Synertec's Snapping Necks and Cashing Cheques (ASX:SOP)
14/08/2019
Trav Mays
Follow @MaysTrav
He then goes on to use an EV/Op Cash flow metric to estimate a potential valuation. He estimates that the Op cash for FY19 to be between $1-1.5m and recommends applying a 8 – 12x multiple, which gives us a share price of between 0.064- 0.11 and a return of between 44 – 144%, in other words, very healthy gains.
The other thing we need to look at is Wini’s FY19 Op Cash assumption of $1-1.5m, which seems quite low given they earned $1.25m Op Cash in 1H19. But we need to remember that we are looking at cash not revenue, cash is quite lumpy, especially when it is dependent on milestones. Since relisting, SOP has spruiked 7 new or extended contracts, totalling $19.26m. Of these, none were completed in 2H19, they did however, complete 4 in July (These projects totalled $8.46m). The final cash portion of these contracts therefore will be received in 1H20, however, a large portion of the final push costs will be recorded in FY19, so I believe it is a good bet that cash in 2H19 will either be negative or quite small, therefore Wini’s $1 – 1.5m assumption sounds about right. Given all of this, what could be causing SOP to be trading at such a low multiple?
Sources:
1.https://www.ifrs.org/issued-standards/list-of-standards/ifrs-15-revenue-from-contracts-with-customers/
2. https://mastersofscale.com/
3.https://www.amazon.com/Search-Excellence-Americas-Companies-Essentials-ebook/dp/B009YM9VOQ
4.http://www.gasprocessingnews.com/features/201310/advancements-improve-custody-measurements-for-lng.aspx
5.https://www.mckinsey.com/business-functions/organization/our-insights/making-work-meaningful-a-leaders-guide
6.https://www.trelleborg.com/en/marine-and-infrastructure/products--solutions--and--services/marine/lng--custody--transfer/synertec
The author is a current owner of a portion of Synertec, given this, they may be subject to one or a number of biases, more specifically anchoring and/or confirmation bias. This article is neither general nor personal advice and in no way constitutes specific or individual advice. The website and author do not guarantee, and accept no legal liability whatsoever arising from or connected to, the accuracy, reliability, currency or completeness of any material contained on this website or on any linked site. This website is not a substitute for independent professional advice and users should obtain any appropriate professional advice relevant to their particular circumstances. The material on this website may include the views or recommendations of third parties, which do not necessarily reflect the views of the website or author, or indicate its commitment to a particular course of action. Please refer to Disclaimer page for a full list of disclaimers.
Today we will be looking at
Synertec Corporation Limited (ASX:SOP), Wini recently posted an evaluation on Strawman which kicked my
FOMO into overdrive, so I had to take a deeper look . If you read my post on LaserBond, Wini will be
familiar to you, for those who haven’t, he predicted the LaserBond rocket ship
3 days before it started its year long journey to a 244% gain. Obviously, there
was a touch of luck in the timing, but that doesn’t take away from his correct
selection of the company. Could that have just been a fluke? Possibly, we will
still need to check his thesis, but he did also predict Advance NanoTek’s 1000%
return (You read that correct, 1000%!) and I know he’s keen on XRF Scientific, so
probably not J.
I’d also like to say that if you
are not already on Strawman,
you are really missing out, amazing place to not only get investment ideas, but
to see how some of the great investors go about evaluating companies, such as Wini’s SOP thesis. I’d
also like to say that I am in no way endorsed by Strawman, I do however reference them quite heavily in this post, so I
thought I would advertise them to my 1500-2000 monthly viewers. I genuinely like their site and would like to see them succeed, probably for
selfish reasons, where would I get all my investment ideas from if they shut
down? J
Evaluation
Wini, within his evaluation, points out that due
to a conservative revenue recognition policy, SOP has been understating the
amount of cash they have been earning each year. The conservative policy Wini
is referring to is IFRS 15,
which pretty much states (I’m not an accountant so I have probably ballsed this
up) that revenue is recorded at different time periods throughout the project to
reflect the stage of completion of the project. More formally, “an entity
recognises revenue to depict the transfer of promised goods or services to the
customer in an amount that reflects the consideration to which the entity
expect to be entitled in exchange for those goods or services”. For example, if
you have a 2 year project with the customer agreeing to pay 60% before the work
begins, 20% at a milestone in the first year and the last 20% at the end, SOP could
choose to smooth the revenue out over the 2 years, instead of recording 80% in
year 1 and 20% in year 2. The excess cash is then recorded on the balance sheet
as a liability, under the term Deferred Revenue. This is a simplification, but
I think it shows how the cash received and revenue can get out of whack,
especially if you have a few contracts going at once.
