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Serial System Ltd - How long can it continue to do business at 1% profit margin?

Kiran Rameshchandra
Investor Central

9/6/2013 – Serial System, a distributor of electronic components listed in Singapore and Taiwan, says its entry into the Japan market will boost H2 FY13.

But it will be impacted by rising costs, inflation and stronger Asian currencies.

On a macro level, it could feel the pain from China’s tepid economic growth, a recovery in the United States and continued difficulties faced by the EU countries.

The company recently announced earnings for Q1 FY13:

Revenue: +19% YoY to US$171.6 mln
Gross profit: +15% to US$15.6 mln
Gross margin: 9.1% vs 9.4%
Profit: +10% to US$1.6 mln
Cash flow from operations: US$6.6 mln vs US$16.9 mln

The increase in sales was led by all markets segments, with growth of major product lines and additions of new customers boosting Greater China sales 11%, South Korea 12%, and Taiwan 20%.

Revenue from Southeast Asia and India jumped 55%, mainly due to the contribution from newer product lines.

NRA Capital Research maintained its OVERWEIGHT rating and a target price of S$0.17 as Serial System is still performing well, with a decent dividend payout.

The analyst has also maintained its profit forecast for FY13-FY15.

CIMB Research has a BUY call with a target price of S$0.15 as it believes the FY13 dividend yield remains attractive at 5.3%.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

1. What is it doing to cut costs?

Despite revenue growth of 19% in Q1 and 7% in FY12 its bottom line has not jumped.

The fall in Q1 profit came mainly from the continued increase in operating expenses that stemmed from higher staff and rental costs in China.

While expenses increased 9% YoY, the net margin fell from 1% to 0.9%.

The same was the case in FY12, where expenses grew 10.8%, squeezing the net margin down to 1.2%.

Therefore, what is it doing to cut costs?

This also leads to our next question:

2. Is the net margin of 1% a concern for the company?

Serial System highlighted in its Q1 presentation that its net margin has been hovering around 1% since FY08, with the highest being 2.2% in FY10.

But this is after Serial's negative net margin of 1% to 2% from 2004 to 2006

3. Will it soon sell its stake in Bull Will?

The Group’s share of loss in its associated companies was about US$0.15 mln in Q1, compared to US$0.22 mln in Q1 FY12.

The losses in Q1 were incurred by the group’s 40.8% equity interests in Bull Will Company, listed on the Taiwan Stock Exchange, due to lower sales achieved and higher fixed expenses incurred by its manufacturing plants and operations.

According to the annual reports, Serial has invested S$8.7 mln in Bull Will since FY07 but it made a total share of loss of S$1.6 mln since then.

However, this excludes dilution gain of S$0.2 mln in FY08 and S$0.3 mln in FY10

In addition, Reuters highlight that Bull Will, since 2007, has burnt cash to the tune of NT$199 or approximately S$8 mln to run its operations.

Therefore, it makes us wonder how long before Serial sells this underperforming stake.

4. Will gross margin continue to decline due to competition in Korea?

The Group’s gross profit margin declined from 9.4% in Q1 FY12 to 9.1% in Q1 FY13 as it sold low margin products at its Singapore subsidiary.

It was also lower due to stiff competition at its Korean subsidiary.

This is also reflected on its balance sheet.

Trade and other receivables increased by US$12.2 mln mainly due to higher sales in Singapore, Taiwan and Korea, and longer average credit periods granted to customers.

Trade receivables average turnover days increased from 61 days in FY12 to 64 days in Q1 FY13.

5. Is Serial System really benefiting from outperforming the Asia Pacific semiconductor industry?

Serial System's Q1 presentation highlights that it has been outperforming the Asia Pacific semiconductor industry for quite some time.

NRA Capital Research believes Serial System is one of the largest semiconductor chip distributors in Asia Pacific and will continue to benefit from the growth in this region.

But let's look at the facts: the Semiconductor Industry Association (SIA) says the global industry's revenue grew 17% on a compounding basis, while the Asia Pacific grew only 7% from 2008 to 2012.

Drilling down, SIA highlights worldwide semiconductors sales reached US$23.3 bln in February, an increase of 1.4% YoY.

In the Asia Pacific growth was a stronger 6.7%.

That's great, but how is this outperformance of the industry reflecting in Serials System's bottom line.

We can't see it.

