Sarine Tech (SGX: U77) announced half year financial result on 4 August 2021. 6 months revenue recorded US$ 36.0 million (+60.5%), and profit for the period recorded US$ 12.6million (+972.4%). In the corporate presentation, a very positive term of “Best first half since 2014” was used. Admist the amazing result, the entity announced US$1.5 cent dividend (approximately 2.6% dividend yield). The article will analyze and summarize the key pointers mentioned within the 1H21 result release that an investor should know.
Brief company overview
Sarine Tech is in the business of provision of systems used throughout the entire diamond value chain. Majority of revenue is derived from the rough diamond sales and polish diamond output segment, while currently trying to expand into the retail sales of diamond segment.
During the half year, 48 Galaxy® family inclusion mapping systems. Compared against the past 2 half year report, the delivery is not considered to be outstanding, in fact 1H2020 have a higher delivery compared to 1H2021.
Currently the sale of equipment to customers are on 2 main models:
- One-off paradigm with no follow-on per-use
- Equipment sale with subsequent per-use cost.
The benefit of one-off paradigm sale will be allowing Sarine to sell the equipment at a higher profit margin, while equipment sale with subsequent per-use cost will have a provide a future recurring revenue source for Sarine.
Personally I like the subsequent per-use cost sales as this allows the firm the scale up with predictable revenue as the larger the installation base is (current installed systems is 679), the higher the potential use of the equipment, which provides a predictable estimate for Sarine’s financial results. From recent analyst report from Maybank Kim Eng on Sarine Tech, Fig 17 showed the breakdown of recurring revenue against capital equipment sales.
Revenue – Increase in polishing activity
Revenue have increased by 60.5% compared to previous half year, mainly due to increase in midstream diamond polishing activity in H1 2021, where recurring revenue increased by 80% compared to prior year.
Revenue – sale made under one-off paradigm
Due to a change in sales mix, where sales made under one-off paradigm will result in a higher upfront sale price to customers.
Based on the disclosure, the recurring revenue contributes to 40% of total revenue, which allows Sarine to benefit from the upturn in the midstream diamond industry. This provides visibility to Sarine financials in the upcoming periods. Personally the high activity will sustain in 2H21 as well.
Research and development expenses
Research and development expense increased by 14.1%, from the past the research and development expense range from 10 to 16% of total revenue. This is a sign where the firm invest in future, which can be seen from the new business streams Sarine is creating in the retail sale segment.
Balance sheet remains to be relatively stable compared to prior year. The firm balance sheet is healthy, where cash is at US$23.9million, while total liabilities is at US$22.6million.
Trade receivables increased from US$24.7million from US$22.0million. From the disclosure by Sarine, credit impairment is not an issue due to better financial condition of the customers.
The upturn of the midstream diamond industry is expected to continue strong into the holiday season. US jewellery sales +108% in June 2021.
Therefore, it will be reasonable that the 1H21 result will be equal or even better than 1H21, contributed by stronger recurring revenue. While there are some uncertainties of meeting the delivery target of 145 systems.
Using x2 of the current 1H21 results, the expected financial metrics are as below:
Price-to-Free cash flow: 12.72x
Return on equity: 29.6%
Return on asset: 23.3%
Solvency ratio at 30 June 2021
Current ratio: 1.44x
Debt to equity: 1.2%
The entity is in net cash position
Besides current sale of equipment and recurring revenue from pay per use model. Sarine is actively expanding into other business, in particular in the downstream of the diamond industry. Based on Sarine presentation slides, the retail sales industry is of $78.1billion.
The current proportion of maintenance and recurring service is at 13% of total revenue, where absolute amount have increased by 62%. This is an encouraging sign where services segment is growing, proving that development in Sarine services is gaining positive traction in the market. I believe the services segment will be a key growth driver in the future, providing Sarine with a smoother revenue and higher gross profit margin.
Sarine Diamond Journey
The disclosure has mentioned that commercial adoption will follow later in 2021 or early 2022. This will mean revenue increase in year 2022.
e-Grading expects to be launched at the end of 2021.
Sarine have accepted that lab-grown diamond (LGD) is the trend and accepted by consumers. Instead of posing a threat to Sarine, Sarine have adapted and provide services to lab-grown diamond, which helps to provide additional revenue stream for the firm.
- Continued strong activity in the midstream diamond industry
- Increase in revenue due to services
- Inclusion into Israel related ETF
The business of the diamond industry is cyclical in nature, as it can be seen from 2017 – 2019 price chart. Due to a buildup in midstream inventory, this resulted lower business activity, translating in lower use of Sarine equipment and usage. Despite there is positive sentiment in the diamond industry, there is still uncertainty how sustainable, or how long it will last.
A significant portion of revenue is generated from India, which saw a spike in COVID-19 cases in May 2021. Cases have subsided since then, but it is uncertain will there be any further spike in the future.
Sarine Tech (SGX: U77) price have increased by 259% since 8 September 2020. The increase in prices is supported by improvement in fundamentals and future sentiments.
At 4 August 2021, the share price is at SGD$0.75, which lies above 20 Days Moving Average and 50 Days Moving Average.
Price have spiked to a high of share price of SGD$0.84 in July 2021, due to hype from listing on Israel stock exchange.
In the past few days, there is build up in volume and bounced off support at SGD$0.665 and 50 Days Moving Average.
With the positive result, it is expected that opening price to further increase, potentially testing previous high of SGD$0.815. Based on the fundamentals and the positive sentiments, it is expected that uptrend will continue.
Valuation/ Price target
The amazing 1H21 results are somewhat expected by the market. The projected earning is expected to be higher than 2016’s USD$21million. The share price in 2015-2016 is SGD$2.5 to SGD$1.5. Considering that there is a general lack of interest in the stock, it is expected that there is further upside.
The historical Price-to-earning is around 20x to 27x, at the current projected 8x Price-to-earning, Sarine Tech (SGX: U77) provides an attractive investment for investors looking for a turnaround play and for value investing.
Using the lower range of 20x Price-to-earning, Vezted is expecting a target price of SGD$1.88 (+250%) in 2 to 3 year time providing the diamond industry remains to be bullish.
Sarine provided an outstanding half year report, with a general positive wording used in the disclosure. As sentiment of the diamond industry continues to be bullish, revenue is expected to continue to increase from both equipment sale, recurring pay per use revenue and services launching in 2021 to 2022.
Generally, the valuation of the firm at share price of $0.75 is considered to be low if Sarine can sustain this level of earning. Will personally consider to add on to Sarine at current price.
Note: Vezted is currently vested in Sarine Tech (SGX: U77), and will continue to hold on to the stock in the future.
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