SCT - Scott Tech

[Snoopy]

I went to the AGM (best food and wine of any I have attended, a bad sign?)

Perhaps the 'grub upgrade' was because SCT were not putting money into renting an AGM venue? That meant they could put that AGM budget towards food and drink?

I am not in a position to compare myself. Despite being an SCT shareholder since July 1997, this year was the first time that I have made the long trek down to Dunedin to attend an Otago based AGM in person. I made the trip because I wanted to take the first opportunity for shareholders to inspect the brand new Dunedin premises. That and to try and get a handle on how the 'automation division', which is headquartered there, really operates.

The new Dunedin HQ, I found to be spacious, modern and clinical in construction. On a present day profit basis you would have to class the 'automation division' as the underperformer of the three business units (the other two being 'Appliance Manufacturing Lines' and 'Rocklabs'). We learned that since 2001 SCT and what is now Silver Fern Farms have invested and written off around $14m in joint venture meat industry robotics, via joint venture company 'Robotic Technologies Limited'. SCT have a 50% share in that joint venture. So that means around $7m of SCT shareholders funds have been spent here and are now gone. $7m is over twice the sum of the net profits of SCT from 2004 to 2009 inclusive. So we are not talking about an insignificant sum of money here.

Is it fair to judge the 'automation division' like this? Probably not. But CEO Chris Hopkins did answer a question on how this 'joint venture business structure' works in practice. According to Hopkins, development money is always written off unless there are tangible cashflows available in the future. In the case of the X-ray grading machine, SCT gets 5c per carcass out of the 'super profits' that result from optimally processing carcasses robotically. This greater yield improves further in relative terms as human workers tire during their shift. 5c per carcass may not sound like much. In terms of the $3 per carcass value gain that has been independently verified in Australia it isn't. But taken over thousands, indeed millions, of carcasses, then what SCT have is a reliable ongoing income stream. This ongoing income stream is represented as a capitalized 'intangible asset' of the kind described under note 11(i) on page 30 of the 2009 SCT annual report. In addition to this SCT gets a fixed margin on the engineering work they carry out for the joint venture RTL. In this way SCT get two bites at the technology cherry.

By contrast another joint venture 'Scott Milktech' (61% owned) has been set up to look at automated solutions in the dairy industry. With nothing close to commercialization as yet, all of the expenses incurred by Scott Milktech have been written off to date.

These joint venture structures are of obvious benefit in the initial commercialization phase of robotic industry technology. The ability to have meat industry players alongside you as marketers is what has allowed Silver Fern's rival Alliance Group to become sold as a customer on a concept that might have once been regarded as something from an engineer's fantasy playground. And now the third step on the way to the automated boning lamb room, the 'Knuckle Tipper', is well underway.

I am not 100% convinced that as the commercialization of the technology progresses, that these joint venture companies will prove the best structures going forwards. Hopkins made it very clear to those who heard his AGM presentation that the board is very aware of getting a return on shareholders funds. And that doesn't rule out the possibility of selling out of a joint venture like 'Robotic Technologies Limited' in the future if it is in the interests of SCT shareholders to do so. Of course 'selling out' does not mean abandoning robotic technology development in the meat industry. I think we are talking here more of streamlining the way this technology is marketed, and carrying on the technological development on a contract basis.

We were told that $10m of Automation Technology is on the order books as we work through FY2010. How much of that translates to net profits for FY2010, it will be interesting to see.

SNOOPY

discl: hold SCT

[Snoopy]

The Directors of Scott Technology Limited advise that the company is to reduce staff numbers by approximately twenty across its Dunedin and Christchurch sites. Three quarters of these redundancies are voluntary.

Following the completion of this process, Scott Technology Limited's staff numbers will be approximately 60 in Dunedin, 70 in Christchurch and 35 at newly acquired subsidiary, Rocklabs, in Auckland; a total of approximately 165 staff.

Yours faithfully

Chris Hopkins
Managing Director
Time:2008-06-27:16:05:50

That was a quote from 18 months ago, and my how things have changed in the outlook! The reason I have brought up this old quote is because there has been a lot of emphasis on company turnover by SCT when quoting jobs in the pipeline. $40m of orders going through each year for SCT does look doable going forwards, even if they don't quite make $40m for FY2010. If we look back to the last time turnover was that high, in FY2003 and FY2004, $40m turnover equated to profits of some $4.7m (around 20cps in those days).

But there have been significant changes to the cost structure since Rocklabs became part of the SCT group. An extra 35 skilled staff will not come cheaply. If we say that each of those workers costs $100,000 to house, equip and pay on average that means an extra $3.5m is now built into the SCT cost structure. And that means for equivalent turnover our long term net profit achievable may be only:

$4.7m-$3.5m=$1.2m

Based on the now 28.5m SCT shares on issue, that means earnings per share could be around 4.2c. At up to $1.40, where SCT has been trading over the last few days, that equates to a PE of 33. That is pretty rich, even for a company with the potential of SCT, I would have to say. I would want to see some more SCT profit results on the table before I was prepared to buy a whole lot more SCT shares at these levels.

SNOOPY

discl: hold SCT

[Snoopy]

There has been a lot of emphasis on company turnover by SCT when quoting jobs in the pipeline. $40m of orders going through each year for SCT does look doable going forwards, even if they don't quite make $40m for FY2010. If we look back to the last time turnover was that high, in FY2003 and FY2004, $40m turnover equated to profits of some $4.7m (around 20cps in those days).

