SCT - Scott Tech

[Waltzing]

Your story tells me a possible SKL but hasnt performed yet.

[Snoopy]

I am not sure SCT management see themselves as a 'no growth' company. But as investors I think it is reasonable to assess the company as a dividend payer only to get some idea of value.

The calculation to work out the equivalent gross figure for the FY2020s unimputed dividend, is as follows:

FY2020 Dividend P.I.: 4.0c (18.41% imputed, 18.41%/28%= 0.6575)
= 2.63c (FI) + 1.37c (NI)
= 2.63c/0.72 + 1.37c = 3.65c + 1.37c = 5.02c (gross dividend)

Year	Dividends as Declared	Gross Dividends	Gross Dividend Total
FY2016	5.5c+4.0c	7.64c + 5.56c	13.20c
FY2017	5.5c+4.0c	7.64c + 5.56c	13.20c
FY2018	6.0c+4.0c	8.33c + 5.56c	13.89c
FY2019	6.0c+4.0c	8.33c + 5.56c	13.89c
FY2020	4.0c (18.41% I) + 0c	5.02c + 0c	5.02c
Total			59.2c

Averaged over 5 years, the dividend works out at 59.2/5 = 11.8c (gross dividend).

I have given some thought as to whether I should revise my sought for "gross yield" in this new environment of very low interest rates. I think that given the trade wars and the inability to move production from affected international production sites, I should not do this.

So based on my previously selected sought after 7.5% gross yield over an historic five year business cycle window, 'fair value' for SCT is:

11.8 / (0.075) = $1.57

Now using my plus and minus 20% range to get a feel how the SCT share price might behave at the top and bottom of its business cycle.

Top of Business Cycle Valuation: $1.57 x 1.2 = $1.89
Bottom of Business Cycle Valuation: $1.57 x 0.8 = $1.26

SCT shares were trading at $1.84 on Friday 22nd May (near the upper end of my expected range) and are IMO now fully valued (from a business cycle projected dividend income perspective). With big capital spending programs on hold for many customer companies, and dividends from more buoyant years boosting my valuation, a significant recovery in business is already priced into SCT shares as they trade today The growth story, if it still exists, has not been priced in though.

I don't think SCT management see themselves as a 'no growth' company. But as investors I think it is reasonable to assess the company as a 'dividend payer only' to get some idea of value.

The calculation to work out the equivalent gross figure for the FY2020s partially imputed dividend, is as follows:

FY2020 Dividend P.I.: 4.0c (18.41% imputed, 18.41%/28%= 0.6575)
= 2.63c (FI) + 1.37c (NI)
= 2.63c/0.72 + 1.37c = 3.65c + 1.37c = 5.02c (gross dividend)

Year	Dividends as Declared	Gross Dividends	Gross Dividend Total
FY2016	5.5c+4.0c	7.64c + 5.56c	5.56c
FY2017	5.5c+4.0c	7.64c + 5.56c	13.20c
FY2018	6.0c+4.0c	8.33c + 5.56c	13.89c
FY2019	6.0c+4.0c	8.33c + 5.56c	13.89c
FY2020	4.0c (18.41% I) + 0c	5.02c + 0c	5.02c
FY2021	0c + ?c	0c + ?c	0c
Total			51.56c

Averaged over 5 years of dividend payments, the dividend works out at 51.56/5 = 10.3c (gross dividend).

I have given some thought as to whether I should revise my sought for "gross yield" in this new environment of very low interest rates. I think that given the trade wars and the inability to move production from affected international production sites, I should not do this. The cancelling of the last two dividend payments from Scotts, I think, shows that a relatively high discount rate on those dividends that were paid is required.

So based on my previously selected sought after 7.5% gross yield over an historic five year business cycle window, 'fair value' for SCT is:

10.3 / (0.075) = $1.37

Now using my plus and minus 20% rule of thumb range to get a feel how the SCT share price might behave at the top and bottom of its business cycle.

