SCT - Scott Tech

[Snoopy]

Snoops …. I think what Scott do is reasonable, problem not that clear

Think retailer like Briscoes ….. Margin (gross) is sales less what the cost of those goods sold …relatively straight forward eh

But Yale Metro Glass where Margin (gross) is sales less the cost of glass (including production/processing) less the cost of glaziers who put the glass in. This basically how Scott calculate their margin I’d say.

Maybe you could look at Scott’s p&l a different way …like recast it as revenues less .’cost of sales’ (calculate that to give the 30% margin) and see what is other stuff is to come to the profit line.

Good thinking. So revenue is $267.526m. 'Group Margin' is 27%. So cost of sales must be: $267.526m x (1-0.27) = $195m

Now, from the 'Consolidated Statement of Comprehensive Income' we learn that 'raw materials, consumables and operating expenses' totalled $158.967m, call it $159m.
So the cost of labour to 'do the job' was: $195m - $159m = $36m.

We also learn that 'Employee Benefits expense' for the year was $79.703m. That means $79.703m - $36m = $44m is spent on non-productive people.

That means a lot more money is being spent on people 'making the tea' and supervising ESG matters than 'doing the job'. That $44m figure no doubt includes CFO Cameron Matthewson as one of the 'chief troughers'?

SNOOPY

[winner69]

Hey Snoops …..Sales and Marketing people get upset if you label them non-productive

[Snoopy]

Based on MHM takeover numbers Forbar reckons Scott value is at least $4.73

“We view SCT's valuation discount to MHM as unjustified, and conservatively believe it should trade at least in line with MHM's multiple,” Lindsay and Twiss stated.

So the valuation has gone up even more since Forbar did their 19th October update? (was $4.47 then)
https://www.forsythbarr.co.nz/assets...ore-growth.pdf

But let's not forget who financed, and is continuing to finance, this ongoing valuation exercise:
"This publication has been commissioned by Scott Technology (“Researched Entity”) and prepared and issued by Forsyth Barr in consideration of a fee payable by the Researched Entity."

And look at those profit projections on the front page of that referenced document. It is a straight line upwards (yeah right), with a near doubling of profits being forecast in just three years time!

Then look at the reference companies from which Forbarr is deriving their comparative ratios from (p6 of that publication). Those comparative norms now seem to be based on large USA based corporations (where did that come from?) Even so the 12m forward PE ratio today looks about right given the SCT price has risen 9% to $3.80 since that report was drafted (so the projected 12 month forward PE is now 17.9, well within comparative norms).

Is the market really undervaluing SCT at $3.80? Only if you believe those 'straight to the sky' profit projections made by a pimply faced lackey using a straight edge as a forecasting tool in a report on Scott funded by themselves.

SNOOPY

[Snoopy]

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.

Year	Dividends as Declared	Gross Dividends	Gross Dividend Total
FY2018	6.0c + 4.0c	8.33c + 5.56c	5.56c
FY2019	6.0c+4.0c	8.33c + 5.56c	13.89c
FY2020 (1)	4.0c (18.41% I) + 0c	5.02c + 0c	5.02c
FY2021	0c + 2c (NI)	0c + 2.00c	2.00c
FY2022	4c (NI)+ 4c (NI)	4.00c + 4.00c	8.00c
FY2023	4c (NI)+ ?c	4.00c + ?c	4.00c
Total			38.5c

Notes

1/ A sample 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)

Discussion

Averaged over 5 years of dividend payments, the dividend works out at 38.5/5 = 7.70c (gross dividend).

I consider that under a more focussed industrial standard product model, an appropriate gross yield return on investment is 7.0%. This means that a 'fair value' for SCT shares, based on the 5 yearly historic dividend record, is:

7.70c / (0.07) = $1.10

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: $1.10 x 1.2 = $1.32
Bottom of Business Cycle Valuation: $1.10 x 0.8 = 88c

SCT shares were trading at $2.75 on Tuesday 15th November as I write this (more than double the upper end of my expected range). By this measure the shares are now ($2.75-$1.10=) $1.65, or 150% 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 150% 'growth premium' (because a capitalised dividend valuation assumes no growth).