As you can see below, IFRS 15,
which was effective 1st January 2018, has had a dramatic impact on
the revenue to cash receipts relationship. Revenue having gone from roughly
double cash in 2H17 was in 1H19 20% below cash receipts.
Clearly the profitability of the company is being somewhat masked here. Wini recommends a simple calculation to uncover it. He states “as an example of what this conservative accounting means is 1H19 EBIT was $64k, while 1H19 operating cash was $1.25m. While the deferred revenue balance is not entirely profits, if you net off the work in progress asset balance (opposite of deferred revenue) and adjust for tax, you come very close to the $2.5m growth in the company's cash balance since FY17”. Makes sense, but let’s check his math.
As you probably guessed it, Wini
was bang on the money, using his simple calculation process, we can account for
all but $50,000 of the cash increase.
He then goes on to use an EV/Op Cash flow metric to estimate a potential valuation. He estimates that the Op cash for FY19 to be between $1-1.5m and recommends applying a 8 – 12x multiple, which gives us a share price of between 0.064- 0.11 and a return of between 44 – 144%, in other words, very healthy gains.
“But is it reasonable to apply 8
– 12x EV/Op Cash multiple to SOP?” That’s an excellent question. To find out, I
have tabulated EV/Op Cash multiples for a number of engineering firms, obviously
there is no like for like, but we can get companies in the same ballpark. To
keep things simple and as relevant as possible, I have simply used the companies
1H19 Op Cash and figures from within the balance sheets, i.e. I didn’t go into
each company’s notes; hence I have also included SOP without the term deposit.
Encouragingly, SOP of the cash flow positive companies, has quite a
substantially lower multiple than the rest, other than EVZ. If we include the
term deposit, SOP is trading at less than a third of ZGL’s multiple, who is a leading
specialist equipment manufacturer and niche engineering service provider.
EVZ’s low multiple got me curious,
so naturally in the hope of finding another potentially undervalued company, I
started to look in to them as well. EVZ, I haven’t had a proper dive, but it
looks like despite their ability to generate a good flow of revenue, they have
been unable to convert it into cash, which has forced them to raise capital.
Over the past 3 years they have issued shares to raise $11.2m (69% of their
current market cap), SOP on the other hand hasn’t needed to raise capital since
re-listing. SOP even went so far as to issue out, to the legacy shareholders,
the proceeds of the sale of legacy assets.
The other thing we need to look at is Wini’s FY19 Op Cash assumption of $1-1.5m, which seems quite low given they earned $1.25m Op Cash in 1H19. But we need to remember that we are looking at cash not revenue, cash is quite lumpy, especially when it is dependent on milestones. Since relisting, SOP has spruiked 7 new or extended contracts, totalling $19.26m. Of these, none were completed in 2H19, they did however, complete 4 in July (These projects totalled $8.46m). The final cash portion of these contracts therefore will be received in 1H20, however, a large portion of the final push costs will be recorded in FY19, so I believe it is a good bet that cash in 2H19 will either be negative or quite small, therefore Wini’s $1 – 1.5m assumption sounds about right. Given all of this, what could be causing SOP to be trading at such a low multiple?
Company
SML Corp (SOP’s original name)
was originally in the gold mining business, owning several plots in Victoria.
They were however unsuccessful in this endeavour, and after several years of
burning cash, SML stated on the 25Th Feb 2016, that “with the
company’s current cash burn rate, unless there is a substantial turnaround in
the current conditions and investment sentiment for the mining sector and commodity
prices, the outlook for the company in the short and medium term is not positive”.
