Posted by: donmihaihai | May 17, 2009

Revenues below expenses

It is easy to understand that in the situation of revenues below expenses, company will be making losses. But there is a trick in it, if this situation arises because revenues is falling fast together with sizeable working capital and sizeable depreciation/amortisation, then it is entirely possible that the company is still generating operating profits for low margin companies. As long as huge Capex and gearing up of working capital not in sight, these companies can be seem as “profitable”. On the other hand, companies with huge margin, low level of working capital, once revenues dropped below expenses, there is no need to second guess. They are burning cash. So it is very important for them to have sizeable cash ready to keep them alive, by burning them daily, weekly, monthly or even yearly. Borrowings will not going to be easy during this situation as the reasons for their high margin and low working capital is not longer there which also mean there are not much assets to be use for borrowing. Since earnings are not available, door for borrowing is basically closed.

ARA Asset Management and Sarin belong to the top of the 2nd group and Micro Mechanics follow not too far behind. Their B/S over the years show that they are keeping cash in the bank rather than passing cash to shareholder with minimum debts. These 3 companies can be separately categories into another 2 group.

1st group belong to ARA Asset Management. Profit is predictable and this makes company willingly to use more cash and willingness of lending by bank. But if revenues dropped by huge amount due says — being kicked out as Suntec REIT manager, then it is quite straight forward that revenues will not goes back easily. If the reasons for that dropped in revenues are too negative, revenues will never recovered and even being kicked out of this business. In another word, while size do play a part in assets management industry, it is very hard to see what the future like in medium to long term for any specify company. That includes ARA Assets Management.

Sarin and Micro Mechanics belong to the other group. Profit is less predictable and they are even less willing to borrow(bank won’t likely to lend them much too). Micro Mechanics B/S is rock solid and while B/S of Sarin is still good, is not as solid as before. Revenues can drop, like what is happening now but it won’t be permanent. This is a transition period for the level of demand and it will drop. But once it stabilise, back to normal, revenues will recovered to a level reflective of the demand. Since they does not compete on price, profitability will move back as well. Even if the level of profitability is unable to reach the earlier period, it won’t be much lower.

Can Sarin earn US$15 million this year?

Would anyone ask this question before Sarin 1Q2009 results? Revenues for FY2007 and FY2008 were US$37 million and US$33 million respectively but Revenues for 4Q2008 and 1Q2009 were US$2.5 million andUS$1 million respectively. What happened? Because there is no demand and it doesn’t matter if the quarter consists of 90 days or 60 days, if customers are not buying, sale won’t be coming in. For Sarin products, demand can be effectively zero in any given period. So Sarin was burning cash in an uneasy fast speed.

And the management is cutting expenses fast and in sizeable amount. In AR2008, projected expenses for FY2009 is US$9 million so it is actually reasonable to say Sarin need US$15 million to break even. Any amount lesser than US$15 million, cash on B/S will be burning. And if US$1 million sales per quarter continue for another few quarters, I will bet that R&D expenses will cut away and Sarin will be in surviving mode. Expect Cash call from shareholder or even selling of shares to other.

At this moment Sarin is still in the mode of waiting, cutting expenses and positioning for recovery. While revenues of US$2.5 million or US$1 million is unsustainable and unlikely to last for a long period, road to recovery can be a long and sub-profitable if the actual demand for diamond is way lower than before recession. This is why R&D is important. Which is why I think there are probabilities while Sarin will become an even more wonderful business after this, current shareholders may not able to ripe the full benefits.

Full benefits in sight

Micro Mech pushed into red and starts to burn cash in last quarter too. In fact, CMA segment pull the whole business down as Semi-con segment is still profitable. So much for the calls and logic for diversification. But stragy wise, it make sense to goes into CMA. And while cash was burning, it is unlikely to last a long period. With enough cash, low maintenance and team largely intact, road to recovery will be sweet or even better. It won’t be a long wait as Micro Mech profit can recover even in a recession.

The chances are after recovery, as long as Micro Mech continues what they are doing, it is unlikely to be value at below $40 million again. I let my actions do the talking.

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Responses

  1. In general, i agree with your assessment of Micro-mech, though i must point out that Micro-mech has been returning cash through increasing dividends in the past few years.

    It was prudent of them not to return all, else the company will be in trouble during this crisis when demand is shrinking.

  2. Oh thank you…. Though I must point out that a very very small amount of those money goes into my pocket yearly as I turns pages of their annual reports

  3. Hi,
    Nice analysis. I’m presume you are already vested by saying ‘I let my actions do the talking.’? 🙂

    Anyway, for companies in volatile industries (high peak-to-peak business cycles), leverage is very dangerous and it is financially wise to stash cash to burn during severe downturns, like. now.

  4. Hi Market Uncle,

    Having cash to burn is good but most importantly, companies in volatile industries must run in a low “Fixed cost” way. “Fixed cost” can be anything that require cash outflow so that operation can be maintained. This is especially so for shipping industry as rate fluctuate. Like current container and bulk segments, higher cost provider will be kick out or raise capital as rate fell below operating cost. Even if they managed to stay on, they may not get the all the benefits of the next upcycle. Low cost provider will stay and benefits shareholder.


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