But there have been significant changes to the cost structure since Rocklabs became part of the SCT group. An extra 35 skilled staff will not come cheaply. If we say that each of those workers costs $100,000 to house, equip and pay on average that means an extra $3.5m is now built into the SCT cost structure. And that means for equivalent turnover our long term net profit achievable may be only:

$4.7m-$3.5m=$1.2m

Based on the now 28.5m SCT shares on issue, that means earnings per share could be around 4.2c. At up to $1.40, where SCT has been trading over the last few days, that equates to a PE of 33. That is pretty rich, even for a company with the potential of SCT, I would have to say. I would want to see some more SCT profit results on the table before I was prepared to buy a whole lot more SCT shares at these levels.

A 'pre interim result' announcement made to the market today gives us a cryptic preview of the first half year. The 1:10 tax free bonus issue, ex March 26th is kind of quaint. But the kiwi punters seem to like this kind of thing, so I guess the directors know what they are doing. And more shares on issue should help liquidity in the long term.

SCT don't normally pay out more than they earn as dividends. But in down cycles, they tend to pay out all that they have earned to keep faith with the long suffering shareholders. The 1.25c interim dividend on the increased share capital equates to a half year profit of around $400,000. That is nearly a $1m turnaround from the $470,000 loss incurred in HY2009. So given the second half year for FY2009 realised a profit of $735,000, it looks like we could see an FY2010 profit of:

$400,000 + $735,000 = $1.14m

That figure is in the ballpark of what I forecast in my 11th December 2009 post. On that basis, I wouldn't expect much of a reaction in the share price once the market digests the interim result. Looks like 'steady as she goes' for SCT.

SNOOPY

[Snoopy]

SCT don't normally pay out more than they earn as dividends. But in down cycles, they tend to pay out all that they have earned to keep faith with the long suffering shareholders. The 1.25c interim dividend on the increased share capital equates to a half year profit of around $400,000. That is nearly a $1m turnaround from the $470,000 loss incurred in HY2009. So given the second half year for FY2009 realised a profit of $735,000, it looks like we could see an FY2010 profit of:

"$400,000 + $735,000 = $1.14m

That figure is in the ballpark of what I forecast in my 11th December 2009 post. On that basis, I wouldn't expect much of a reaction in the share price once the market digests the interim result. Looks like 'steady as she goes' for SCT.

The actual half year 2010 profit announcement was out today.

"The Group's unaudited result for the six months ended 28 February 2010 was a net profit before tax of $1.4 million,"

That is rather better than I was expecting, but has been tempered by the following

"During this period we have been successful in securing significant system sales within the Appliance, Precious Metals and Meat Processing markets. Contracts for new projects destined for Australia, Brazil, China, Chile and the USA *have stretched our capacity to a point where we have a requirement
for additional resources*.

Translated, this means either subcontractinng or hiring and training new workers. This is bad news for the second half profit, as it means that the company is already operating at short term 'profit capacity'. In turn that means that even if turnover goes up in the second half, company profits have probably plateaued. Past experience with skilled contractors would indicate that SCT will probably only break even on that part of the work.

I am now projecting a full year SCT profit of $2.8m. With the 28.5m shares now on issue, this equates to earnings of 9.8c per share. With a share price of $1.20 this equates to a PE ratio of 12.2. Does any one want to argue that this isn't about right?

SNOOPY

discl: hold SCT

[Arthur]

Thanks for the analysis Snoopy. It would be nice to think that they can increase their margins if they have this much work on. They did say that they were stretched at the AGM, so they have had time to be more selective looking for work. They have sold another boning machine which will be paying a royalty, not much but in the right direction. Cheers Arthur

[Snoopy]

Thanks for the analysis Snoopy. It would be nice to think that they can increase their margins if they have this much work on. They did say that they were stretched at the AGM, so they have had time to be more selective looking for work.

Did you see that welding robot they were building for some outfit in Wellington (IIRC) as a working display at the AGM? I am sure it will be very successful. But the thought did cross my mind that welding robots are really at the 'commodity' end of the robotic work they are doing. I would have thought they might be better accelerating the development of the next stage of the automated boning room. Or the automated milking shed concept they were working on? I did think afterwards: "Why did they take that Wellington job on?"

Meanwhile "back on the market" the SCT share price rose 5c to $1.25 today, but buyers were there at $1.27 at the end (equivalent to $1.40 pre bonus issue) which means a real rise of 5.8% today. That is still only a projected PE of 12.9. Perhaps I was a little too downbeat on my assessment of the result yesterday?

SNOOPY

[Lizard]

That looks great! Having spent one university summer standing on the "catch and pack" side of one of those bandsaws, I'd be happy to leave it to the robots! (Oh and they probably won't mind spending their summer at 10oC either!).

[Sideshow Bob]

Liz, I think this sort of them is what you are talking about:

http://www.nzherald.co.nz/business/n...ectid=10642474

[Snoopy]

A disgraceful announcement was made on 'Sharechat' yesterday. Notice was given that Stuart James McLaughlan (Director), Kevin Francis Kearney (Manager) and Christopher John Hopkins (Managing Director) had filed changes in their shareholdings. But no mention was made as to whether they had increased or decreased their holdings, which is the critical information the market needs!

Nothing on SCT's own website, but by going to the NZX I found SJM bought 5560 shares at $1.12, KFK bought 3038 shares at $1.18 and CJH bought 4000 shares at $1.11. Insider buying is generally a good thing, but why send us on a complicated web chase to retrieve the information? Sharechat, you should be ashamed of yourselves.

SNOOPY

[Phaedrus]