They therefore sort to change “the nature of its business and activities to
property development, initially, in Asia where there are numerous opportunities
for relativity high returns in the short term with relatively low capital
costs”. This was planned to occur through the
acquisition of a private Singaporean property development company called OSC
Group, however this fell through in September, with the board stating that they
“will continue to actively seek opportunities through, investments, mergers and
acquisitions for the company to ensure its long term viability and prosperity”.
6 months later (10/03/17), SML stated that they would be purchasing Synertec,
turning them into the speciality engineering firm we know today. The whole
process was finalised, with SML taking on the name Synertec and being reinstated
on the ASX at the start of August (09/08/2017).
SOP had pivoted away from being a
holder of gold mining assets, to a speciality engineering firm, which if you
are a fan of the podcast “Masters of Scale”, you’ll know that that is a massive red flag. Reid Hoffman
(Co- founder of Linkedin and host of Masters of Scale) frequently points out
that “The most successful pivots stay somewhat close to the company’s original
mission”, clearly SOP did not. But SOP’s pivot wasn’t typical, they didn’t
simply point the company in a new direction and start again, it was a reverse
acquisition, they purchased Synertec, slashed and burned all the old parts and
kept on some of Synertec’s management. These last two points are extremely
important. Mr. Hoffman says “You can pivot from failure to success, but only if
you slash and burn the rest of your business”. The slashing and burning gives
the leadership team the ability to develop a new vision, focusing the workforce
on a common goal, whilst simultaneously giving everyone a sense of purpose and
a feeling of comradery. If you have ever worked for a great leader you will
know what I am talking about, the human beings need for purpose is such an
amazingly powerful force, especially when you couple this with our belief that
we as individuals are all above average (To find out more click here or here). It results in high moral and high productivity, as Mr. Dan
Cable and Mr. Freek Vermeulen point out in their Mckinsey article “Making Work
Meaningful: A Leader’s Guide”, “Research repeatedly shows that people deliver
their best effort and ideas when they feel they are part of something larger
than the pursuit of a paycheck" and who doesn’t want that? Obviously for
this to be the case you need excellent management, and this is where the second
important point comes into it.
One of the main reasons that Mr. Hoffman
says pivoting too far away from your initial business doesn’t usually turn
out well, is because the company loses its edge. If a company that is
originally an app developer notices that they aren’t doing very well, see’s a
lot of people eating ice cream and says “I need to get me some of that ice
cream money”, pivots to an ice cream manufacturer, usually this won’t end very
well because the two businesses are just too dissimilar. App developers don’t
usually have the knowledge and experience to run an ice cream manufacturing
plant, which on the face of it is exactly what SOP did. Originally a miner, then
unsuccessfully tried to become a Asian property developer and ended up becoming
an engineering firm, neither of these are remotely close to SOP’s original
mission. But the purchase of Synertec came with an ace up its sleeve, that aces
name is Mr. Michael Carroll. Mr. Carroll stayed on after the acquisition and
now sits as Managing Director, bringing with him over 23 years of experience
running Synertec.
“But is Mr. Carroll the type of manager who is able to take the new vision and reinvigorate everyone?” I don’t know him personally and have never meet him, but a quick Linkedin stalk session gives me the impression that he probably is. Within the book “In Search of Excellence”, by Thomas Peters and Robert Waterman Jr., they state that one way to motivate employees is through positive reinforcement, but more specifically, that “small rewards are more effective than large ones”. They also state that the outcome of positive and negative reinforcement is asymmetrical, whilst both nudge the employees to change their behaviour; negative reinforcement changes their behaviour in unpredictable ways, whilst positive reinforcement usually pushes them in the intended direction. For example, if an employee gives a poor presentation and you choose to criticise them, the next presentation could be good, or it could be bad, depending on the type of person you gave that criticism to. Whereas, if you where to give them positive reinforcement, highlighting the areas where they did excellently, the next presentation is more likely going to have those areas further exaggerated, which if repeated, will slowly nudge them to give excellent presentations in the future. In summary, small but frequent positive reinforcement is, according to them, an excellent way to motivate and encourage your employees. We can see Mr. Carroll displaying this type of behaviour on Linkedin, he’s three most recent comments are “Great work Jarrod - again!”, “All the best for the future Heidi.” and “A great effort by our Perth team!”(Clearly this is not the best platform to view this type of behaviour, who is going to give negative reinforcement online? But the fact that he does this, I believe, increases the likelihood that he is also like this in real life). Another way to try and see if Mr. Carroll is actually like this in real life is to view his direct reports online activity, as the old idioms go, “A fish rots from the head”, or “Shit roles downhill”, well not only does poor leadership roll downhill but excellent leadership does as well. Mr. Joern Buelter, SOP’s COO seems to have taken up this type of management style as well, with comments such as “Congratulations & well done Christopher & the Senversa team!” and “Congratulations!”, seen in his Linkedin activity. They also have a score of 3.3 out of 5 on seek, not a bad score given that there is only 4 reviews so far (not the best sample size) and people usually only take the time to give a review when they are disgruntled.
