most likely the next untouched lamb boning market. But internationally, lamb processing is a niche industry. Beef processing is of most interest to controlling shareholder JBS. JBS’s first plant processing beef sides is now working at JBS Dinmore in Queensland. Beef processing automation has a great future throughout the Americas and Europe, both inside and outside JBS. Pork and Chicken processing are areas where robotic expertise will be expanded. Indeed, a $3.5 million order from the United States for an X-Ray Pork Primal Cutting system was announced at the AGM. The key intellectual property (IP) that makes these developments superior is Scott’s DEXA (Dual Energy X-ray Absorptiometry) system. This not only allows a precision cut to be made in exactly the right place in each individual carcass. It can also simultaneously calculate meat fat and bone ratio – or lean meat yield.

Scott’s has on the balance sheet $26m of ‘excess capital’ (amounting to 33.5cps). Thirty acquisition targets were considered over the year. But only a couple, with the ability to significantly enhance an existing business unit or seriously disrupt it are still under active consideration. The ‘institutional imperative’ suggests that if a business has money in the bank they will spend it. Thankfully Scott’s is showing a much more disciplined approach to utilising shareholder cash. More opportunities will come up. Yet after the meeting, it was made clear to me that returning excess capital to shareholders was very much a continuing option.

Question time, and a shareholder asked about the absorption of two separately registered associated companies into the parent ‘Scott NZ Limited’ fold.

1/ Scott Milktech Limited, developing automated cow milking technology, was 61% owned. Is the former 39% equity partner still involved? Answer: No. Scott’s have bought out the former development partner to assume 100% ownership.

2/ HTS-110 Limited, the super-conductive magnet business, has made two high profile international installations ( one to a major US pharmaceutical company and another neutron and X-ray analysis tool into Germany – the sixth there). Yet revenue for the year was down nearly 50% (AR2017, p34). Should we shareholders be worried? Answer: No. This kind of variation in business is not inconsistent with the nature of HTS-110. It is part of the overall balanced business mix where not every Scott business unit does well every year.

A second shareholder railed against the Fisher Funds sell down of Scott shares around ‘JBS capital reconstruction time’ in early 2016. The missed opportunity of the ensuing capital gain has proved a disastrous misjudgment for Fisher Funds stakeholders, he pointed out. This same shareholder praised the reintroduction of the dividend reinvestment plan . Particularly that JBS and other independent directors and senior managers showed confidence in the future direction of Scotts by reinvesting with it.

Following the meeting, the workshop was opened up to all-comers prepared to wear safety glasses. My diversity observation of the day was that there was at least one woman in overalls in the workshop – good to see. There were two ‘active projects’ to inspect.

1/ The “Bladestop” safety bandsaw gave we shareholders a working demonstration. It works via the operator wearing a wire belt around their waist. This completes an electrical circuit should any part of the operator’s body touch the blade. An air actuated cylinder can fire off the brake that halts the saw blade in 9 milliseconds. A back up camera system that senses the operator mandated blue gloves provides a back up switch. Fingers and tendons will be saved.

2/ Development for a new manufacturing technique for LED lights. Essentially a high pressure plastic welding system, the job was to connect the soft printed circuit board that flashed the LED light to the plastic lens that cover it. The previous manufacturing process used an ultimately unwanted plastic sheet manufacturing by product which, if it didn’t come free, could contaminate the finished LED unit. Productivity gains plus less waste equals good business.

Finally it was time to adjourn back to the food and drink spread, and Scott’s did not disappoint. There were crumbed fish bites , mini spring rolls, mini meatballs on the end of a toothpick ready for the tomato sauce dip and a varied array of gourmet club sandwiches.
As for the drinks, what kind of wine would you like? Or beer? I don’t know if it was the time of day (4pm) or the audience. But the orange juice ran out first.

SNOOPY

[sb9]

Nicely summarised there snoops, very invaluable input.

[Jerry]

What was the $1.36M off-market trade on Friday all about?

[sb9]

https://www.nzx.com/announcements/314520

Another nice strategic acquisition, good stuff...

[Snoopy]

More information is available subsequent to the FY2016 result being declared. I will add to that my own sleuthing on likely contributions from RobotWorx and MAR earlier this month. So what is my best guess for the outlook for SCT over FY2017 now?

