SCT - Scott Tech

[Snoopy]

Scott's 'have a plan' (see post 1010) and are 'executing the plan'. The flaw in the plan execution is the mediocre (to a Buffett eye at least) return on equity capital. This isn't a surprise for an asset rich manufacturing business, particularly so when war is on the doorstep of the company's largest revenue earner, the Material Handling Automation unit in financially strained Europe. Yet all the of those Buffett tests are by their nature historical. Let's look to the future. What is the contracted 'workload on the books', signed up to at years end?

	Forward Work (1)	Revenue in Following Year
FY2020	$102m	$216,234m
FY2021	$119m	$221.757m
FY2022	$172m	?

Note

1/ Forward Workload is 'contracted activity' taken from slide 4 of FY2022 results presentation (PR2022).

By this indicator, FY2023 is looking to be better than FY2022. Much of this forward work must be in 'Materials Handling', because there is $190m of such equipment on the order book (slide 6 PR2022).

I like to use a 30th September reference date, In the case of SCT, it covers the run up period to when the annual result is released. So there is a good incentive for institutional investors to align their expectations (by buying or selling shares) to bring the share price into line with what is a generally well signalled result. On 30-09-2022, the SCT share price was $2.80. That means the company was trading on a normalised historical PE ratio of: $2.80/$0.169= 16.6. This is a big drop from the equivalent historical PE ratio of last year (20.9) and is the lowest PE ratio Scott's have traded on since 2015. Nevertheless a PE ratio of 16.6 is not cheap, and implies significant future growth.

An alternative way to price growth is to create a 'no growth' valuation. The difference between the share price and the 'no growth' valuation is therefore the market priced 'growth premium'. The 30-09-2022 actual Capitalised Gross Yield for SCT (post 1014) is 7.7c / $2.80 = 2.75%.

	Share Price equals	Capitalised Dividend Value plus	Implied Growth Premium
30-09-2021	$2.85	$1.27	$1.58 (+124%)
30.09-2022	$2.80	$1.10	$1.70 (+155%)

By this measure, despite the share price being lower than last year, the market growth premium has increased.

What do I make of all this? Buffett is looking for a good return on equity. CEO John Kippenberger is working towards that goal, but is not there yet. So Buffett is off elsewhere seeking out suitable investment gems. What about we shareholders on the register already? We are waiting for growth while being paid just under 3% on our invested capital while we wait. Last year, with interest rates still near their record lows, that would have sounded OK. This year, if you pick the right bank, you can earn 5% on your term deposit money. So a 3% gross dividend yield doesn't cut it. It only makes sense to hold SCT today if you believe in the growth story. Finally if you do believe in that growth story, you have to decide what is a fair price to pay for that growth story.

If I look at the compound 'eps' growth rate 'g' over the last 5 years:

12.0cps(1+g)^5= 16.9cps => (1+g)^5 = 1.40 => g= 7.1%

To me paying a PE of more than 15 is a high price to pay for that level of growth. Granted the level of eps growth was higher last year: 16.9cps/14.2cps= 119% (or +19%). But 19% is the highest normal operating eps growth for the company on record. I am expecting growth going forwards to moderate. So I think that an SCT share price of $2.80 with an implied PE of 16.6 looks about right. SCT is a 'hold' for me at $2.80.

This post is the wrap on the results of the four FY2023 Buffett Tests recorded in posts on this thread: 1077, 1069, 1073, and 1075. Scotts has passed the significant business scale test, the increasing earnings per share test and the ability to raise margins above the rate of inflation test. But Scotts has failed the return on shareholder equity test. Unfortunately one failure means 'overall failure' which is not quite as bad as it sounds (it just means I can't use the Buffett inspired compounding earnings model to predict the share price going forwards).

All of those Buffett tests are by their nature historical. Let's look to the future. What is the contracted 'workload on the books', signed up to at years end?

	Forward Work (1)	Actual Revenue in Following Year
FY2020	$102m	$216,234m
FY2021	$119m	$221.757m
FY2022	$172m	$267.526m
FY2023	$179m	?

Note

1/ Forward Workload is 'contracted activity' taken from slide 4 of the FY2023 results presentation (PR2023).
By this indicator, FY2023 is looking to be better than FY2022, albeit the increase is a modest 4% (fairly flat if you consider inflation).