“But is Mr. Carroll the type of manager who is able to take the new vision and reinvigorate everyone?” I don’t know him personally and have never meet him, but a quick Linkedin stalk session gives me the impression that he probably is. Within the book “In Search of Excellence”, by Thomas Peters and Robert Waterman Jr., they state that one way to motivate employees is through positive reinforcement, but more specifically, that “small rewards are more effective than large ones”. They also state that the outcome of positive and negative reinforcement is asymmetrical, whilst both nudge the employees to change their behaviour; negative reinforcement changes their behaviour in unpredictable ways, whilst positive reinforcement usually pushes them in the intended direction. For example, if an employee gives a poor presentation and you choose to criticise them, the next presentation could be good, or it could be bad, depending on the type of person you gave that criticism to. Whereas, if you where to give them positive reinforcement, highlighting the areas where they did excellently, the next presentation is more likely going to have those areas further exaggerated, which if repeated, will slowly nudge them to give excellent presentations in the future. In summary, small but frequent positive reinforcement is, according to them, an excellent way to motivate and encourage your employees. We can see Mr. Carroll displaying this type of behaviour on Linkedin, he’s three most recent comments are “Great work Jarrod - again!”, “All the best for the future Heidi.” and “A great effort by our Perth team!”(Clearly this is not the best platform to view this type of behaviour, who is going to give negative reinforcement online? But the fact that he does this, I believe, increases the likelihood that he is also like this in real life). Another way to try and see if Mr. Carroll is actually like this in real life is to view his direct reports online activity, as the old idioms go, “A fish rots from the head”, or “Shit roles downhill”, well not only does poor leadership roll downhill but excellent leadership does as well. Mr. Joern Buelter, SOP’s COO seems to have taken up this type of management style as well, with comments such as “Congratulations & well done Christopher & the Senversa team!” and “Congratulations!”, seen in his Linkedin activity. They also have a score of 3.3 out of 5 on seek, not a bad score given that there is only 4 reviews so far (not the best sample size) and people usually only take the time to give a review when they are disgruntled.
Great management is extremely
important, but if the sales team are unable to bring in orders, than it’s not
really worth much, there’s no point in having a well managed team with no work
to do. They have however done an excellent job bringing in new work since they
listed, as I said earlier, they have signed 7 new or extended contracts for a
total value of 19.26m since relisting. Along with their project work, SOP also
has site proven IP in their LNG Custody Transfer system (Brochure here). These types of
systems are installed to accurately calculate the volume of LNG being
transferred between producers and buyers. They do this by measuring the flow rate
within the pipe and simultaneously calculating the percentage of the different elements
to accurately calculate the volume of LNG. Which sounds quite simple, but is in
actual fact extremely difficult. Things such as pressure changes,
containments or the liquid’s temperature increasing above its due point,
causing it to undergo a phase transition into a gas, all need to have no effect
on the measurements, accuracy is crucial given the massive potential loss if
the system isn’t working correctly. According to the Gas Processing & LNG site, “a one
percent error in LNG transferred can equate to as much as a $600,000 to
$800,000 AUD in misallocation or disputes during custody transfer”. SOP’s
system can combat all of these challenges, operating with a 99.98% accuracy,
giving it all of the required ISO and GIIGNL compliances. To help sell their
system, SOP has teamed up with Trelleborg AB, a speciality Engineering firm
based out of Sweden. I’m sure this helped SOP sell their second unit to Chevron, the first being at their Wheastone LNG plant in
WA and the more recent at their Gorgon LNG plant on Barrow Island. The second
system was sold on the 27th of March and completed on the 4th
July, taking a total of 13 weeks from sale to completion, pretty impressive
delivery time.