6. How will the group benefit from Sam Goi Kok Neng coming on board?

The free float of Serial System is 47%, with Chairman and CEO, Dereck Goh holding a 36.3% stake, and the famous popiah king, Sam Goi Seng Hui owning 12.5%.

Sam Goi is a substantial shareholder of a number of listed companies, but mainly in the food and beverage industry.

But he has been a shareholder of Serial System for more than 10 years, and has been raising his stake in recent years.

A son of Sam Goi, Goi Kok Neng, has joined the board of directors of Serial System.

However, his past experience highlights that he has worked as a manager at Tee Yih Jia Food Manufacturing Pte Ltd, as a General Manager at Honjji Foods and and Deputy Director, Trigiant Group Ltd.

Therefore it makes us wonder what benefit there is to an electronic company such as Serial System from Goi Kok Neng's presence on the board.

7. When will the joint venture in Japan turn profitable?

The 60:40 joint venture between Serial System and Japan-listed company, AMSC, will start operations in June this year.

The joint venture (JV) will sell and distribute semiconductors and other electronic products in Japan.

Management says Japan is a promising market given its size of more than US$40 bln a year, and Serial System will be the only Asian distributor in the country.

Japan is the latest market that Serial System is entering, having gained a foothold through the years in markets such as Taiwan, South Korea, China and India.

The JV will buy over the assets of AMSC which will be then de-listed from the Osaka Securities Exchange.

It wants to work with Japanese suppliers to extend their business out of Japan.

At the same time, it will extend Serial System's franchise with existing suppliers into Japan.

Serial will pay S$2.5 mln for a 60% stake.

The working capital needs of the JV will be funded via bank borrowings with the security provided by Serial System, or via a shareholder’s loan from Serial System to the JV.

Working capital needs will range between S$11.6 mln to S$15.6 mln.

However, the group does not expect the JV to be profitable this year.

Hence, our question.

This also leads to our next questions:

8. Which two key distributorships did AMSC lose?

In its Q1 briefing, the CEO highlighted that AMSC's revenue was around US$50 mln a year but was much higher at around US$400 mln until AMSC lost two key distributorships.

The website of AMSC highlights that it has/had many distributorship agreements but we would like to know which two key distributorships it lost.

9. How much is Serial System concerned about continued weakening in the Japanese Yen?

Dollar-Yen has weakened around 15% year-to-date, and has crossed an important level of 100 Yen to the Dollar.

Therefore, it makes us wonder about the impact of the weakening Japanese currency on Serial System's bottom line.

10. Did it burn cash on operations since 1998?

Serial System changed its functional currency from the Singapore Dollar to US Dollars at the beginning of FY13.

It did this because the majority of sales and costs are transacted in US Dollars.

We tried to dig into the company's historical "cash flow from operations" (CFFO) since its listing.

We then used the Singapore Dollar CFFO numbers from the annual reports provided on its website since 2005.

It turned out that it generated S$2.1 mln of net CFFO since 2004.

We then tried to use Reuters' CFFO numbers for Serial System in US Dollar terms since 1998.

It is worth noting that Serial System has burnt cash amounting to US$10.7 mln.

Hence, our question.

11. Will it scrap its Taiwan listing?

Serial System listed on the Taiwan Stock Exchange in 2011 in order to raise funds and achieve a better valuation than in Singapore.

On the SGX, it has been trading between S$0.075 and S$0.195 for the last ten years.

It made a high of S$0.89 in June 1999 and a low of S$0.03 during the global financial crisis in 2009.

But in Taiwan, it seems that the shares have performed the same.

It share price is trading just NT$1 above its price of NT$8 on the listing date in 2011.

12. Would it borrow cash in order to keep paying dividends?

Research houses, CIMB and NRA Capital, have a positive outlook on the stock as it offers a decent dividend yield which compensates for its poor liquidity.

It pays a regular dividend of 45% to 50% of profit.

No wonder.

And for as long as Derek Goh is the major shareholder, it seems the dividend payouts will continue.

But will it have to borrow cash to afford the dividend?

13. How much impact will Serial have from Taiwan government’s recent cut in its GDP expectation from 3.6% to 2.4%?

Taiwan slashed its 2013 economic growth outlook, showing increased concern that lacklustre global demand poses a threat to the island's pivotal technology exports to China and the United States.

The government chopped to 2.4% from 3.59% its forecast for this year's growth in gross domestic product.

We have sent these questions to the company to invite them for an on-camera interview, and/or seek their written response.

Sofar, we have not had a reply (which is why you are seeing this message).

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