I like to use a 30th September reference date. In the case of SCT, it covers the run up period to when the annual result is released. So there is a good incentive for institutional investors to align their expectations (by buying or selling shares) to bring the share price into line with what is a generally well signaled result. On 30-09-2023, the SCT share price was $3.23. That means the company was trading on a normalised historical PE ratio of: $3.23/$0.193= 16.7. This is consistent with FY2022 and is still the lowest PE ratio Scott's have traded on since 2015 (Note: As of 8th November 2023 the share price has risen to $3.88). Nevertheless even a PE ratio of 16.7 is not cheap, and implies significant future growth.

An alternative way to price growth is to create a 'no growth' valuation. The difference between the share price and the 'no growth' valuation is therefore the market priced 'growth premium'. The 30-09-2022 actual Capitalised Dividend Valuation for SCT (post 1094)
sees 'fair value' for SCT shares, based on the 5 yearly historic dividend record, to be averaged earnings divided by acceptable gross yield: 6.52c / (0.06) = $1.09

	Share Price equals	Capitalised Dividend Value plus	Implied Growth Premium
30-09-2021	$2.85	$1.27	$1.58 (+124%)
30.09-2022	$2.80	$1.10	$1.70 (+155%)
30.09-2023	$3.23	$1.09	$2.14 (+196%)

The market growth premium for Scott's has increased greatly from FY2022. Scotts historical gross dividend yield (8.0c / $3.23) is at our reference date 2.5%. A 2.5% gross dividend yield doesn't cut it in today's much higher interest rate market. It only makes sense to hold SCT today if you believe in the growth story. Finally if you do believe in that growth story, you have to decide what is a fair price to pay for that growth.

If I look at the compound 'eps' growth rate 'g' over the last 5 years:

13.4cps(1+g)^5= 19.3cps => (1+g)^5 = 1.44 => g= 7.6%

To me paying a PE of more than 15 is a high price to pay for that level of growth. Granted the level of eps growth last year was good: 19.3cps/16.9cps= 114% (or +14%). Yet 14% is a growth moderation from the somewhat heady record of 19% eps growth over FY2022. So I think that an SCT share price of $3.23 with an implied PE of 16.7 looks about right. If the share price sank to $2.90 for an historical PER of 15, then I would consider SCT a 'buy'. Today's price, being almost a dollar higher than that $2.90 figure can only be justified on takeover speculation IMV.

SNOOPY

[Sideshow Bob]

https://www.nzx.com/announcements/421550

In June, the company commenced a strategic review of its ownership structure with a view to exploring options to maximise value for all shareholders. As part of this process, the company engaged with a group of potentially interested parties in relation to transactions involving an offer to all shareholders for their shares in Scott.

Those discussions will not progress further at this time, as no offers were received at price ranges which reflected the independent directors’ view of value for all of the company. However, a range of other initiatives have been identified during the process. These are at an early stage and will continue to be worked on by the company, together with its advisers. There can be no certainty that any transaction will result from the continuing strategic review and no further comment will be made by the company in respect of the strategic review at this stage.

The Board remains committed to the Scott 2025 strategy and believes the ongoing implementation of the strategy will continue to drive value for shareholders.

[Snoopy]

https://www.nzx.com/announcements/421550

In June, the company commenced a strategic review of its ownership structure with a view to exploring options to maximise value for all shareholders. As part of this process, the company engaged with a group of potentially interested parties in relation to transactions involving an offer to all shareholders for their shares in Scott.

Those discussions will not progress further at this time, as no offers were received at price ranges which reflected the independent directors’ view of value for all of the company. However, a range of other initiatives have been identified during the process. These are at an early stage and will continue to be worked on by the company, together with its advisers. There can be no certainty that any transaction will result from the continuing strategic review and no further comment will be made by the company in respect of the strategic review at this stage.

The Board remains committed to the Scott 2025 strategy and believes the ongoing implementation of the strategy will continue to drive value for shareholders.

Oooooh! That news release was at 11:04am. So all those smart suited investment advisors would either be in client meetings or preparing for an early lunch. The Scott share price could still be in for a 'high dive' after that lunch is digested as the speculators bail out. I see last sale was at $3.85, but there are now sellers at $3.82. I have to say I am somewhat relieved as I wasn't looking forward to having more investor capital to reallocate, when I would rather carry on for the ride. It would have been a shame to see an end to what has become my 26 year long shareholder relationship with Scotts (although average capital holding time is a 'mere' 15 years). Sentimental? Maybe. But even as a 'buy and hold' investor at heart, I have had a couple of capital reallocation exercises along the way. Just checked my records and my current average buy price for my SCT shares is 83.0c. So if the takeover had gone through, I would have been looking at near to a 'five bagger'. An overnight success after 26 years!

The wording in these press releases always interests me. Those 'potentially interested parties', sought out by Scotts (not the other way around I note) if indeed they were those private equity guys as touted in the AFR, couldn't see a way to make a 'quick buck'. So I guess that is a back handed compliment to Scott's current management and direction.