The Pursuit for Baggers
As with recent articles, I will
again look for the 6 similarities, pointed out by Mr. Chrisopher Mayer in his
book “100 Baggers: Stocks That Return 100-to-1 and How ToFind Them”, of companies that where 100 baggers between 1962-2014.
1. Start Small
You don’t get much smaller than SOP,
with a current market cap of $9.37m (share price $0.45) a FY18 revenue of
$11.4m and profit of -$0.3m (adjusted for
listing expense) it doesn’t really get much smaller than that. I wouldn’t worry
too much about the negative profit figure, as I said earlier, profit is being
postponed, they generated $0.99m in Op cash flow and as Wini suggested, if you
subtract work in progress and tax from deferred income, you can see they
generated ~$1.8m in cash.
2. Low multiple
As you can see from the table
above, SOP is operating on a very low EV/Op cash multiple, one third of the
next engineering firm (apart from EVZ). They are also operating on a low price
to sales ratio of 0.87 for FY18 and a price to book value of 1.73. Unfortunately, due to the revenue recognition policy,
the metrics that I normally use are of little to no use.
3. High Returns on Capital
I was unsure of how to correctly
calculate the return on invested capital for SOP, the hidden earnings in FY18
and 1H19 was influencing the outcome quite considerably. I therefore have used
Op Cash as the return, which as I stated earlier is quite lumpy, especially in
an engineering firm. This is evident in the difference between FY16 and FY17,
the huge increase in FY16 was offset by a large loss in FY17. If we exclude
these two outliers, we can see that FY15, FY18 and 1H19 (which I believe is a
pretty good substitute for FY19) all have a ROIC of 18%, quite a good figure.
4. Owner Operators
Mr. Carroll is one of the initial
founders, having worked for SOP for over 23 years, he also owns ~45% of the
company. When we add this to the other board members holdings, we find that
they own a combined 49%, you don’t get management and shareholder interests much
more aligned than that.
5. They have invested in themselves
SOP has spent an average of 1.2%
of revenue each year on business development. Along with this, 2 years ago,
they expand their operation, opening another office in Perth. We can also see
that they are investing heavily in employees, having advertised for 17
high/senior level positions over the past 12 months. A number of these would be
contract work for the specific projects, such as the site supervisor roles in
Newcastle (Newcastle Terminal expansion project, won in Dec 2017) but I don’t
think all. Especially when we see that Employee + Super costs have increased
from $4.3m in FY16 to $6.2m in FY18 a 44% increase.
6. Long Time Horizon
Long time horizon is referring to
the companies taking a long time to become a 100 bagger, they need time to capitalise
on the good work of the past and to reinvest into themselves. Due to IFRS 15,
this may take a little longer with SOP as the profit in the statements is
deferred, increasing the time it will take for analysts to notice them and look
further into the notes.
SOP therefore has 5 of the 6
ingredients to be a 100 bagger, they will still need the most important one
though, the ability of management to continue to find and pursue investment
opportunities that generate a high return. Easier said than done.
Risks
Whilst SOP has the endorsement of
a pretty big hitter and from my research is looking pretty good, that doesn’t
mean it doesn’t come without risks. A big one that I am certain is having a
huge influence on this thesis is the Halo effect. The Halo effect as stated on
Wikipedia is “a perception distortion that affects the way people interpret the
information about someone that they have formed a positive gestalt with”. It
also applies to information that they publish, if you like someone, or perceive
them as an expert, you are less likely to think independently, taking what they
say not quite as gospel, but definitely seeing their publishing’s through rosy
coloured glasses. Wini’s amazing results on Strawman would be blinding me to
any flaws that I might have seen, hopefully I’m not fully blinded, but maybe
just one eye J.
