Sarine Technologies Ltd – Monday Surprise

I have been reading up Sarine Technologies Ltd for quite some time and has always been impressed by its fundamentals (read here). It is one of the stocks which is mentally at the back of my mind…. didn’t memorize the company’s details, but it did make an impression. I like the fact that after the financial crisis, they have altered their sales model to have an element of recurring revenue (from its installed base of Galaxy family systems), and this recurring revenue has been growing.

So it came as a good surprise to me to know that the stock price of Sarine has dropped by approx. 24% (read here) – in a single day. Nowadays I seldom find stocks like these with low debt, high growth rates, high profit margins, dropping sharply – more often it is the Noble / Olam (which has mediocre fundamentals & vague accounting) which are being attacked by short sellers / bloggers. Note: recently Shanghai index & more recently Hong Kong index have had tremendous run-ups. And even more surprising – the price drop (of Sarine) is caused by news released by none other than Sarine itself – talk about being frank about one’s short comings.

The drop in price is due its Sunday announcement (Q1 2015 Profitability Guidance And Diamond Industry Conditions Update – read here). Well I am sure, you can read these in detail.

Needless to say, there have been some discussion in Value Buddies debating if this decline in profit will be permanent. With commodities like diamond – whereby prices are not transparent (esp. between rough cut and polished diamonds), it is not easy to estimate the future trend. We have to take the company’s words for it (eg. during the first quarter of 2015… [diamond] manufacturers had reduced output by some 20 – 30% accordingly). However seems like diamond price is on a forever upward trend (see here). In addition, the market in which Sarine is operating in (derives most of its revenue from India) seems to be having credit issues. While Sarine is not directly affected by the credit shortage given its strong net-cash position with zero borrowings, many of its customers depend on credit to fund their business (read here).

Looking purely at P/E (24.37), Price to Book (8.2), EV/EBITDA (22.65) – Sarine will appear expensive. However, if we factor in the long term earnings growth, I find Sarine current stock price very attractive. No doubt the coming 1Q results will be terrible, but I do not judge a company by just one bad quarter (or even one year’s bad result) against the multi quarters & multi years good results – check out the results in the 25-02-2015, 02:13 PM post in Value Buddies (read here). Also, I felt this is not a fundamental deterioration in the company (rather due to macro economics) – and with Sarine’s zero debt, they can tide this over – but growth moving forward will be slower.

1) Trailing PEG

If we do a quick trailing PEG, which will be 24.37/(73.36+0.04) = 0.33. It is a super low 0.33!

However if we the compound growth rate is changed to 15.8, the trailing PEG will be 24.37/(15.8+0.04) = 1.53.

2) Intrinsic Value

If we calculate the intrinsic value.

Annual compound growth rate of EPS from 2003 (ESP: US cents 1.56) to 2014 (US cents 7.83) = 15.8% (12 years).

Annual compound growth rate of EPS from 2008 (ESP: US cents 0.5) to 2014 (US cents 7.83) = 73.36% (6 years).

F = P(1+R)^N

• F = the future EPS
• P = the starting (present) EPS (SGD 0.10)
• R = compound growth rate (15.8%)
• N = number of years in the future (5)

Estimated future EPS: 0.21

I will be estimating the future PE of Sarine to be 19.2 (from Kim Eng report).

Future Stock Price

P=EPSxPE

• P = future stock price
• EPS = future EPS
• PE = future PE

Hence future stock price of Sarine is 0.21x 19.2= SGD 4.032

 

Intrinsic Value

P=F/(1+R)N

• P = present (intrinsic) value
• F = future stock price (4.032)
• R = MARR (15% or 0.15)
• N = Number of years (5)

Hence intrinsic value of Sarine is SGD 2.

Given the current stock price of Sarine at SGD 1.94, the margin of safety (percentage at which current stock price is lower than intrinsic value is 3%.

However if we factor in the Annual Compound Growth Rate of the EPS as  73.36%, the intrinsic value would be way of the chart eg. SGD 15. The margin of safety (percentage at which current stock price is lower than intrinsic value is 87%! But would be safer to stick to a longer time period for the EPS growth eg. 15.8% (and the EPS in 2008 [0.5] and 2009 [0.46] were exceptionally low – read here. Which could explain the extremely high 5 year annual compound growth rate for the EPS).

I have previously just increased my cash quota (by selling some shares), and was initially quite reluctant to purchase another stock. I like to keep my portfolio small – don’t like to monitor too many stocks. However after considering the long term historical growth rate of Sarine, good fundamentals (esp. the zero debt), current sharp price drop, I have decided to initiate a position in Sarine Technologies.

I still harbor the hope of selling the shares of the mediocre companies in my portfolio to trim down the no. of companies.