Karin Technology Holdings

As there's no thread about Karin Technology, and as a passtime on Sunday, I'd like to share Chairman's Letter to Shareholder marking the 35th anniversary.

21 February 2012

Dear Shareholders

Karin Technology achieves another five-year milestone

Last month we celebrated the Karin Group’s 35th anniversary.

Some people may find it strange to mark 35 years. But for our Group, it is a tradition to set new business targets every five years and to celebrate when we achieve these objectives. We believe five years is a good timeframe to set short term achievable goals that will motivate us towards our long term goal, which is to
build a sustainable and profitable company that achieves good returns for our shareholders.

We have come a long way since our humble beginnings as an electronic components and computer distributor in 1977. That we have managed to build a company that has been profitable every year in its 35-year history is not through sheer luck. Over the years, we have witnessed the expansion of the Karin Group in keeping with
the introduction of industrial and technological changes. We have also kept up with the ever changing needs of our diverse customer base. The Group is now poised to deepen and broaden its portfolio of products, solutions and services through the widening our vendor base. We are also looking at diversifying our reach through new ventures, new business models and making strategic property investment for the future expansion of our Group as well as for rental yields.

For the half year ended 31 December 2011, (“1H2012”), net profit of the Group up 6.5% to HK$22.8 million from HK$21.4 million in the previous corresponding period (“1H2011”), driven by strong revenue growth. With this strong set of interim results and barring any unforeseen circumstances, we expect FY2012 to be another
profitable year for the Group.

We have rewarded our shareholders every year since listing on the Singapore Stock Exchange in 2005. We are proud of this achievement and hope to maintain this track record. By including the interim and special dividends for the half year ended 31 December 2011 which are to be paid to shareholders on 9 March 2012, the percentage of cumulated dividends we would have paid back to public shareholders would be 77.4 percent, with an aggregate dividend per share of S$0.1336 for the period between 2005 and interim 2012.

Moving forward, the Executive Board will continue to ensure the Group maintains good financial health and to uphold the primary objectives of:

i.Targeting double digit growth both in revenue and net earnings;
ii.Rewarding our loyal shareholders with dividends; and
iii.Establishing a strong and dedicated workforce that will take the Group into the next level of growth.

As we cross this latest five-year mark, I want to take this opportunity to thank you for your support and trust in us. We will work hard to ensure your investment continues to bring good returns in the years ahead.

Phillip Ng
Executive Chairman


<vested>

This stock deserved further research.

Thanks Cyclone.

Will share any info/finding if any

I had a quick look at the FY12 (Jun) financials.

- Very low Profit Margins, GPM ~6% ; NPM ~2%
- Biz segments in Consumer Electronics Products (53%) , IT Infrastructure (25%), Component distribution (17%), IC Application Design (5%)
- Revenue grew a lot (+49%) in FY12 due to Consumer Electronics Products where they'd been given the rights to distribute the full range of Apple products. As such, debts had also gone up a lot

I suppose at this point in time, they're predominantly in the biz of Apple products distribution.

In my case, I never did like low GPM + NPM biz. Also, not familiar with HK market. I suppose I'd look at similar Singapore companies to compare (I rembered reading quite a few threads of such cos. in VB like EpiCentre?) if I could overcome my fear of low GPM/NPM...

In general, low GPM + NPM alone may not be conclusive for company performance, high asset turn-over will make it a decent biz.

A quite look into it

ROA is 7.7% and ROE is 14.4% in FY2012, not bad, but not impressive either. Refer to past 5 years data, the performance is improving over time after the FY2009.

Dividend yield in FY2012 is approx 5.8%, and dividend is declared consistently for the past 5 years.

Cash reserve is increasing over the past 5 years, to HK$ 77 mils in FY2012, with debt of HK$109 mils in FY2012 and gearing of 0.24. It is a concern due to sudden increase of debt in FY2012, and it is a short-term in nature (current liability).

Looking further into the cash flow statement, OCF seem volatile on alternative years, might due to fluctuation in WC. An average over the past 4 years, average OCF is approx HK$43 mils. With CE approx HK$ 20-25 mils, the average FCF is approx HK$ 20 mils. (noted that the OCF in AR is after discounted the dividend, so the FCF is for cash reserve and/or investment). It seem the dividend payout should be sustainable with payout ratio of approx 50%

It is new stock to me. Further due diligent needed before invest.

