Sarine Technologies - Recurring Revenues Shine
- Sarine Technologies (SGX:U77)'s 1H22 revenue was US$31.2m vs US$36.0m in 1H21 (+19.2 h-o-h, -13.3% y-o-y). The 13.3% decline y-o-y can be attributed to a high base effect in 1H21 during the post pandemic rebound of the diamond industry. 1H22 revenue amounted to 54.5% of our full year estimates, broadly in line with expectations as the first half of the year is typically stronger.
- 1H22 gross margins dipped to 71.3% vs 74.6% in 1H21. The lower profitability is on the back of lower overall sales and absence of the sale of inventory that was previously written off. Overall net margins also declined to 21.0%, from 35.0% previously upon the normalization of operating expenses as activities such as trade shows have partially resumed. Coupled with lower sales, net profit fell 48% y-o-y from a high base.
- Capital equipment sales declined by ~30%, offset by higher recurring revenues. The lower capital equipment sales can be attributed mainly to geopolitical uncertainties. Our checks indicate that this sharp drop is unlikely to recur as there has been some easing in geopolitical uncertainties. Nonetheless, this was cushioned by an 22% increase in recurring revenues that consisted of trade related revenues and diamond scanning revenue.
- In 1H22, Sarine Technologies delivered 32 Galaxy family inclusion mapping systems, including 12 systems for larger stones mainly to customers in Africa. This is comparably higher to 5 systems for larger stones in 2H21 and 8 systems for larger stones in 1H21. The increase in sale of systems for larger stones was brought about as the government in Botswana and Angola encouraged domestic cutting and polishing. As at 1H22, Sarine Technologies’s total installed base stands at 743 systems.
- Higher margin trade-related revenues more than doubled. Trade revenues grew 70%, reaching 11% of total revenue from just ~6% in 1H21. Sarine Technologies is seeing increasing adoption of the Sarine Diamond Journey by many global brands such as Maison Boucheron and the Aura Consortium which comprises Cartier and LVMH.
- China’s National Gem Testing Centre, the largest gemological laboratory has adopted The Sarine Profile, which should support growth in trade-related revenues. There are also further developments in two key trade-related services with the broader roll-out of e-grading to midstream customers and beta-testing of Sarine AutoScan. Advancements in the trade-related segments have been encouraging and we believe that the growing trade revenues will be a key catalyst for Sarine Technologies.
- India’s diamond midstream manufacturing activity sturdy in 1H22, reflected in higher diamond scanning activity for Sarine Technologies. According to the GJEPC India, India’s 1H22 cut and polished exports came in at US$12,493 million, 4.3% higher than the same period last year. We observe a similar pattern in Sarine Technologies’s diamond scanning revenue which benefitted from higher quantities of rough diamonds scanned on the Galaxy systems in 1H22.
- 1H22 was robust but we remain cautious of macroeconomic weakness. The Mastercard Spending Pulse for the month of July shows that US jewelry spending jumped 19% y-o-y and was 109% higher than the same period in 2019. While US inflation has eased slightly to 8.5% in July, US disposable income is still under pressure. Thus far, jewelry sales in the US have continued to thrive however that may change if the macroeconomic environment worsens significantly.
- Interestingly, demand for diamonds 3ct and above remains strong whereas demand for smaller 1-2ct diamonds is diminishing. This is reflective of the effects of inflation on the affluent and the middle class. In a high inflationary environment with a higher risk of recession, middle-class consumers are likely to delay or put off discretionary purchases such as diamonds. However, we note that the diamond industry has generally been resilient to mild recessions. Hence, we do not see significant dips in diamond scanning revenue unless the economy tips into a severe or prolonged recession.
- China’s zero-COVID policy a headwind for Chinese retail demand and the supply chain. The Shanghai Diamond Exchange (SDE) which reflects China’s shipment of diamonds for domestic sale reported that polished imports declined 36% y-o-y. Diamond demand in China was weaker in the first half owing to waves of COVID-19 cases. Nonetheless, the President of the SDE is optimistic of recovery in the domestic market with the launch of economic stimulus packages. In addition, the lockdowns have also impacted Sarine Technologies’s Chinese suppliers which has resulted in longer lead times and price increases. As yet, the impact of the supply chain disruptions has been minor as the secondary effects on Sarine Technologies’s suppliers in other regions are less pronounced.
- Sarine Technologies declared an interim dividend of US$0.01 per ordinary share and a special bonus dividend of US$0.005. This gives rise to a dividend yield of 8.7% assuming that Sarine Technologies pays out US$0.01 as its final dividend. Excluding the special dividend, Sarine Technologies currently trades at an attractive dividend yield of 7%.
- Upgrade Sarine Technologies to BUY with unchanged target price of S$0.50. Our target price is based on 11.2x the average of FY22F and FY23F earnings, around the historical mean. There are no changes to our revenue assumptions however we have increased our net profit forecasts by 14% and 12% respectively for FY22 and FY23 on improvements in net margins. We have also assumed an exchange rate of 1.38 (US$/S$). Sarine's share price has dropped, and the stock appears to be trading at reasonable valuation.
Above is the excerpt from report by DBS Group Research.
Clients of DBS may access the full report in PDF @ https://www.dbs.com/insightsdirect/.
Sachin MITTAL DBS Group Research | Singapore Research Team DBS Research | https://www.dbs.com/insightsdirect/ 2022-08-12 2022-08-12
Previous report by DBS Research:
2022-05-19 Sarine Technologies - Growing Trade Revenues To Lift Margins
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