I believe that the company is presenting a compelling opportunity for investors, due to the following:
- While pressured on cost, the company was able to grow its revenue base rapidly and thus maintain a slim but stable profitability. With the advent of Internet of Things and the continuous need for PCBs this is unlikely to change.
- The stock is undervalued from both a relative and absolute point of view with a price to tangible book being only 0.49., EV/EBITDA under 5 and P/E around 11. The NCAV of the company is also only 32% lower than the share price.
- While the company lacks a precise catalyst, in the past the shares have surged twice without an underlying change in fundamentals. The most recent surge happened in 2014 and since then the company continued increasing its revenue, yet the share price declined.
None of these points were negatively impacted by the release of the annual report on July 29.
Share Price Reaction
As you can see the share price have started to move upwards on the back of a strong volume, which is though not that unusual for SGMA at around its earnings results.
The share price move makes sense as the company reported another quarter of increased revenues (overall a 10% increase for FY2016). Furthermore net income doubled and the company was able to maintain stable margins, which shows that the cost pressure is not an imminent risk for the company.
Impact of the results on the investment thesis
- Revenue streams are still solid
I would say that the annual report presents us with more or less unchanged picture of the company as the revenue opportunities are still present. This is not only supported by the 10% increase in net sales YoY, but by the continued growth in backlog, which increased from $142 million to $167 million. Thus it kept pace with the revenue as you can see below.
The management has also mentioned that while they acknowledge the sluggishness of the global economy, they believe that FY2017 should see further revenue growth. Segment-wise, home appliances still form the bulk of the sales, but the company has seen a significant increase in the proportion of medical device sales (from 2.6% in FY2015 to 4.5% in FY2016), which is one of the most promising revenue areas of the electronic manufacturing industry. This then supports the managerial optimism.
The report also stated the following:
The Company has received forecasts from current customers for increased business that would require additional investments in inventory. To the extent that these forecasts come to fruition, the Company may need to raise capital from other sources of debt or equity.
The Company engaged an investment banker for the purpose of completing a capital raise during fiscal year 2016 and subsequently terminated that agreement. The Company plans to evaluate alternatives for raising capital in fiscal year 2017.
This further confirms the strength of the revenue opportunities. The most likely capital raise is through an additional credit line as mentioned in my previous article.
- Margins are not an increasing issue
Both operating and gross margins were slightly higher (gross margin was up 0.5% to roughly 10% and operating margin was up 0.6% to 1.7%). This supports the notion that the company is able to withstand the cost pressure in the industry and thus the company is not facing an imminent threat of loss of profitability.
- Valuation continues to be compelling
The results have not impacted the balance sheet much. While the cash flow helped to increase the cash position of the business to $4.7 million, the inventory levels fell down as they were the primary reason behind a strong operational cash flow. The company though did end up with a lower amount due on its credit line, but this was not enough to meaningfully impact the valuation.
Thus the NCAV remains more or less the same at $4.1. The price to tangible book remained unchanged and sits around 0.49x after the slight run-up. P/E also slightly decreased to around 11x. This means that the stock is still undervalued on both the absolute and relative basis (as seen in my previous article).
In my first article I suggested that investors that would want to go long, should have waited until the results to initiate a position. I believe that the results were positive and the stock is a compelling buy. I have initiated a position that now accounts for roughly 50% of my desired SGMA's holdings. I will add further 30% after Q1 in September if the trends continue and I will finish off the initiation in December, if the company reports positive Q2 and the share price does not appreciate significantly by then.
Disclosure: I am/we are long SGMA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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