Sarin – Kim Eng
Focus on long-term structural growth
Softer 3Q12 than we expected. Although we were expecting weak 3Q12 numbers, the decline was greater than what we anticipated. Revenue came in at USD11.7m (-26% YoY, -35% QoQ) with corresponding net profit of USD2.5m (-41% YoY, -62% QoQ). 9M12 net profit made up 64% of previous FY12F forecasts. We have advocated looking beyond FY12 numbers previously so this set of weak results is not too much of a concern. Maintain Buy with TP reduced to SGD1.57.
What happened this quarter? Sales in 3Q12 were affected by weak demand from Indian manufacturers as they put off capex spending. This was mainly due to two key reasons: (1) High rough diamond prices, coupled with short-term weakness in polished diamond prices erode manufacturers’ margin and (2) Indian manufacturers face liquidity and credit line issues. Sales of GalaxyTM were also affected, as only 5 were sold this quarter (compared to 13-14 in the preceding 2 quarters). Sarin also warned that it may miss its target of 100 installed GalaxyTM machines by year end given that it has only 88 as at 3Q12.
Signs of easing. There are however positive signs emerging from (1) DeBeers’ 10% cut on rough diamond prices, and (2) holiday buying of polished diamonds, which should aid in the recovery of the Indian manufacturing sector as liquidity issues dissipate.
Structural growth story intact. We believe that inherent demand for GalaxyTM has not abated but is temporarily subdued by customers’ financial positions. We see potential for resumption of sales momentum towards end 4Q12. Progress of its polished diamond products could see some breakthrough in end 4Q12 if it manages to establish commercial agreements with major industry opinion leaders for its Sarin-Light product.
Maintain Buy. We cut FY12F net profit forecast by 16% on weaker 3Q12 numbers and trim FY13-14F figures by about 5-7%. Growing recurring revenue base (25% of total revenue for 9M12) from GalaxyTM has improved quality of earnings and helped reduce volatility. We remain positive as we believe that the adoption cycle of Galaxy is still in its early stage. Maintain Buy, TP reduced to SGD1.57 pegged at 13x
Sarin – Kim Eng
Early signs of easing
De Beers cut rough diamond prices. In the last DTC sight in August, De Beers reduced rough diamond prices by an average of 8%. As a result, all rough diamonds were taken up by sightholders, compared to more than 20% rejections in the previous two sights. Based on a Rapaport report, the cut in rough prices narrowed the gap between rough and polished price movements from about 15% to 5%. This is a positive move for the industry as it would ease liquidity challenges and profit margin pressures for manufacturers.
Polished prices more stable. Polished diamond prices were more stable in August, following steep declines in previous months. There should be gradual improvement in demand ahead of the fourth-quarter buying season. Demand for lower-quality and cheaper diamonds appears steady while that for high-quality stones is still relatively weak. All eyes are on the Hong Kong jewellery show in late September, which would give a clearer indication of polished buying demand.
Indian manufacturers still face liquidity problems. While there is an improvement in sentiments, given the added burden of a weak rupee, Indian manufacturers are still plagued with liquidity issues. We do not expect these manufacturers to resume capital equipment purchase until further signs of easing as they remain cautious. However current developments are moving in the right direction.
Look for growth beyond FY12. We maintain our view of looking for the next leap of growth for Sarin beyond FY12, which would come from the penetration of the polished diamond market. Meanwhile, we are not even midway through the adoption cycle of the Galaxy, which would drive recurring revenue to reach about 30% of total revenue by FY13F.
Current valuations a steal, reiterate BUY. Current depressed stock price offers a good opportunity for accumulation. While Fidelity trimmed its position from 6.2% to 4.8%, Sarin has bought back 0.3m of its own shares recently at SGD0.90-0.92, demonstrating its confidence in the company. We lower FY12F net profit by 4.4% as we incorporate more conservative 3Q12 numbers. We roll forward our valuation multiple onto FY13F earnings and our target price is marginally higher at SGD1.68, peg to 13x peer average forward PER.