The number of projects that they
win could decrease, either from economic conditions or poor management. I have
seen, on more than one occasion, such poor handling of customers that after a
project is company they are blacklisted, never to work with them again.
Unlikely, but it does happen.
The custody transfer skid isn’t
patented and whilst I’m in no way an expert, I couldn’t see any real advantage
over other custody transfer skids. They all seem to have the same level
of certifications and whilst SOP’s team would be extremely competent in the
metering systems, so would all other custody transfer skid builders. This means
that SOP is relying heavily on their sales staff’s ability to create and
maintain relationships, which might help to explain why they enlisted the help
of Trelleborg AB. I would therefore not assume that these custody transfer
skids are going to be a big money earner anytime soon. If I am wrong about this
or you have further insight, I would really appreciate it if you could get in
contact.
Liquidity risk, this is not a
thesis specific risk but a share price risk
Opportunity cost; it could take a
long time for other investors to uncover the understated earnings, potentially causing
us to miss out on other profitable investments whilst we wait.
Discussion
I think it’s pretty clear that I
am pretty keen on SOP, but what could unlock the potential gains Wini has
calculated, what could be the catalyst?
The large amount of cash
currently being generated is being stock piled, which will eventually mean that
they will spend it. Whether they allocate it to buybacks, dividends, internal
growth or acquisitions, the fact that they are doing it will help put SOP on a
large number of people’s stock screens. It might take a little longer,
especially given the size of SOP, but a little advertisement will help speed
that up.
We also have the power of the
Wini post, this stock went from held by 0 and followed by very few, to held by
2 and followed by 27 after Wini posted about it. He is currently being followed
by 609 people on Strawman and not only that but Strawman advertised this write
up in their weekly newsletter which gets sent out to the ~4000 Strawman members
(assuming none have opted out). That’s some bloody good advertisement.
Conclusion
SOP is a little gem, unfavourable
listing, hidden profits, owner operators, proven IP, low margin; it’s the
perfect recipe for an undervalued company. But that doesn’t mean that they
don’t come with risks, risks that the management team will need to watch to
ensure that shareholders are able to benefit from the hidden profits.
Anyway, I
hope I have inspired you to start your own research and as always, thanks a lot
for reading, I really appreciate all the feedback I have received so far. I am
on Twitter Follow @MaysTrav and Linkedin if
you’d like to connect, feel free to send me a msg, it’s always great to
meet other ASX investors, especially those who have a different view
point
if
you’d like to connect, feel free to send me a msg, it’s always great to
meet other ASX investors, especially those who have a different view
point
Thanks for reading
Just Culture Investor
Trav Mays
Sources:
1.https://www.ifrs.org/issued-standards/list-of-standards/ifrs-15-revenue-from-contracts-with-customers/
2. https://mastersofscale.com/
3.https://www.amazon.com/Search-Excellence-Americas-Companies-Essentials-ebook/dp/B009YM9VOQ
4.http://www.gasprocessingnews.com/features/201310/advancements-improve-custody-measurements-for-lng.aspx
5.https://www.mckinsey.com/business-functions/organization/our-insights/making-work-meaningful-a-leaders-guide
6.https://www.trelleborg.com/en/marine-and-infrastructure/products--solutions--and--services/marine/lng--custody--transfer/synertec
The author is a current owner of a portion of Synertec, given this, they may be subject to one or a number of biases, more specifically anchoring and/or confirmation bias. This article is neither general nor personal advice and in no way constitutes specific or individual advice. The website and author do not guarantee, and accept no legal liability whatsoever arising from or connected to, the accuracy, reliability, currency or completeness of any material contained on this website or on any linked site. This website is not a substitute for independent professional advice and users should obtain any appropriate professional advice relevant to their particular circumstances. The material on this website may include the views or recommendations of third parties, which do not necessarily reflect the views of the website or author, or indicate its commitment to a particular course of action. Please refer to Disclaimer page for a full list of disclaimers.