Lastly, IPO price $0.20 in 2005, current price is $0.295, about 47% profit over 7 years, with extra dividend yield of ~5% annually. That definitely deserve attention.

Will add it into my watch list to follow-up

Further looking into the operation

Inventory turnover is only 18 days, and receivable turnover is 34 days.

Further looking into the past 3 years, the inventory and receivable turnover is declining, which is a good sign.

Low NPM generally means they have to either turnover sales fast enough or leverage high enough to ensure a decent returns on its assets/equity. ROA & ROE are in its low teens. As CityFarmer mentioned, not too bad but not very good either.

The risk of low NPM is that there is little room for mistakes. If cost surged a little or GPM drops, it can result in a loss. 2012's GPM went down to 6% - a record low from 2007-2012. However, mgmt was lucky as they managed to lower cost as well to maintain NPM at 2%. If it had been otherwise, NPM could have fallen into 1% range.

CCC days are normal as well. There is no consistent trend in its CCC days. Sometimes, it is 30 days, sometimes it is 60 days. Generally, it fall well within the usual 30-60 days cycle - typical for a small company like Karin Tech which probably has little bargaining power on either sides (customers & suppliers).

Debt has increased in 2012 with a large portion in current liabilities. Though the increase is alarming, it is of less concerns to me. At 7% net gearing, there is still room for them to leverage. Default risk is minimal.

What's unattractive to me is the dismal cash flow performance. From 2007 to 2012, Karin only booked positive operating CF in 2009 & 2011. On a yield to PAT basis, the yield is huge. This makes me wonder whether Karin is burning cash in 2 years but milking high yield CF in the 3rd year. Aggregating all the CF over 2007 to 2012, it turns out they have generated only HK$62m out of HK$280 accounting PAT - this translate into 22% yield - below average performance.

CAPEX - from purchases of PP&E - is not huge but free cash flow is negative as it takes a huge hit from the negative CF.

The most positive attribute is their ability to pay dividend every year and its implied yield has been impressive - between 4 to 8%. My guess is dividend is likely to be financed by borrowings.

I didn't take a look at its business model as closely yet but judging from what they mentioned about innovative solution in technologies, I presume they are focused on human capital development. But its financials show otherwise. Low margins & burning of cash meant it is likely they are more of a manufacturing company. I can't confirm on this as my knowledge in its business is limited as of now. Just what I think based on its financials.

No doubt, if mgmt allows, they can carry on with its dividend payment via financing it with debt but I don't really like the negative operating CF picture.

At 6.6x P/E & 0.9x P/B, it seemed Karin is pretty fair-valued. I will go for it at 4 to 5x P/E or 0.5x P/B

Hi dzwm87, any fair idea why 5 year operating cashflow is only 22% yield of hkd280m PAT? If the company has been profitable for past 5 years, I would imagine the main impact is coming from working capital changes or non cash income like revaluation of assets, inventory or forex gain etc? Good structured analysis of the financial btw. I wonder u managed to churn this out so quickly or via Bloomberg? Hehe.

(17-09-2012, 11:11 PM)dzwm87 Wrote: Low NPM generally means they have to either turnover sales fast enough or leverage high enough to ensure a decent returns on its assets/equity. ROA & ROE are in its low teens. As CityFarmer mentioned, not too bad but not very good either.

The risk of low NPM is that there is little room for mistakes. If cost surged a little or GPM drops, it can result in a loss. 2012's GPM went down to 6% - a record low from 2007-2012. However, mgmt was lucky as they managed to lower cost as well to maintain NPM at 2%. If it had been otherwise, NPM could have fallen into 1% range.

CCC days are normal as well. There is no consistent trend in its CCC days. Sometimes, it is 30 days, sometimes it is 60 days. Generally, it fall well within the usual 30-60 days cycle - typical for a small company like Karin Tech which probably has little bargaining power on either sides (customers & suppliers).

Debt has increased in 2012 with a large portion in current liabilities. Though the increase is alarming, it is of less concerns to me. At 7% net gearing, there is still room for them to leverage. Default risk is minimal.

