tag:blogger.com,1999:blog-3008642600708028986.post5109814586368506947..comments2023-09-07T20:42:08.035+08:00Comments on Market Uncle's Blog: I upped my stakes in Surface Mount Technology on 27th May 2008market unclehttp://www.blogger.com/profile/16460144334144587714noreply@blogger.comBlogger2125tag:blogger.com,1999:blog-3008642600708028986.post-12832288493004048262008-05-30T23:26:00.000+08:002008-05-30T23:26:00.000+08:00Hi Musicwhiz, Thanks for giving your frank commen...Hi Musicwhiz,<BR/><BR/> Thanks for giving your frank comments. I do appreciate them alot.<BR/><BR/> I take this discussion in 3 parts:<BR/>i) discount to NAV<BR/>ii) cash burn<BR/>iii) resilience of a going concern<BR/><BR/><B>i) discount to NAV</B><BR/><BR/> You brought up a point that I didn't realise until now. All along, I thought fixed asset are "fairly" valued, factoring depreciation. However, there's always a huge decrepancy between the number on the balance sheet and the actual net realizable value during a normal market sale (let alone a fire sale).<BR/><BR/>I've looked it up a little and the following put it well:<BR/><I><BR/>...<BR/>Estimating an asset’s useful life solves half of the depreciation question. What about the rate of depreciation? Will the physical deterioration of equipment occur evenly over its useful life or will the decline be more rapid at the beginning or end of an asset’s useful life? Should depreciation be based on the decline in an asset’s economic value instead of its physical deterioration? The two forms of decline do not necessarily occur simultaneously. For example, the market value of computers declines very rapidly compared to their physical deterioration.<BR/>...<BR/></I><BR/><BR/>In short, since the fixed assets would be worth much less then what's reflected on the balance sheet, the actual discount to NAV would not be as big as my initial estimate. The actual recoverable value per share if the company are to go into liquidation should then be substantially lower than the 50 odd cents I've estimated. <BR/><BR/><B>ii) Cash burn</B><BR/><BR/>While a net loss of 21.8M in Q4, 2008 vs a net gain of 14.2M in Q4, 2007 is a huge plunge. A closer look at the cash flow statement can tell a slightly different picture. <BR/><BR/>Cash generated from operations in Q4 2008 is 9.565M vs Q4 2007's 39.6. But Q4 2008 is dragged down by an increased inventory of 33.6M vs a decreased inventory of 25.5M last year. If the management can still be believed, "<I>The increases in inventories and trade payables are to prepare raw materials for production to fulfill customers’ order<BR/>requirements."</I>. The cash flow from operations is actually still decent. The seemingly huge net loss this quarter is an accounting fact, not yet a operational fact. Cash is not burnt yet, unless the built up in inventories is a result of canceled orders from customers.<BR/><BR/><B>iii) resilience of a going concern</B><BR/><BR/>From negligible profit margin (you are right that its about 5%) to loss making, the company just keep performing worse than before.<BR/><BR/>However, if management is determined to pressed on, there might be light in the end of the tunnel. As least they are still building/fitting out factories; banks are still granting them loans. I take these signals to signify that the management believe the business can persist and the banks believe the business can continue to generate the capacity to repay the loans.<BR/><BR/>As with all cigar butts, the management have done all the can to destroy shareholder value. Anything right out of the many wrongs will result in an improvement.Market Unclehttps://www.blogger.com/profile/13926458268187430049noreply@blogger.comtag:blogger.com,1999:blog-3008642600708028986.post-32350052834305693672008-05-30T02:52:00.000+08:002008-05-30T02:52:00.000+08:00Hi Market Uncle,I would like to comment on your pu...Hi Market Uncle,<BR/><BR/>I would like to comment on your purchase of more SMT at 13.5 cents.<BR/><BR/>A casual glance at SMT's financials shows deteriorating margins and a profit to net loss situation for FY 2008 ending March 31. Though distribution costs had dipped, admin expenses soared 34.8% which more than offset the meagre 7.1% increase in revenue (I am talking about 4Q 2008). This had caused a loss of HK$21.8 million which is very substantial if you consider the fact that in prior period, profit after tax was HK$14.2 million.<BR/><BR/>In addition, the Balance Sheet also shows that quick ratio is below 1, meaning most of the company's assets are tied up in Inventory. You used a model whereby you computed the liquidation value of each class of assets to justify that NAV is at least 50 cents per share. However, inventory in a fire sale (as you say) may not be worth much and importantly, fixed assets may not be able to be liquidated at book value (historical cost) due to depreciation. Hence, market value of fixed assets may be substantially lower than book value and you should use NRV to value fixed assets and not historical costs. The practical problems involved in selling fixed assets quickly to generate cash is also another issue. Therefore, I do not think that the 50 cents per share NAV is a reasonable measure of the company's worth at this point in time.<BR/><BR/>Another factor I will consider is that since Management is destroying shareholder's value (not creating it), the book value per share may consequently also fall and this may be the reason why the share is trading at a significant discount to book NAV. <BR/><BR/>Looking at their presentation slides, their net margin (when they were profitable) is historically very low (highest was 5.9% in FY 2004) which represents a very risky business model (as in this case, a small escalation in costs can wipe out residual traces of profit). Cash burn is also pretty severe as both FY 2007 and FY 2008 recorded a drop in cash balances with no corresponding improvements in profit, implying that purchased assets (most of their cash outflows relate to investing activities) are not being effectively utilized to generate profits/cash.<BR/><BR/>In summary, the company is operating under very difficult business conditions and the industry itself is commoditized with no apparent competitive advantage which the company can demonstrate.<BR/><BR/>Hence, I am puzzled by your intention to purchase more of this company to average down your cost of purchase.<BR/><BR/>Regards,<BR/>Musicwhiz<BR/><BR/>P.S. - Pardon me for being rather frank and direct, these are just my observations as a layman to this industry and by reading the financials and presentation.Musicwhizhttps://www.blogger.com/profile/10950754156386935254noreply@blogger.com