This current gross annual dividend rate being modelled of 7.7cps cps, is very close to the current twelve month dividend rate of 8cps. So it may not be reasonable to expect increasing dividends going forwards.

It is clear the market is pricing SCT well above what we might expect from 'a dividend payer'. This means the market clearly believes the growth story. So capitalising the dividend is not a good sole tool to measure the worth of this company.

SCT management do not 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.

Year	Dividends as Declared	Gross Dividends	Gross Dividend Total
FY2019	6.0c+4.0c	8.33c + 5.56c	5.56c
FY2020 (1)	4.0c (18.41% I) + 0c	5.02c + 0c	5.02c
FY2021	0c + 2c (NI)	0c + 2.00c	2.00c
FY2022	4c (NI)+ 4c (NI)	4.00c + 4.00c	8.00c
FY2023	4c (NI)+ 4c (NI)	4.00c + 4.00c	8.00c
FY2024	4c (NI)+ ?c	4.00c + ?c	4.00c
Total			32.6c

Notes

1/ A sample 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)

Discussion

Averaged over 5 years of dividend payments, the dividend works out at 32.6/5 = 6.52c (gross dividend).

I consider that under a more focussed industrial standard product model, with a year's evidence of sound execution, an appropriate gross yield return on investment is now 6.0%. This means that a 'fair value' for SCT shares, based on the 5 yearly historic dividend record, is:

6.52c / (0.06) = $1.09
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: $1.09 x 1.2 = $1.31
Bottom of Business Cycle Valuation: $1.09 x 0.8 = 87c

SCT shares were trading at $3.85 on Tuesday 7th November 2023 as I write this (about triple the upper end of my expected range). By this measure shares are now ($3.85-$1.09=) $2.76 or $2.76/$1.09= 250% 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 250% 'growth premium' (because a capitalised dividend valuation assumes no growth).

This current gross annual dividend rate being modelled of 6.52cps, is a bit below the current twelve month dividend rate of 8cps. Furthermore the expected future restoration of imputation credits (after 3.5 years of none) would suggest the modelled gross dividend return, compared to what is likely, under-states the likely real gross return in the future. That means the modelled growth premium going forwards is actually not likely to be as high as $2.50 per share.

Nevertheless it is clear the market is pricing SCT well above what we might expect from 'a dividend payer'. This means the market clearly 'believes the growth story'. So capitalising the dividend is not a good sole tool to measure the worth of this company.

SNOOPY

[Snoopy]

Snoopy have you seen today's Forbar research on Scott Technology?

You can get it free - care of signing up to MST Access (likewise free). It's company commissioned so take w/ a grain of salt (but in reality one way or another all research is sponsored, directly or indirectly).

A bit behind catching up on the Forbarr analysis of SCT (Muse's heads up was in April). But I have made up for it by reading the latest version.
https://www.forsythbarr.co.nz/assets...ore-growth.pdf

A few statements in that exercise in self funded promotion stood out. From p3
"SCT has now fully its tax losses, so corporate tax rates in the future should normalise toward NZ headline rates."

The revenue from New Zealand operations ($49.864m) only makes up $49.864m/$267.526m = 18.6% of the productive capacity of the company. So why would corporate tax rates head towards the NZ tax rates, when 81.4% of Scott's output are produced in countries like the USA, China, Australia, Belgium the Czech Republic and France? Does this not have implications for the rate of dividend imputation (assumed by ForBarr to be 100%) going forwards?

From p6
"Given its recent revenue growth trajectory and prospects relative to peers, these (valuation) discounts appear unjustified. SCT's revenue rose +21% in FY23 and we forecast a solid +13% increase for FY24. By contrast, companies included in the peer group are expected to grow revenues by an average of +5% over the next year."