What's unattractive to me is the dismal cash flow performance. From 2007 to 2012, Karin only booked positive operating CF in 2009 & 2011. On a yield to PAT basis, the yield is huge. This makes me wonder whether Karin is burning cash in 2 years but milking high yield CF in the 3rd year. Aggregating all the CF over 2007 to 2012, it turns out they have generated only HK$62m out of HK$280 accounting PAT - this translate into 22% yield - below average performance.

CAPEX - from purchases of PP&E - is not huge but free cash flow is negative as it takes a huge hit from the negative CF.

The most positive attribute is their ability to pay dividend every year and its implied yield has been impressive - between 4 to 8%. My guess is dividend is likely to be financed by borrowings.

I didn't take a look at its business model as closely yet but judging from what they mentioned about innovative solution in technologies, I presume they are focused on human capital development. But its financials show otherwise. Low margins & burning of cash meant it is likely they are more of a manufacturing company. I can't confirm on this as my knowledge in its business is limited as of now. Just what I think based on its financials.

No doubt, if mgmt allows, they can carry on with its dividend payment via financing it with debt but I don't really like the negative operating CF picture.

At 6.6x P/E & 0.9x P/B, it seemed Karin is pretty fair-valued. I will go for it at 4 to 5x P/E or 0.5x P/B

Generally i agreed with your analysis except the following

The OCF data below in HK$
2008 : (87.51) mils
2009 : 181.20 mils
2010 : (48.91) mils
2011 : 102.95 mils
2012 : (62.08) mils

It seem the OCF performance is alternating. IMO, the assessment of OCF should take average of even number of years. The average OCF (past 4 years) is actually positive i.e. HK$43 mils

If you had taken a closer look, the OCF is ex-dividend paid. So the dividend is actually well-sustained by FCF (with average capex of approx HK$ 23 mils)

The CCC day is having a consistent declining trend for the past 3 years.

2010 : 41.1 days
2011 : 31.0 days
2012 : 23.6 days

Not sure on your working?

CityFarmer:

My bad, missed out the dividends payment under Op Cf - this is what happened when you try to do analysis at night.

But that said, adjusting for dividends will still yield an average performance. I won't say their cash flow is strong.

I did mention about the trend in net op CF - probably 1 or 2 years negative followed by a year positive. Hence, I did an aggregate of all net op CF to see how it looks. I extended the time frame from 2005 till 2012 - since they were listed. Throughout these 8 years, their cumulative net op CF ex dividends was HK$245m. At the same time period, cumulative PAT was HK$336m - translating into a yield of 73% - which is average (above 100% consistently will be impressive).

Adjusting for dividend from its net op CF, it does seem that dividend payment is able to be financed from its internal FCF. Cumulative FCF was HK$345m during the mentioned time frame while cumulative dividend payment was HK$169m. It seem to be well-financed but if you look at the trend, FCF was supported by a huge one-off boost in 2009 (FCF: HK$210m) & a less stronger boost in 2011 (FCF: HK$145m). Excluding this, it seemed that all of FCF has been used to finance dividend payment.

The huge boost to FCF in 2009 & 2011 was attributed by positive WC changes. This means that if the company chooses not to invest, there is huge cash flow. Moreover, 2009's huge net op CF was due to a plunge in A/R (from HK$444m to HK$210m). Recent trend shows that A/R is gradually increasing which means that the huge net op CF in 2009 was one-off.

My CCC days calculation is the usual - use sales for A/R and COGS for inventories & A/P. Nonetheless, the argument is still the same - it is well within 30 to 60 days. The decline shouldn't be seen as a major game changer as well. In fact, at such a low NPM, a rule of thumb is that they should have very low CCC days - less than 10 days or so. But it seem that their nature of business and their small size have led it to be otherwise.

What's dismal to me other than the average CF is is declining fundamentals. GPM actually hit a record low of 6% since it was listed. Like I mentioned before, if not for the cost management, they would have achieved record low NPM. Even with that, they managed to hit NPM 2% which was just similar to its low of 2009. I am not sure of the drivers for this change yet but with it, the stock price have rallied to 29.5c. This has probably got to do with their recent announcement of deal with Apple. A better assessment needs to be done regarding this. Having a deal with Apple doesn't equate to the Midas Touch. In fact, Apple is well known for squeezing out margins.