I wonder what can be read into the 'other issues identified'? Unless there is an offer for the whole company, I can't see a way for majority shareholder JBS to exit at a good price, which was presumably the aim when the strategic review started.

SNOOPY

[Snoopy]

To me paying a PE of more than 15 is a high price to pay for that level of growth. Granted the level of eps growth last year was good: 19.3cps/16.9cps= 114% (or +14%). Yet 14% is a growth moderation from the somewhat heady record of 19% eps growth over FY2022. So I think that an SCT share price of $3.23 with an implied PE of 16.7 looks about right. If the share price sank to $2.90 for an historical PER of 15, then I would consider SCT a 'buy'. Today's price, being almost a dollar higher than that $2.90 figure can only be justified on takeover speculation IMV.

Started the day at $3.90. Ended the day at $3.66 down 6.2% for our 'market leader', (i.e. SCT 'leading the market down' today). Take out that off market trade and on market volume was pitiful. If those speculators 'want out' some swallowing of pride will be required. Down another 6.2% tomorrow would see the price settle at $3.43. Now hanging onto my top ten position in the stock picking competition by my fingernails at no.10. SCT getting closer to that $3,23 price I regard as 'fair value'.

SNOOPY

[winner69]

SCT barely covers it cost of capital ……..as such shouldn’t trade much above Book Value of $1.40 unless the market believes the future is going to be phenomenal

Current share price of $3.66 is outrageous

And the guru directors obviously think it’s should be lot higher …oh well

[Snoopy]

SCT barely covers it cost of capital ……..as such shouldn’t trade much above Book Value of $1.40 unless the market believes the future is going to be phenomenal

Current share price of $3.66 is outrageous

I ask a lightly different question. What will be the cost of capital at SCT be when interest rates fall a couple of percentage points and the increasingly reliable cashflow stream wipes out some of that share price volatility? You invest on that basis rather than worrying about what the cost of capital might be at SCT today. All those cost of capital calculations are always retrospective anyway. Get up to date and you will see the cost of capital going forwards will be about 6%. Invest on that basis.

And the guru directors obviously think it’s should be lot higher …oh well

I have gone back to October 2015 and the last offer for Scott's made by JBS for control. The Northington Partners valuation was made on the basis of an EBITDA multiple of between 7.5x and 8x. Of course that was pre-IFRS16. So we have to back those lease payments (now regarded as interest payments) out of present day income figures.

Operating EBITDA was declared as $30.374m for FY2023. We have to take away from that the 'total cash outflow from leases' ($4.040m) and the interest expense on lease liabilities ($0.528m). That gives us a pre-IFRS16 EBITDA of $30.374m - $4.040m - $0.528m = $25.806m. This gives an upper and lower bound 'per share' valuation of:

(7.5 x $25.806m)/ 81.198m = $2.38 (lower bound)
(8.0 x $25,806m)/ 81.198m = $2.54 (upper bound)

I can see why Scotts did not go back to get a company valuation from Northington Partners this time!

SNOOPY

[Muse]

Any need to deduct net debt from the enterprise value? Havent looked at the northington valuation but from your paragraph above would appear they calc’d an EV using an ebitda multiple, from which one would deduct net debt to derive an equity value using that approach

[Snoopy]

Any need to deduct net debt from the enterprise value? Havent looked at the northington valuation but from your paragraph above would appear they calc’d an EV using an ebitda multiple, from which one would deduct net debt to derive an equity value using that approach.

I had a more careful look at the Northington valuation Muse. I thought it was just a straight EBITDA multiple valuation. But it turns out you are right. I do have to take off debt. So thanks for the correction.

I have gone back to October 2015 and the last offer for Scott's made by JBS for control. The Northington Partners valuation was made on the basis of an EBITDA multiple of between 7.5x and 8x. Of course that was pre-IFRS16. So we have to back those lease payments (now regarded as interest payments) out of present day income figures.

Operating EBITDA was declared as $30.374m for FY2023. We have to take away from that the 'total cash outflow from leases' ($4.040m) and the interest expense on lease liabilities ($0.528m). That gives us a pre-IFRS16 EBITDA of $30.374m - $4.040m - $0.528m = $25.806m.

Bank debt at balance date (EOFY2023) was: Bank Overdraft $9.036m. Non-current borrowings $11.324m.. => Total Debt = $20.360m

This gives an upper and lower bound 'per share' valuation of:

[(7.5 x $25.806m)-$20.360m]/ 81.198m = $2.13 (lower bound)
[(8.0 x $25,806m)-$20.360m]/ 81.198m = $2.29 (upper bound)

I can see why Scotts did not go back to get a company valuation from Northington Partners this time (same conclusion as before)!