Top of Business Cycle Valuation: $1.37 x 1.2 = $1.64
Bottom of Business Cycle Valuation: $1.37 x 0.8 = $1.10

SCT shares were trading at $2.33 on Tuesday 29th December (well above the upper end of my expected range) and are now at least 30% overvalued (from a business cycle projected dividend income perspective). Another way of interpreting the same information is to say that SCT shares currently contain a 30% growth premium (because a capitalised dividend valuation assumes no growth).

History would show that such a growth premium can be justified, in my view. But such a premium also assumes successful, and profitable, execution of the growth plan. Given the much slower roll out (or even failure) of the automated beef boning room project, and an unlikely rapid bounce back in Europe, I am glad that I acquired my SCT shares at an average price of just 72.6cps (admittedly over a more than 10 year average acquisition timeframe). I still 'believe the story' which is why I am holding. But I now can't rule out a further 'down leg' before the eventual recovery.

SNOOPY

[Snoopy]

I might argue that 'cashed up' and 'with regional and global expansion plans in place' is a good description of Scott's position since it listed in the 1990s!

It is only in recent times, with the acquistion of Robotworx (USA) and MAR (Oz) that the balance sheet has been looking strained. Now fixed of course with the cash issue. Scott's need a strong balance sheet, because they need to be able to fund projects with a time lag from many months to one to two years between 'receiving an order' and 'delivery and payment'. In this business having access to plenty of cash is a necessity. 'Ambitious' I will grant you, although Scott's have been 'pushing the limits' in engineering terms right back to the early production systems days.

Today's shareholders might be interested in how my perspective on Scott's has changed from four years ago. Under new CEO John Kippenberger, they have been told to be less ambitious, go thoroughly over new project risks before quoting a price, and if possible stick to building stuff they already know how to do well - like the 'Bladestop' band saws.

Is their relationship with their bankers fraught? Section C3 in AR2020 discloses that their main source of funding through ANZ is being 'renegotiated'. The ANZ debt facility of $19.7m is only drawn to $5.2m. So I wonder if the 'renegotiation' is at the behest of ANZ and not Scott's management?

Supporting this view is that post Covid-19, Scott's have had to draw on their majority shareholder. JBS Australia, for a $10m loan facility drawn to $2m. That quantum of loan looks to be well within the scope of the existing ANZ arrangement. So it reads like ANZ are unhappy with Scotts. Given JBS Australia is itself under pressure, after being locked out of Chinese meat export markets, I hardly think that JBS will be in a position to lend to Scotts at less than bank rates.

In pre Covid-19 days, I might have suggested that Scott's are in breach of their banking covenants. That kind of thing can happen with a dramatic fall in earnings. But as we know that can't happen now because, post Covid-19, banks have become much more 'lovey dovey' and 'friendly' and want to work with their clients.

SNOOPY

[Snoopy]

Is their relationship with their bankers fraught? Section C3 in AR2020 discloses that their main source of funding through ANZ is being 'renegotiated'. The ANZ debt facility of $19.7m is only drawn to $5.2m. So I wonder if the 'renegotiation' is at the behest of ANZ and not Scott's management?

Trouble at Scott's?

https://stocknessmonster.com/announc...ct.nzx-367972/

It appears the Chief Operating Officer, Chris Steedman, has been sacked. 'Virtual Command' from afar is not working.

SNOOPY

[Beau]

Must be hard to run 4 different regions from home base. Got to be more efficient to have Regional Director in each region. Especially with travel at present time. You would wonder why that wouldn’t be in place anyway.

[Snoopy]

Must be hard to run 4 different regions from home base. Got to be more efficient to have Regional Director in each region. Especially with travel at present time. You would wonder why that wouldn’t be in place anyway.

I think it was in place. There were four regional directors reporting to Chief Operating Officer, Chris Steedman. I understood it was the plan to have regions as 'centres of excellence' for particular kinds of jobs. Thus being able to control them from the point of view of an inter-regional Co-Ordinator made sense. Not sure what happens now? All the regions just 'do their own thing' with no co-ordination or oversight?