While I would love this to be true, why is it that revenue is expected to grow at a rate so far above Scott's comparator companies again? Oh that's right, revenue grew by 21% last year, so just dial down last years growth rate a bit and carry on. But if you look at the growth rate over the last five years (AR2023 p3), the actual compounding annual revenue growth rate at SCT was:
$211,585m(1+g)^5= $267.526m => g=4.8%,

or very close to the 5% industry average that ForBarr talk about. I would also expect growth in Scott's new product sales to be offset by the reduction in revenue from some of the larger more complex projects that Scott have done in the past and are now being phased out. Furthermore even if revenue did grow at these annual +10% heady rates, in the past this has meant more work at overtime rates, and sub contracting. And that means there is not a linear increase in profit rate with revenue rate (you only need to look at European production over FY2023 with segment revenue up 54% while segment profits fell by 3.3%, to see this).

From p1 of the report
"The Materials Handling and Logistics segment had a blockbuster period. This reflected an unwinding of the forward order book due to easing supply chain constraints."

So even ForBarr themselves are saying that much of the MHL division growth from $57.885m to $88.997m = $31.112m was due to a one off catch up situation, even as total company revenue grew from $221,757 to $267.526m = $45.769m over the same period. Take out the one off MHL effect and underlying revenue growth was $45.769m-$31.332m=$14.437m, or $14,437m/ $221.757m = 6.5%. That is still good but only half the growth rate that Forbarr are projecting out into the future for three years in a row!

I am calling BS on the growth rates going forwards assumed in this ForBarr analysis, and the underlying assumption that growth in revenue will necessarily be followed by growth in profits to the same degree. Like it or not, SCT have customers in cyclical industries. Mineral production and the global markets for meat have been very up and down in the past. I don't believe those revenue projections and in particular I don't believe these profit projections out to FY2026 will be met. Revenue trends in these industries do not go up in a straight line like that, they just don't!

By the same token I am not saying SCT will be a poor investment going forward. But successful investing is very much about timing. If only I had bought a parcel of shares in January of this year when the historical PE fell back to that multi year low of 15 and the share price was just $2.50! Oh, hang on, I did do that. I guess what I am saying here is that buying shares in SCT has been most rewarding when the shares are at 'minimum hype'. Going forward with a PE of 18 or 19, where SCT is trading today does not tick the value box for me. And remember it only jumped to these lofty PE levels when a hint for an offer for the whole company that 'might happen' was disclosed to the market in June.

This talk of a private equity offer at 5 bucks? Yes it might happen. But are those Pacific Equity Partner people that stupid? Surely they will have their own people pouring over the books and will not be relying on any ForBarr report. Current Scott CEO JK has already trimmed the dead wood from the company operations. I don't see that loading Scott up with debt, as private equity is prone to do, will help things. In fact it was just such a scenario (insufficient ability to raise cash) that drove Scott into the arms of JBS in 2015.

Of course if that $5 per share offer does come through, then I will immediately get down off my moral high horse and sell out, (as all short term minded kiwi investors are destined to do).

SNOOPY

[Snoopy]

Hey Snoops …..Sales and Marketing people get upset if you label them non-productive

Ah, but who was it that brought up the subject of 'group margin' to start with? There is no need to report such figures, according to accounting reporting conventions. It was Scott's who chose to create these data reference points, and chose not to reveal the methods used to calculate such figures. The only way they could quote such high margin percentages would have been to ring fence out some administrative or service costs to make the 'group margin' look better. Personally I do believe that the administrative core of 'back office guys and gals' does serve a useful function. If Scott's choose to ring fence these people out to boost their 'group margin', then it is Scott's that are calling out their own back office as 'non-productive'.

SNOOPY

[Snoopy]

So what conclusions can I draw from all this information?

The following is a review of the information presented in post 1078.
https://www.sharetrader.co.nz/showth...=1#post1027993

I went through this again yesterday and corrected a transcription error that rippled through the table. It was only a small correction that didn't change the big picture. But I am now satisfied that the whole table, an expansion of the table found in the annual report under 'Segment Information' (AR2023 p47), is correct. Discussion points I note are as follows.