SNOOPY

[winner69]

Share price down again today. ……. A few days ago getting close to 400 ….Close today 349 ………heading back to 300 I reckon

Was about 260 when they said they were trying to hock off the company …..so 300 with not suitors seems reasonable

[Snoopy]

Time to bring a measuring stick to Scotts via my annual 'battle of the manufacturers' with Skellerup. Scotts is different in that it sells complete package solutions and not components. But it is the same in that both companies have a similar geographic market spread and rely on Intellectual Property and trusted staff that can turn that knowledge into profits.

	Skellerup (SKL)	Scott Technology (SCT)
Operational Sector	Manufacturing	Manufacturing
Total Employees	869	633
Manufacturing Hubs	NZ, Australia, Europe, North America, Asia	NZ, Australia, Europe, North America, Asia
Share Price 27-11-2022	$5.45	$2.65
Market Capitalisation 27-11-2022	$1,064m	$212m
Capitalised Dividend Valuation per share (2018.5 to 2022.5)	$2.57	$1.10
Declared earnings (FY2022)	$47.813m	$12.657m
Normalised earnings (FY2022)	$47.205m	$13.510m
Normalised eps (FY2022)	24.1c	16.9c
Normalised eps growth over 5 year period (FY2017 to FY2022)	+136%	+40.8%
Historical PE (FY2022)	22.3	16.6
dps (paid during FY2022)	10.5c+7.5c	4c+4c
Earnings Payout Ratio (excluding DRP)	75%	47%
Gross dps (paid during FY2022)	12.54c+8.96c	4c+4c
Historical Gross Dividend Yield (using Share Price 29-11-2022)	3.94%	3.02%
Shareholder Equity (based on equity at EOFY2022)	$211.208m	$100.406m
ROE (based on equity at EOFY2022)	22.4%	13.5%
Sales (FY2022)	$316.829m	$221.757m
Net Profit Margin (FY2022)	14.9%	6.1%
Total Bank Debt (last balance date EOFY2022)	$40.000m	$11.970m
MDRT (Based on bank debt at balance date EOFY2022)	0.84 years	0.94 years

Scotts and Skellerup form the 'tech' part of my portfolio. And since tech investments are frequently dressed up as 'exciting prospects' it is easy for we 'investors in tech' to get overly enthusiastic. This 'head to head' exercise has the objective of putting two of the longer serving listed players in the tech sector up against each other, both as a snapshot of performance, but also to check that some of those market set metrics have not got over-enthusiastically 'out of line.' Scotts sells complete package solutions. Skellerup concentrates on critical components which have a substantial rubber or silicone or foam content . But both companies have a similar geographic manufacturing and market spread and rely on Intellectual Property and trusted staff that can turn that knowledge into profits. The first task is to line up the raw data.

	Skellerup (SKL)	Scott Technology (SCT)
Operational Sector	Manufacturing	Manufacturing
Total Employees	807	656
Manufacturing Hubs	NZ, Australia, Europe, North America, China	NZ, Australia, Europe, North America, China, Vietnam
Share Price 14-11-2023	$4.96	$3.49
Market Capitalisation 14-11-2023	$973m	$283m
Capitalised Dividend Valuation per share (2019.5 to 2023.5)	$3.38	$1.09
Declared earnings (FY2023)	$50.941m	$15.436m
Normalised earnings (FY2023)	$53.501m	$15.702m
Normalised eps (FY2023)	27.3c	19.3c
Normalised eps growth over 5 year period (FY2018 to FY2023)	+82.0%	+58.2%
Historical PE 14-11-2023 (FY2023)	18.1	18.0
dps (paid during FY2023)	13.0c+8.0c	4c+4c
Earnings Payout Ratio (excluding DRP)	75%	47%
Gross dps (paid during FY2023)	12.54c+8.96c	4.00c+4.00c
Historical Gross Dividend Yield (using Share Price 14-11-2023)	4.33%	2.29%
Shareholder Equity (based on equity at EOFY2023)	$225.426m	$113.899m
ROE (based on equity at EOFY2023)	23.7%	13.8%
Sales (FY2023)	$333.537m	$225.436m
Net Profit Margin (FY2023)	16.0%	5.9%
Total Bank Debt (last balance date EOFY2023)	$43.924m	$12.475m
MDRT (Based on bank debt at balance date EOFY2023)	0.86 years	0.81 years

SNOOPY