	Divisional Profit (NPAT)	Explanation
Superconductor Magnets	$0m	(Increased sales offset by costly new HQ)
Meat Industry Robots	$6.400m	(20% NPAT margin on $32m sales, equiv 4 big installations)
Appliance Production Lines	$2.099m	(Mirror of FY2013 segment result based on $16.3m turnover)
Mining Services	$2.981m	(Adjusted from FY2014 segment result based on $17m turnover)
RobotWorx USA	$1.309m	(From my post 593)
MAR Australia	$0.845m	(From my post 595)
Interest From Cash Balance	$0.739m	(based on 3.0% of $34.244m taxed at 28%)
less Head Office Costs	($3.515m)	(Unallocated FY2015 costs)
Total	$10.858m	(addition)

(Note: I have used FY2015 heads office costs are these are not corrupted by the JBS takeover one off effects.)

With 74.788m shares on issue this gives a projected 'eps' of:

$10.858m / 74.788m = 14.5cps

At $2.60, SCT is on a projected PE ratio for FY2017 of:

$2.60 / $0.145 = 17.9

A PE of 17.9 generally implies a 'growth premium'. Given:

1/ the long pipeline of JBS work ahead (provided the proven lamb carcass robotics can be successfully adapted to beef), AND
2/ the continued progress of the superconductive magnet business, which should eventually make a contribution to the bottom line.

THEN that $2.60 share price looks reasonable, if no longer a bargain. There is still the possibility of a capital return too, if management can't find a good use for the proceeds of their last capital raising. I still can't think of another growth share, except perhaps Skellerup, listed on the NZX that I would rather own.

I like to review last year’s predictions, before working out where I think profits will be going in FY2018. The headline NPAT figure for FY2017 was $10.265m. But to get the underlying net profit, I have added on the following adjustment:

0.72 x($0.001m -$0.001m -$0.269m - $0.143m) -$0.936m - $0.073m = -$1.306m

Explanations for the six items that form the complete my normalising adjustment are in order as follow

1/ Fair value losses on firm commitments ($0.001m, p31)
2/ Fair value gains on derivatives held as fair value hedges ($0.001m, p31)
3/ Foreign Exchange Gains ($0.269m, p31)
4/ Unrealised fair value gains on foreign exchange derivatives ($0.143m, p31)
5/ Fair value gain on purchase of business (reflecting inventories plant and equipment of DC Ross purchased at less than market value) ($0.936m, p30, assumed not taxable)
6/ Gain on sale of property plant and equipment ($0.073m, p30, assumed not taxable)

‘Adjusted Net Profit After Tax’ is therefore: $10.265m – $1.306m = $8.959m

My prediction last year was $10.858m, so what went wrong? It is impossible to say for sure. That’s because I was making my profit predictions based on the profits in different ‘industry sectors’. ‘Industry sector’ profits are no longer reported. The following observations may prove useful though (page numbers referenced from AR2017).

1/ Assumed head office costs $3.515m. Actual head office costs $4.985m.

2/ Assumed appliance line turnover $16.3m. Actual appliance line turnover $26.308m. Have I underestimated Appliance line revenue and hence profits? Turnover is not necessarily related to profitability because workloads above normal can be farmed out to subcontractors which increases costs and reduces profits.

3/ Assumed meat industry robotics turnover $32m. Actual turnover $39.581m. Possible underestimate of profits assuming a 20% margin: $1.516m

4/ Assumed Mining Services turnover $17m. Actual mining services turnover $26.461m. Possible underestimate of profit $1.659m.

5/ Assumed superconductor magnet sales: $3.335m+. Actual sales $1.747m. Together with the increased costs of a brand new bigger and brighter head office, this division could have made a substantial loss (my predictive assumption was $0m profit) that wiped out all the increased profits from meat industry robotics and mining services.

6/ Assumed Interest earned from cash balance $0.739m. Actual interest earned $0.664 x 0.72 = $0.478m

I note that the difference between observations and reality of item1 and 6 only is a NPAT difference of: -$1.470m -$0.261m = -$1.731m. This accounts for almost all of the difference between what I predicted and what actually occurred.

SNOOPY

[Snoopy]

https://www.nzx.com/announcements/314520

Another nice strategic acquisition, good stuff...