No doubt, I believe this is a dividend stock but I suspect dividend might drop. At 29.5c is too narrow a margin of safety. 6x P/E seems fair for such a small-cap company. It will have been better if I can purchase it at below 20c

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mrEngineer:

I wished I have Bloomberg at home. But this info can be easily "data-entered" from their annual reports. After doing it a while, you can quickly get the data together. But the downside in speed is that you can miss out important info - just like hope I missed out the dividend stuff. (:

(18-09-2012, 09:54 AM)dzwm87 Wrote: CityFarmer:

My bad, missed out the dividends payment under Op Cf - this is what happened when you try to do analysis at night.

I have similar experience too BTW, it is not a norm to deduct dividend payment from OCF in cash flow statement, only a handful of company did that.

(18-09-2012, 09:54 AM)dzwm87 Wrote: But that said, adjusting for dividends will still yield an average performance. I won't say their cash flow is strong.

I did mention about the trend in net op CF - probably 1 or 2 years negative followed by a year positive. Hence, I did an aggregate of all net op CF to see how it looks. I extended the time frame from 2005 till 2012 - since they were listed. Throughout these 8 years, their cumulative net op CF ex dividends was HK$245m. At the same time period, cumulative PAT was HK$336m - translating into a yield of 73% - which is average (above 100% consistently will be impressive).

During 2005-2012, which is within a difficult period of 2009-2010, so the performance expectation should be moderated. IMO, 73% yield ex-div should be above average.

The fact that the cumulative dividend payout is more than 60% of IPO price in FY2011, and share price appreciated close to 50% during the period may be a good reflection of its performance.

(18-09-2012, 09:54 AM)dzwm87 Wrote: Adjusting for dividend from its net op CF, it does seem that dividend payment is able to be financed from its internal FCF. Cumulative FCF was HK$345m during the mentioned time frame while cumulative dividend payment was HK$169m. It seem to be well-financed but if you look at the trend, FCF was supported by a huge one-off boost in 2009 (FCF: HK$210m) & a less stronger boost in 2011 (FCF: HK$145m). Excluding this, it seemed that all of FCF has been used to finance dividend payment.

The huge boost to FCF in 2009 & 2011 was attributed by positive WC changes. This means that if the company chooses not to invest, there is huge cash flow. Moreover, 2009's huge net op CF was due to a plunge in A/R (from HK$444m to HK$210m). Recent trend shows that A/R is gradually increasing which means that the huge net op CF in 2009 was one-off.

IMO, i am not so worry on WC. The average WC seem growing consistently with the increase in sales over years.

(18-09-2012, 09:54 AM)dzwm87 Wrote: My CCC days calculation is the usual - use sales for A/R and COGS for inventories & A/P. Nonetheless, the argument is still the same - it is well within 30 to 60 days. The decline shouldn't be seen as a major game changer as well. In fact, at such a low NPM, a rule of thumb is that they should have very low CCC days - less than 10 days or so. But it seem that their nature of business and their small size have led it to be otherwise.

What's dismal to me other than the average CF is is declining fundamentals. GPM actually hit a record low of 6% since it was listed. Like I mentioned before, if not for the cost management, they would have achieved record low NPM. Even with that, they managed to hit NPM 2% which was just similar to its low of 2009. I am not sure of the drivers for this change yet but with it, the stock price have rallied to 29.5c. This has probably got to do with their recent announcement of deal with Apple. A better assessment needs to be done regarding this. Having a deal with Apple doesn't equate to the Midas Touch. In fact, Apple is well known for squeezing out margins.

No doubt, I believe this is a dividend stock but I suspect dividend might drop. At 29.5c is too narrow a margin of safety. 6x P/E seems fair for such a small-cap company. It will have been better if I can purchase it at below 20c

Yes, i agreed with you the CCC should be better, with its low margin biz. I am not sure on optimum CCC day. It is not fully a retail biz i.e. dealing with consumer directly which should has very low CCC day.

Further research into their biz model is required, before putting in the $