Previous post, we posted a business analysis of IQGROUP. In this post, we explore the financial figures of IQGROUP. Before that, we would like to remind our readers that in our every case study, we start with a Business Analysis post and followed by a Financial Analysis post. Business Analysis is always fun to read as we explore the story behind the company. On the other hand, Financial Analysis can be boring sometimes. As mentioned in our post The Inception of Stockify’s Portfolios, in terms of financial / quantitative analysis, our stock selection is based on few main criteria, i.e. good fundamentals with low / no debt, reasonable profit margin, cash generation capability and sufficientMargin of Safety. As a result, Financial Analysis posts may sound repetitive (because they were selected based on the same criteria in the first place!). Thus, to ease the readers’ pain, we would present the main criteria with charts & figures and only go into depth for something really stands out for the company under coverage.
Table 1 shows the profitability of IQGROUP over the years and presented in charts in Illustration 1 & 2. As we can see in Illustration 1, there is an uptrend in revenue, gross profit and net profit in the group. You would notice we add a net profit without other income in our analysis, as the “other income” of IQGROUP fluctuated over the years (presented in table 1). The unsteady other income was mainly attributable to net foreign exchange gain (loss) resulting from operating across the continents. We believe that we should discount this factor to measure the core earnings capability of IQGROUP. Having said that, favourable exchange rate while sales is made would still be reflected in revenue and for that there’s nothing we can do about that.
The net profit margin of IQGROUP stood out from the rest. The profit margin grew from 43% in FY12 to 52% TTM 2QFY17. This is a typical gross profit margin of a technology company where cost of sales plays a small part in operating expenses. After the deduction of other operating expenses like Research & Development (R&D) rental expenses and depreciation of property, plant and equipment, the EBIT drop to the level of 14%. Another interesting point, as presented in illustration 2, margin expansion is not consistent in EBIT margin & net profit margin, but there is consistency expansion in net profit margin without other income, where non-core income doesn’t play a part.
IQGROUP has been staying in net cash position since FY12. In fact, when we checked the history, IQGROUP was already a net cash company when it was listed in FY06. As shown in Table 2, the net cash per share for IQGROUP is RM 0.61, representing 21.94% of the market capitalization (at time of writing IQGROUP is trading RM 2.78). Table 2 indicates that IQGROUP has a very strong liquidity ratio, i.e. current ratio, quick ratio, and cash ratio that enable it to meet its short-term obligations easily.
Cash Flow Statement
Cash flow of IQGROUP has been improving tremendously. In Table 3, we can see that cash flow from operating activities (CFFO) and free cash flow (FCF) of the Group has achieved a whooping CAGR of 30.6% and 50.7% respectively. Due to the improved FCF, the Group has started paying dividend in FY15 in an increasing manner. Assume IQGROUP maintains second interim dividend of 6 cent per share in Q4FY17, it would make up 11 cent for FY17, equivalent to 3.96% based on the price of RM 2.78 at time of writing. Despite the fact that we are satisfied with IQGROUP cash flow growth, we opine there is still room of improvement as the Group CFFO is only make up to 79% of its net income in TTM 2QFY17 and FY16, suggesting weaker cash cycle.
Assessing the management of IQGROUP with usual management efficiency ratio (i.e. ROE, ROA, CROIC, ROIC) as indicated in illustration 4, we don’t see stable uptrend in the chart. However, all of the ratios surpass our standards especially for ROIC and CROIC, exceeding 20% most of the time in recent years.
Excerpt from Annual Report FY16
Table 5 shows the directors remuneration over the past 5 financial years. The total remuneration paid to the directors in FY16 was just 11% of the profit made during the year. At the same time, the excerpt of annual report FY16 shows that the founder cum managing director of the Group, Kent Chen is holding 65.9% stakes in IQGROUP. Our findings improved our confidence in the management, as the Group managing director’s interest is in line with retail investors, he will more likely reward his management based on their performance, and increase his income by raising dividend.
Research & Development (R&D)
As mentioned in previous post, R&D plays an important role for IQGROUP to maintain and expand its business. R&D expenses also made up to a big portion of the Group operating expenses (as shown in illustration 2, when comparing gross profit margin with EBIT margin). Thus, it is important for us to make sure the R&D of IQGROUP is bearing fruits. With limited disclosure in R&D, we can only measure the return of research capital (RORC) by tracking ITS past record, with the formula of: Gross Profit of current year / R&D Expenses of previous year. Table 6 shows the RORC of IQGROUP over the 5 financial years. To interpret it, ROIC of 20.71 in FY16 means that for every RM 1 spent in R&D in that year is generating RM 20.71 in TTM 2QFY17.
We have also included the government grant which IQGROUP has been receiving from Malaysia Industrial Development Authority (MIDA) as an incentive for its R&D in our analysis. The grant amount stands only a small portion of the total R&D expenses, it means that IQGROUP has been self funding its R&D and investors should not be overly concerned with the termination of such incentive in the future.
Regardless how good is a company in terms of its business prospect, business model and management, you don’t want to pay for a price that has already reflected its intrinsic value, or even exceeded its value.
Table 7 presents 3 simple valuation metrics out of IQGROUP based on price at time of writing RM 2.78 and TTM 2QFY17. While P/E is probably the prime valuation metric that is most commonly used nowadays, it is hardly the best valuation metrics, but the probably easiest to derive. The biggest drawback of P/E ratio is that it ignores the capital structure (the debts) of a company and therefore misrepresenting earning capability of the business. EV/EBIT is arguably the “better” valuation metric because the Enterprise Value (EV) takes into account of balance sheet so it allows comparison of companies that are using different capital structures. P/FCF valuation takes another step to measure the valuation of a company by using the FCF generated, instead pure earnings, on the belief that it is the cash reach your hands matters.Table 7 shows that IQGROUP passed two out of the three simple valuation metrics presented.
Despite not a big fan of another similar metric EV/EBITDA (Warren Buffett 2002 Berkshire Hathaway’s Shareholders Letters), Warren Buffett has said that he will generally pay 7x EV/EBIT for a good business that is growing 8-10% per year. EV/EBIT is also the major component in The Margic Formula designed by Joel Greenblatt, which has contributed a lot in Stockify’s stock screening process. As shown in Table 7, EV/EBIT of IQGROUP has passed our standard of less than 8x. Assuming the fair value of IQGROUP is to trade at EV/EBIT of 8x, the intrinsic value of IQGROUP is RM 3.18, providing potential gain of 14.3%, and MOS of 12.5% at time of writing.
Intrinsic Value of IQGROUP using EV/EBIT valuation metric
Simple valuation metrics are relative value methodologies, in other words, they would be much more meaningful when comparing against peers. Unfortunately, we couldn’t find a direct peer in KLSE to compare with IQGROUP. The closest peers we could find are those E&E manufacturers listed in KLSE but we believe the comparison would not be meaningful.
More importantly, there is no one metric that is able to assess the company’s intrinsic value and dictate your investment decision alone.
In analyzing the business of IQGROUP, we are impressed by IQGROUP’s ability to move up the manufacturing value chain, evolving from OEM to ODM, pure manufacturer to technology company. It is also in a very good position where the global lighting industry is heading. From financial analysis, high gross profit margin of the company reiterates our view that IQGROUP is in fact a technology company. We are impressed with the cash position of the Group over the years. R&D is the major factor to decide if the Group is going to continue to perform in future years, thus there lies the greatest risk, and also the greatest potential. With very limited information disclosed regarding the Group R&D, we could only analyze it with past financial records. And from there, at least we think it has been bearing fruits.