SNOOPY

[fastbike]

Press release from 1 May 2020

Scott Technology Limited is pleased to announce the appointment of Chris Steedman as Chief
Operating Officer, commencing 1 June.
...
This is an absolutely critical role for any successful organisation of Scott’s size and complexity and I am
excited to have someone of Chris’s calibre to drive operational excellence throughout our business.
Improvements in our processes and capabilities will help manage design risk, while driving production
efficiencies and better outcomes for our customers.

Yesterday's release says

The Board of Directors wishes to advise that the role of Chief Operating Officer, previously held by Chris Steedman, has been disestablished.

All reference to him in the "Our People" page has been excised.

So what has changed such that the absolutely critical role is no longer needed 7 months later ?

[Snoopy]

The major ramp up in work with JBS has never happened. I think this is because the automated beef boning room project has never been completed. But even without that I was still thinking $3.50 is possible, providing the existing businesses operate to their potential at the same time.

Getting all divisions synchronised and doing well might be a pipe dream. But I still believe a share price of around $3 is possible within a year or two. The problem is earnings supporting that kind of share price certainly won't happen in FY2021. So SCT looks overpriced on that basis. But if you look further out there has to be a recovery, because the sort of projects that Scott's do are really needed! This is my basis for continuing to hold against a bleak immediate picture. Given the share market is always forward looking, we still might get some price action in CY2021. This is my basis for selecting SCT in this years 'beat the brokers' competition.

If you look at any portrait of CEO John Kippenberger, you can see he knows a bit about 'getting a good haircut'. The half year result shows that the razor blade approach to Covid-19 may have been what was needed at Scotts. The figure that stood out for me on the income statement was this.

	HY2021	HY2020
Employee Benefits Expense	$30.059m	$38.242m

Add back the comparative half year's '$12.212m of restructuring expenses and you have the 'total explanation' of the near $20m HY2021 to HY2020 profit turnaround. Net debt is down to a meagre $2.9m (c.f $20.9m at the last full year balance date) , which I guess must have appeased their ANZ bankers enough to agree to a new funding package going forwards.

It is the nature of Scott's big ticket business projects that debt does go up and down over many months of construction. One thing I have never quite got my head around on the balance sheet is how the 'Contract Assets' ($12.264m) relate to the 'Contract Liabilities' ($16.385m). ''Contract liabilities', are a separate balance sheet category from 'Trade creditors and accounts'. These terms are clarified in section B3 of AR2020.

1/ Contract Assets are balances due from customers under under long term project contracts that arise when the group receives payments from customers in line with a series of performance related milestones.

2/ Any amount previously recognised as a 'contract asset' is reclassified as a trade debtor at the point at which it is invoiced to the customer.

3/ A Contract Liability, as part of a long term project contract, arises if a particular milestone payment exceeds the revenue recognised to date.

I could be overthinking this. But I think what the balance sheet is telling me is that Scott's have booked:

$16.385m - $12.264m = $4,121m

of profit at the half year that they haven't really earned yet. And when the declared total half year NPAT is $4.714m, that means the real half year profit figure is a rather paltry $0.593m. Could that explain why the nevertheless welcome half year dividend of 2cps is unimputed? I guess it all goes to show that there are still some smoke and mirrors available when it comes to cashing up work from these big projects?

Taking the half year progress report at face value, I have to be satisfied with the the position of the company as it has adapted to the Covid-19 shock. The sharemarket reaction has ensconced me firmly inside the top 50 in the annual share pickers competition too, which is more than I hoped for at this point in the competition. But has Mr Market right now rewarded CEO JK a little ahead of where he and the company deserves to be?

SNOOPY

P.S. What happened to the old 'Scott Tech looking cheap' thread header? I thought it encapsulated the Scottish attitude to business rather appropriately!

[Snoopy]

It is the nature of Scott's big ticket business projects that debt does go up and down over many months of construction. One thing I have never quite got my head around on the balance sheet is how the 'Contract Assets' ($12.264m) relate to the 'Contract Liabilities' ($16.385m). ''Contract liabilities', are a separate balance sheet category from 'Trade creditors and accounts'. These terms are clarified in section B3 of AR2020.

