Elsoft Research Berhad (Elsoft) kcchongnz

Elsoft Share price movement

Elsoft has been listed in the ACE market more than ten years ago in August 2004. Figure 1 below shows its share price has nothing much to show until late 2013 when I guess of the news that it was going to be lifted to the Main Board. Since after transferring to the Main board, its share price jumped steeply from the adjusted price of around 60 sen to RM1.91 at the close on 10^th April 2015, more than triple in about a year. What a big jump for this stock!

Figure 1: Share price movement of Elsoft

I do not usually advocate chasing of shares when their prices have risen sharply as this is not the practice of fundamental investor, unlike those momentum players. Fundamental investors tend to believe that share price tends to mean reverting. But now let us first keep an open mind and examine its business.

Business Background

Elsoft is engaged in the research, design and development of test, burn-in and application specific embedded system. Elsoft mainly provides awaiting test equipment (ATE) solutions to the semiconductor, optoelectronic and automation industries. Other activities include design and production of specialized machinery and equipment namely material handling equipment and robotic factory automation equipment. Its subsidiaries are Siangtronics Technology Sdn. Bhd., which is engaged in the manufacture of electronic devices and modules assembly, test and burn-in system integration and producing customized manufacturing solutions, and AGS Automation (Malaysia) Sdn. Bhd., which is engaged in machine designing, fabrication and automation.

Next we are going to examine its past financial performance, but always bearing in mind that the future may not follow the past.

Past Financial Performance

Figure 2 below shows Elsoft’s 9-year growth of revenue and profit to the end of year 2014 since listing in 2004. Revenue plummeted since listing in tandem with the advent of the US Subprime Mortgage Crisis in 2007. After that it recovered and grew at a very high compounded annual growth rate (CAGR) of 50% from less than RM6 m in 2009 to RM45.1m last year for a five year period. Net profit grew at a higher CAGR of 66% from RM1.6m to RM19.8m. Thanks to the strong demand for its automation equipment and systems. Elsoft is certainly a high growth company in revenue as well as profit which appeals to growth investors.

Am I happy with the high growth in revenue and earnings of Elsoft? I think so as I do not see any increase in share capital nor any debt taken since listing 10 years ago. Growth was all internally generated. However, we are investing for the future, not the past, although the past may provide some clue of its future. So let us take another step further to check the performance of this company and answer some questions below.

1. What is the potential of its growth?
2. Is its profit margin higher than its industry?
3. Does it make higher return than its cost of capitals?
4. Does its cash flow increase in tandem with the earnings?

Growth Potential

The Semiconductor Industry serves as a driver, enabler and indicator of technological progress. Industry Development Corporation estimates that the semiconductor market will grow at a 7.9% CAGR from 2013 to 2020. Elsoft being involve in this industry, and starting from a low base, will benefit from this growth. It has shown that it was able to grow at a high rate of 50% a year since five years ago.

Moving forward, Elsoft plans to expand its customer base and produce LED testing equipment for medical devices, which it expects to boost revenue by 20%. Meanwhile, its associate company, Lesoshoppe is seeking to list on the ACE market, to fund the expansion of its trading equipment business in Thailand, Indonesia and the Philippines.

At a revenue of just RM45.1m, and with a high return of capital, and plenty of cash in hand, there seems to be plenty of more room to grow for the next few years.

Profit margin

Figure 3 below shows the comparison of net profit margins of Elsoft and Globtronics, another company involved in the semiconductor industry and doing some of the similar businesses. It is noted that Globtronics is a market leader and has a longer high performance history and it is a much bigger company than Elsoft.  Many investors like to invest in the leader in an industry, and Globtronics is one.

Elsoft’s profit margin of 43% now, has been consistently much higher than that of Globtronics over the years. Average net profit margin of Elsoft last four years is about 40%. This is much higher than that of Globtronics at 18% and the semiconductor industry average of about 7%.

Margin itself is seldom used as a benchmark for performance and efficiency. The return on capitals are more widely used and accepted as bench marks. Those are the things investors are interested in.

Return on Capitals

Figure 4 below shows that the Return on Equity for Elsoft has been very good. It rose from 3.5% in 2009 to 27% for year ended December 2014. It is noted that the high ROEs were remarkably achieved with zero debts, and purely from increased sales and increased profit margin. ROE of Elsoft is much higher than its cost of equity (10%-12%) and that of Globtronics of 22.6%. It is also way above the industry average of about 15.7%. A better representation of its return may be its return on invested capital, ROIC, which is much better as shown in Figure 4 below. ROIC of Elsoft shot up to 64% last year.

Hence it appears the quality of its growth is good if not considered excellent with the shareholder value enhancing higher ROE and ROIC than the costs of capitals, which is also in an increasing trend.

Cash flow

One common problem with high growth company is the cash flow. Many of them have poor cash flow from operations due to the need for increasing working capital and capital expenses. Is Elsoft in that category? Table 1 below shows the cash flow of Elsoft since it listing in 2004.

Table 1: Cash flow of Elsoft

Year ended Dec 31	2014	2013	2012	2011	2010	2009	2008	2007	2006	2005
CFFO	13967	10858	5059	1461	1665	2344	7219	5470	12466	7045
Capex	-651	-4363	-6049	-51	-178	-83	-107	-233	-6638	-711
FCF	13316	6495	-990	1410	1487	2261	7112	5237	5828	6334
FCF/Revenue	29%	26%	-5%	11%	13%	38%	43%	35%	24%	19%
CFFO/NI	71%	100%	76%	30%	42%	148%	108%	79%	98%	42%

Table 1 above shows that there were positive cash flow from operations every year since its listing in 2005. There were also positive free cash flow every year except for 2012 when they spent more than RM6 m in capital expenses. Besides that year, FCF were all the time above 10% of revenue. It was a high of 29% of revenue last year. This shows the excellent quality of its earnings and shareholder value enhancement capability of the management.

The above analysis shows that Elsoft is indeed is a good company from every angle. It is a high growth company with high margin and return on capitals as compared to its peer and the industry average. It has excellent cash flow throughout the years. Its balance sheet is squeaky clean.

Price Vs Value

A good company may not be a good investment as it depends on what is the price. Often your return on your personal investment I shares depends on the price you pay. So is the price of Elsoft at RM1.91 worth investing?

We will carry out some simple valuations and a discount cash flow analysis to determine if the price is right in the next article.

In the meantime, for those who wish to learn the fundamentals to determine if a company is good like above, please contact me at

ckc15training2@gmail.com

Tis goeth down to a fundamental aspect that “An investment in knowledge pays the best interest”            - Benjamin Franklin

K C Chong (13^th April 2015)