1/ The administrative 'Net Profit Before Tax adjustment' (table row 4) is just my way of allocating 'outside of direct sale costs' back among the operating divisions. My method of doing this will tend to over-allocate costs to areas where less management time is needed to 'keep the ship steaming'. For example, where Scott's has a well established 'standard product' selling into a 'defined market' very little wider input outside of the direct sales and product construction teams will be needed. That means my table may have exaggeratedly estimated, in a negative way, the adjusted earnings from the Australian hub that manufactures 'Bladestop' band saws. For Australia my administrative allocation expense almost wiped out all of the Australian division profit! However, it doesn't change the view that Australia is still a problem hub for Scotts, as evidenced by the careful examination of Australian goodwill highlighted in the Deloitte auditors report (AR2023 p84).

2/ In Europe the administrative 'Net Profit Before Tax adjustment' similarly almost wiped out the European manufacturing hub profit. In this instance, with Europe assuming management control of the USA division, European management would certainly have required more procedural approvals with head office staff. Perhaps more trans-Atlantic flights to keep up the intercontinental contact as well. Furthermore, because the patent protection available for materials handling is somewhat less than the rest of the Scott product portfolio, I think it is very reasonable to assume that revenues are closely correlated with head office 'back up work' hours. I apply a similar argument in reverse to the USA based hub. I do believe that the overall loss making picture that the table shows - taking all relevant costs into account - both in Europe and the USA, is genuine.

3/ The notional tax rate (table row 8) contains what most would see as 'crazy figures'. But I have double checked them and those figures are correct. These figures are based on actual tax expense during the year, which may reflect top up payments from previous years as well as current tax. For example in New Zealand the error in any provisional tax paid is not corrected until the subsequent tax year. The other point to consider is that overseas jurisdictions may not be working on the same allocation of head office expenses that I have used. In the news media this kind of thing often comes under a news heading of 'transfer pricing'. 'Transfer pricing' is normally read about in the context of large multinationals adding exorbitant costs onto their NZ operations to avoid paying tax in New Zealand. However in this instance I am talking about an opposite process called 'transfer costing'. That means that we in NZ Scotts HQ shoulder what are really overseas business costs that Scott's overseas subsidiaries should be incurring, thus increasing tax paid by Scott's in those overseas countries. What good global citizens we are at Scotts to do this! The reason some of those tax percentages in the table look so crazy is that I have allowed for 'transfer costing' (by dint of the way I have redistributed unallocated expenses), but Scotts in their actual tax payments have not. This could explain why the tax bill paid by Scott's Europe is more than 20 times my 'adjusted earnings' for the same period(!).

I have been thinking more on the discussion we have been having on this mysterious metric that Scott have come up with called 'group margin'. The more I think about it, the more I think 'group margin' should be ignored. I don't think you can disregard a whole sub group of business costs just to make your 'margin' (whatever you deem that to mean) look better. Furthermore using a metric like this can lead to what I deem to be inaccurate comments. For example, Slide 15 from PR2023 states:
"Appliance business remains challenging with the overall contribution to group profitability still being marginal."

Yet if we look at my table in post 1078, it is showing the China division, which has been exclusively dedicated to appliance line manufacturing as the second most profitable manufacturing country in the Scott manufacturing hub portfolio, almost the equal of New Zealand! The moral of this story is that 'profitability depends on how you allocate costs'. And 'you should not misallocate (or ignore) certain costs to reinforce your own personal biases'.

One thing that has ballooned out from year to year are the company central administration costs: From $9.959m (FY2022) to $14.835m (FY2023), a rise of 49% in a single year! No wonder Scotts want to leave at least some of these costs out, in their measure of 'group margin' profitability!

Looking at each of the five geographical manufacturing hubs, it is New Zealand showing the best profitability. This will be largely due to the globally unique automated lamb boning unit, soon to be boosted by the well received automatic trussing machine for chickens. Meanwhile, China has just moved to new premises. This should increase project build capacity, and eliminate any need to outsource (at higher cost) work at peak demand.