1/ Contract Assets are balances due from customers under under long term project contracts that arise when the group receives payments from customers in line with a series of performance related milestones.

2/ Any amount previously recognised as a 'contract asset' is reclassified as a trade debtor at the point at which it is invoiced to the customer.

3/ A Contract Liability, as part of a long term project contract, arises if a particular milestone payment exceeds the revenue recognised to date.

I could be overthinking this. But I think what the balance sheet is telling me is that Scott's have booked:

$16.385m - $12.264m = $4,121m

of profit at the half year that they haven't really earned yet. And when the declared total half year NPAT is $4.714m, that means the real half year profit figure is a rather paltry $0.593m. Could that explain why the nevertheless welcome half year dividend of 2cps is unimputed? I guess it all goes to show that there are still some smoke and mirrors available when it comes to cashing up work from these big projects?

Ah so no-one spotted the deliberate ;-) mistake in the above? Or maybe I am the last SCT shareholder left on the forum, so no-one cares?

Those 'Contract Assets', 'Contract Liabilities' and 'Trade Liabilities' are revenue figures, not profit figures. There are some occasions where revenues equal profits. Sometimes Scotts do what in effect is prototyping work that gets written off, but is later exhumed at zero cost and transformed into a customer solution down the line. Generally though you have to multiply the 'revenue' by the 'profit margin' to understand the effect on profits of the accounting shenanigans that I am describing above.

The profit margin for Scotts in the FY2021 half year was:

NPAT / Revenue = $4.714m / $104.486m = 4.512%

Using this number will likely overstate the profits on these big projects, because we know that JK is trying to shift the company to making more 'standard' equipment sales where technical risk is known and profits are greater. Nevertheless I won't try to be clever and attempt to judge how low the real profit margin is for these jobs on the books.

That means of the $4.121m of revenue that I am claiming Scott's has booked in advance, the profits booked in advance associated with that are likely to be:

0.04512 x $4.121m = $0.186m

Not nothing, but a figure that amounts to 4% of profit, not 87% of profit as I had calculated previously. Phew! I am further comforted by the fact that the 'Recognition of Revenue on Long Term Projects' remains a 'key audit matter' for auditors Deloitte.

SNOOPY

[bullfrog]

Ah so no-one spotted the deliberate ;-) mistake in the above? Or maybe I am the last SCT shareholder left on the forum, so no-one cares?

Those 'Contract Assets', 'Contract Liabilities' and 'Trade Liabilities' are revenue figures, not profit figures. There are some occasions where revenues equal profits. Sometimes Scotts do what in effect is prototyping work that gets written off, but is later exhumed at zero cost and transformed into a customer solution down the line. Generally though you have to multiply the 'revenue' by the 'profit margin' to understand the effect on profits of the accounting shenanigans that I am describing above.

The profit margin for Scotts in the FY2021 half year was:

NPAT / Revenue = $4.7m / $104.5m = 4.5%

Using this number will likely overstate the profits on these big projects, because we know that JK is trying to shift the company to making more 'standard' equipment sales where technical risk is known and profits are greater. Nevertheless I won't try to be clever and attempt to judge how low the real profit margin is for these jobs on the books.

That means of the $4.121m of revenue that I am claiming Scott's has booked in advance, the profits booked in advance associated with that are likely to be:

0.045 x $4.121m = $0.185m

Not nothing, but a figure that amounts to 4% of profit, not 87% of profit as I had calculated previously. Phew! I am further comforted by the fact that the 'Recognition of Revenue on Long Term Projects' remains a 'key audit matter' for auditors Deloitte.

SNOOPY

You’re not the only Scott supporter! Really appreciate your insights into the financials.

My understanding is if a contract milestone payment exceeds revenue received, Scott has paid a subbie or for materials in advance of billing the client for the work, therefore it’s a liability until the client pays for it. I’d classify that as WIP, and is a risk and should not included in profit calcs.