Monday, 20 March 2017

New Counter: Sapphire Corporation

In a bid to reach my target portfolio size of 8 counters, I will spend my bonus on acquiring 2 more stocks. Sapphire is the first of the 2.

Equity: Sapphire Corporation (SGX: BRD)

Business: Rail Infrastructure Construction
Markets exposed: Primarily China, increasingly Developing Asia
Stock exchange: SGX
Purchase price: 0.335
Purchase month: March

10% per annum: 

Sapphire Corporation is a turnaround that is now poised to be a fast grower.

Introduction:

Sapphire has been reworking their business model since 2014. They sold their steel business, bought the mining business Mancala, bought Ranken, and recently sold 81% of Mancala. With the sale of 81% stake in Mancala, Sapphire Corporation's business is now primarily concentrated in Ranken, a rail constructor.

In terms of Geography, China is currently Ranken's biggest revenue contributor. The company is branching out into other parts of developing Asia such as Bangladesh.

Considerations:

1) Strong Governance

As usual, corporate governance is top of my list. Sapphire Corporation comes in at 346 on 2016 SGTI Index. While Sapphire has an independent Chairman, only 3/9 of Sapphire's directors are independent. These statistics thus far suggest that Sapphire's governance is perhaps merely passable.

However, having observed the actions of Sapphire's board and management over the past year, I have come to realize that Sapphire's directors update shareholders frequently and deliver on their promises more often than not.

From selling the steel business to buying and selling Mancala, the directors have always provided forward guidance on their decisions.

2) Growth

2.A. Short Term Growth Driver - Disposal of Mancala

Sapphire Corporation had sold a 81% stake in Mancala for HKD$63,200,000. This effectively values Mancala at about S$14.2 million. While Sapphire is still awaiting to finalize the costs of acquisiton for Mancala (as the 2nd and 3rd tranche of payment depends on profits filed in 2015 and 2016), I opine that they have probably made a profit on the sale of Mancala given that management estimated payables for Mancala equivalent to only S$13.1 million. This is therefore clearly not a fire-sale.

Mancala had made a loss of S$1.7 million in 2016. Ceteris paribus, the sale of Mancala would therefore automatically increase Sapphire's bottom line by S$1.4 million. As an added bonus, if the new controlling shareholders do turn Mancala's business around, Sapphire will stand to benefit with their 19% equity stake. Mancala was profitable as recently as FY2015, so the possibility for a quick turnaround is sizeable.

2.B. Long Term Growth Driver - Developing Asia's infrastructure push

While Ranken might have had a bad end to their year, there remain reasons for optimism.

Source: Sapphire's Financial Statements
*Ranken's first full contribution is in 4Q'15

Sapphire's main business of Ranken is gaining traction. Sapphire's order book stands at S$478 million, which is more than 4x their market capitalization. I believe Sapphire has shown sufficient execution prowess in the past 5 quarters to expect them to fulfill their obligations.

As an added bonus, they have unbilled fees worth approximately 1/3 of their total 2016 revenue to be billed in the coming year - revenue to be billed without lifting a finger!

Source: Sapphire's FY2016 Financial Statement

As developing Asia embarks on its infrastructure push, I think rail development is a rather safe bet in the longer term.

3) Fixed Asset Light

Sapphire operates a non-current asset light model, thus giving them flexibility to change their strategies according to different circumstances. They will also require lower CAPEX.

Source: Sapphire's FY16 Financial Statement

4) Insider Purchase

Sapphire's CEO Mr. Teh Wing Kwan had bought 300,000 shares in Sapphire on 1st March 2017 - just a day after Sapphire's result release. I interpret this as a strong signal of management conviction and commitment in the business.

Source: SGX Announcement

Risks

A) Worsening Days Sales Outstanding

As with all construction firms, trade receivables present a challenge. Ergo, it is worrying that Sapphire is seeing an increase in debtors' turnaround time.

Source: Sapphire's FY16 Financial Statement

While Sapphire might still be seeing relatively strong operating cash flow, the situation is worth monitoring. On a related note, investors can seek comfort from the fact that most rail projects are backed by the local government in some ways.

Conclusion

Assuming the following base case scenario for FY17:

1) Ranken maintain's FY16 revenue (executes less than half of order book) and net profit margin
2) Mancala maintains FY16 performance (i.e. clocks S$1.7m loss again)
3) Sapphire bills half of unbilled revenue

Sapphire will clock a minimum EPS of 4.17c, translating to a 41% increase in bottom line in FY2017. Based on a PE valuation of 11 (a slight decrease from my purchase PE of 11.3), they should trade at around $0.46 in one year's time. This provides a sizeable safety margin over my required 10% per annum.

Any improvement in valuation will further raise Sapphire's share price in the scenario described here. Naturally, any improvement in performance will also likely raise Sapphire's bottom line.

This is neither a recommendation to purchase or sell any of the shares, securities or other instruments mentioned in this document or referred to; nor can this blog post be treated as professional advice to buy, sell or take a position in any shares, securities or other instruments. The information contained herein is based on the study and research of Dan O (“the Author”); is merely the written opinions and ideas of the Author, and is as such strictly for educational purposes and/or for study or research only. This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. The Author make it unequivocally clear that there are no warranties, express or implied, as to the accuracy, completeness, or results obtained from any statement, information and/or data set forth herein. The Author, its related and affiliate companies and/or their directors, executives and employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.

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