- RM 33.2m productive assets (Equipment, Plant and Machinery) were added in FY2017, which is 108% of FY2016 balance (RM 30.6m)
- Accordingly, I estimate the sales of FY2018 to be RM 283m, RM 41m higher than my old estimate RM 242m
- Current market cap (RM 610m to 630m) implies 20% rate of return over 3 years holding period
- You may change some assumptions and simulate your own SCGM investment case
The annual report of FY2017 was published two weeks ago. The first financial data I looked up was their productive assets in the balance sheet. As I firstly proposed a capacity-led growth model for SCGM valuation in May, the core productive assets of SCGM are Equipment, Plant and Machinery (EPM), so the capacity of EPM is the limiting factor to sales growth. The notes in its FY2017 financial statements reveal a significant surge in EPM assets from RM 30.6k to RM 57k. This post discusses what would be the implications on SCGM sales in the next few years and the corresponding updates to its valuation model.
Updates on major charts
Most of us will be impressed by the pace of growth of the productive assets in FY2017, as clearly shown in the charts below. Note that the scale of the charts are adapted since last published in May in order to contain the "new high"!
Impressive new arrivals
SCGM management discussions in the annual report of FY2016 reveals that a new production site (building) will be constructed at 5 km away from their existing site in Kulai. Furthermore, it details the following shopping list of machines for production use.
- Auto punching machine: 4
- Extrusion machine: 5
- Press forming machine: 1
- CNC machine: 1
- Thermo-forming machine: 8
- Cup manufacturing machine: 1
RM 15m + 33m = RM 48m
In my post in this May, Hau's view assumed that this CAPEX will be spent quite evenly in FY2017, 18 and 19. However, the arrival of the new machines was significantly earlier than I anticipated. Or, equally possible, I underestimated the required CAPEX to put the production machines to work in a new factory - there are some basic facilities to be installed so that the production lines work properly.
According to the management discussions in the latest annual report, they rented a building and already commissioned 2 extruction machines and 4 thermo-forming machines there in Q3 FY2017. The dimension of expansion is impressively shown in the chart; RM 33.2m EPM assets were added and RM 7.3m were depreciated, pushing up EPM assets to RM 57m. In other words, it means RM 33.m capital (108% of EPM assets in FY2016) was committed, contracted, installed, commissioned and registered in the balance sheet as EPM assets within a year! The pace of execution is impressive. We should praise the operators and the supervisors for their hard work.
In May Hau's view (May 2017) gave some initial opinions on several key inputs. Since then, there are some latest financial data from the annual report of FY2017 and new updates from the management. Below are latest Hau's view (Aug 2017):
Net profit margin:
I revise the margin down to 14% flat in the next four years.
Adding EPM (CAPEX) (replacing EPM investment rate):
According to the management discussion in FY2017; RM 20m in FY2018 will be invested. For the remaining FY2020 and FY2012, there is no guidance from the management. So, I’m a bit conservative and I assume just RM 15m each.
EPM depreciation rate:
According to SCGM’s Significant Accounting Policies, the principal annual deprecation rates used for EPM are 10% - 20%. My assumption is 18% flat in the next four years.
EPM assets turnover:
I revise it down to 5.0 flat in the next four years.
Dividend payout ratio:
I simply assume 65% in the next four years.
SCGM management so far gives us their production expansion plan till 2019. So, Hau's view (May 2017) prefers an investment time frame to three years. After the result annoucement of FY2017, it has two years left.
PE multiple when selling shares:
As of today, the trailing PE multiple is around 26 to 27. Is it high? Here we need careful judgement. My gut feeling is to take 20.
Required rate of return:
I demand at least 16% average compounded rate of return in this investment case.
In the past few days, SCGM shares were trading at around RM 610m to 630m. If I buy it at RM 624m market cap, I could possibly achieve 20% rate of return over the next 3 years holding period.
What does it imply on FY2018 sales?
Hau's view (May 2017) estimated that EPM assets would reach RM 57.1m in FY2019; unexpectedly, it is now already RM 57m in FY2017 and another RM 20m recently announced CAPEX will be allocated in FY2018 to buy 2 extruction machines and 4 thermo-forming machines in a rented factory in Klang Valley. The new FY2018 sales estimate is RM 283m, RM 41m higher than the old estimate RM 242m. The chart below compares the differences between Hau's view in May and Aug 2017.
Simulate your own investment case
You can simulate your own “What if” scenario and create your own investment case. You may NOT agree with me on some key assumptions like future net profit margins; or you may prefer to a five-year holding period and believe that you have high chance to sell your shares at PE multiple 25. Then take control of your own investment case by applying your preferred input settings and simulate your investment results! Here is the link to simulate your own SCGM investment case. Have fun and good luck!
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