The European hub assembly facility in the Czech Republic has recently moved to a larger manufacturing premises too. Will this allow Europe to increase sales? Perhaps it is this build program, and the one in China, that has greatly increased underlying administrative costs this year (FY2023)?

I understand the drive to create 'Centres of Excellence' at different locations. No point in 'inventing the wheel' twice on both sides of the world. Yet my vision on the 'Australian Centre of Excellence' remains opaque. Yes the 'Bladestop' technology was designed and invented in Australia. But with Bladestop as a 'standard product', surely it can now be manufactured anywhere? With the wind down on those complex non standard mining application projects, where does that leave Australia's 'core expertise'? Is the real Australian specialty skill now 'losing money'?

Scott aren't big on 'future forecasting', instead preferring to release progress to the market as new opportunities are signed. But I find it worthwhile to cast one's eye over the currency hedging in place (section D1 in the annual report) to get an indicator on the comparative quantum of work on the books. For FY2023, the Foreign Currency Risk Management for Assets (this is I think represents future repatriated revenues) looks very encouraging indeed. Revenue assets booked to be brought home from the USA (Transbotics) and Australia (Bladestop) and China (completed manufacturing lines) are nearly doubling,compared to the previous year. However, we have to remember that such revenue is historically lumpy. So we can't say if this increasing revenue is a definite annual trend. Furthermore, it is early days for forecasting repatriating profits for FY2024. The hedged asset return is still only one quarter of the total FY2023 revenue (perhaps our best guide as a FY2024 revenue measuring stick). Nevertheless these early indications, for what they are worth, would suggest that Scotts are headed for a record year. The share price keeps climbing to all time highs (buyers at $3.93 as I write this). I expect that materials handling on both sides of the Atlantic will return to 'actual net profit after tax' in FY2024 rather than the self calculated 'superior gross margin' that Scotts go on about. Before I sign off on the foreign currency exchange commentary, it is worth remembering we are talking about revenues here and not profits.

The way we go over returns from the just finished financial year in the referred table is, by definition, historical. What is not reflected in these figures is any upside from the fully automated beef boning room project, should it ever come to fruition, or the Caterpillar electric mining truck robotic refuelling project. These are two 'free options' you get to hold by owning Scott Technology shares.

SNOOPY

[BlackPeter]

Snoopy, I agree that this group margin thingee is probably not too useful for investors who want to assess the performance of their holding.

I believe however that it has its justification in internal accounting. I remember seeing managers using basically the same metrics to assess in not so good times, whether a certain deal is making a loss (i.e. the cost of sales are higher than the sales price), is breaking even (cost of sales equal to sales price) or - contributing to the overhead (i.e. cost of sales lower than sales price) - in other words - is the group margin positive or negative?

Investors are obviously interested, whether the company overall (including overhead, warts et all) makes money, but for the individual manager it is important to have some metric for the individual deal.

But again - I am not sure either it makes a lot of sense to gloat with these numbers in the annual report, given that they say little about the performance of the organisation as a whole.

Maybe the fact that they seem to have the need to do this is an indicator for investors? ... run for the hills?

[kiora]

"Gross Margin vs Operating Margin: What's the Difference?
https://www.investopedia.com/ask/ans...ing-margin.asp "

[Snoopy]

"Gross Margin vs Operating Margin: What's the Difference?
https://www.investopedia.com/ask/ans...ing-margin.asp "

Thanks for the reference. I believe Scott's declared 'group margin' is the same as the 'gross profit margin' as described below from the reference.

Gross profit margin, represents the percentage of total revenue a company has left over above costs directly related to production and distribution. The percentage figure is calculated by subtracting those costs from the total revenue figure and then dividing that sum by the total revenue figure.

Operating margin additionally subtracts all overhead and operational expenses from revenues, indicating the amount of profit the company has left before figuring in the expenses of taxes and interest. For this reason, operating margin is sometimes referred to as EBIT, or earnings before interest and tax.

The only problem being, as BP pointed out, as an investor you want to know the profit after all company costs, because as a shareholder you have to pay them all! I.e. you want to know the company's 'Operating margin' and more than that - net profit after tax.

SNOOPY