The acquisition of the Alvey Group in Europe has been treated favourably by the market. But what difference will this make in ‘earnings per share’ terms? Unlike other substantive purchases over the last few years, no new shares have been issued as a result of the takeover. The purchase was made from cash reserves. At balance date these were $26.7m. Take away the cash paid for Alvey Group and the cash reserves left on Scott’s books are:

$26.7m – (12.1euro/0.6) = $6.5m

We know that $0.664m (after tax) was the cashflow earned on this balance over FY2017. So post purchase, the annual interest earned is likely to come down in proportion:

$0.664m x ( $6.5m/$26.7m ) = $0.162m

This will lead to a reduction in annual NPAT of:

$0.664m - $0.162m = $0.502m

Now we know what is likely to be lost. But what is the concomitant gain NPAT gain from the Alvey purchase? There isn’t enough information in the press releases to know this for sure. But I can make an educated guess.

Alvey’s last year’s annual revenue was $56.5m. That price represented an EBITDA multiple of approximately 4.5 times. So EBITDA for Alvey’s most recent year must have been:

$56.5m / 4.5 = $12.5m

To calculate the NPAT of the acquisition under Scott’s ownership, we need to subtract the ‘ITDA’ bits from this. Let’s do that.

‘I’ (Interest payable): Because the Alvey purchase was made by cash, the ongoing interest bill associated with the purchase is zero
There is no information on Alvey’s depreciation or amortisation bills. But because the business looks like a smaller version of Scott’s, (combining intellectual property and spread international manufacturing facilities), I have decided to treat it as a small version of Scott’s and work out the depreciation and amortisation by scaling the Scott figures in proportion to the revenue of both companies before the merger.

‘D’ (Depreciation ) for Scott’s was $1.694m. Scaling according to company revenue, I estimate the annual depreciation at Alvey to be:

$1.694m x ($56.5m/$132.5m) = $0.722m

‘A’ (Amortisation) for Scott’s was $1.293m. However, on closer inspection, almost all of this ($1.261m) was a result of amortizing the recently acquired ‘Bladestop’ technology. IMO it is not reasonable to assume that Alvey has similarly spent a large amount of money on externally acquired intellectual property which must be similarly amortised. If I remove the ‘bladestop adjustments‘ from Scott’s accounts, I get a representative amortisation for Alvey of :

($1.293m - $1.261m) x ($56.5m/$132.5m) = $0.014m

So now we have enough information to calculate EBT for Alvey.

EBT = EBITDA –I –D –A = $12.5m - $0m - $0.722m - $0.014m = $11.764m

Assuming a New Zealand tax rate of 28% (Note: this is likely a wrong assumption, but I don’t want to make an uninformed guess about EU tax rates and tax subsidies that may exist), I get an incremental NPAT for the soon to be Scott owned Alvey of:

$11.764m x 0.72 = $8.470m

This is the kind of gain in net profit after tax I would expect once it is bedded in, and I must say it looks very juicy!

SNOOPY

[Snoopy]

We know that $0.664m (after tax) was the cashflow earned on this balance over FY2017. So post purchase, the annual interest earned is likely to come down in proportion:

$0.664m x ( $6.5m/$26.7m ) = $0.162m

This will lead to a reduction in annual NPAT of:

$0.664m - $0.162m = $0.502m

<snip down to underlying Alvey profitability>

$11.764m x 0.72 = $8.470m

This is the kind of gain I would expect once it is bedded in, and I must say it looks very juicy!

If we add to this the underlying profitability of Scott Technology today, I get an underlying profitability for the combined ‘Scott’ and ‘Alvey’ group of:

$8.959m -$0.502m + $8.470m = $16.927m

This projection assumes no profit growth or decline from either company.

I do not expect the Scott Technology result for FY2018 to be this high, because Alvey will have only been owned for part of FY2018. Nevertheless I believe this figure is representative of the ongoing profitability of the group and should be used to assess value ahead of whatever the actual FY2018 result turns out to be.

With 74.681m shares on issue, Scott/Alvey should have ‘eps’ figures of:

$16.927m / 74.681m = 22.7cps

With a share price of $3.50, this means Scott’s is currently trading on a projected PE of:

$3.50/ 0.227 = 15.4

Note that this projection does not include the expected future ramp up of Meat Industry Robotics work to be done in association with major shareholder JBS. Compared to some of the sky high valuations on the market at the moment and with much growth to come, something around $3.50 is looking reasonable

SNOOPY