First, my comments on the Valuebuddies Spindex thread on the 1H11 results:

I think the following points are worth considering when reviewing Spindex’s 1H11 results:

– Is there a likely reversal of the USD vs. the SGD
– Is the decline in Net Profit temporary (i.e. just for this 6-12 months)?

My personal assessment is that:

1) Spindex’s fall is due to a decline in general economic conditions.
– Yes, Net and Operating margins have fallen. But look at the details.
– Sales have increased, albeit very slightly.
– The loss was mainly due to the USD depreciating against other Asian Currencies.
– Their customers have finished with inventory restocking (taken from FY2010 commentary). This suggests that results this half would have been less than spectacular. It could be a bad year for Spindex if the economy starts to slow further.
– Spindex, as already pointed, has increased capex a fair bit so that when demand picks up, they will be there to capitalise on that.
– Trade receivables have come down quite a bit (~20%) suggesting that the company has been prudent in making collections.

2) Spindex still has very strong balance sheets.
– Net cash position.
– Debt greatly reduced.
– At 35cents, it is still below it’s Net Tangible Asset of 48.1 cents.

3) Things going against it
– I think in the long-run, the USD will only depreciate further. The only way that’s not going to happen is we have China’s economy tank. However, that’s going to be worse for everyone else.

I’m not advocating to buy or sell Spindex but I think that there’s no need to go Chicken Little about Spindex’s results. The company seems to be run by capable people and I don’t think the business that they are in is in danger of becoming obsolete in the near-term future.

However, the market dis-agrees with me. Spindex is down 5 cents to $0.30 at point in writing. Margin of Safety is becoming wider.

So as it turned out, Spindex indeed had a very bad year.

Income Statement

– Net profit (NP) down from $6.096mil to $3.723mil (-38.9%). Accounting for Foreign Currency translation, this was even more pronouced (from $5.913mil to $0.630mil, or a hefty -89.4%). The disappointment in NP was due to mainly two items- an increase in taxes payable and the afore-mentioned loss from foreign currency translation.

– As pointed out in the Valuebuddies thread, Spindex is operating in a highly commoditized business. Razor-thin margins fell from an already low 7.2% to 0.77%.

 Balance Sheet

This is where Spindex remains strong.

– Receivables went down $2.5mil and Inventories rose $1.3mil.

– Spindex still firmly in a nett cash position.

Cashflow

– Free Cashflow turned negative (-$1.43mil) on increased Capex, which is something Chairman Tan Choo Pie mentioned in his statement. Their investment in increased production capacity means that when the economy recovers, expect revenues and profits to rebound.

Overall

Dividend has been cut to 0.9cents per share. You’ll see that this is roughly what happened in 2005 as well, where FCF turned negative and their dividend got cut. I think this is the prudent thing to do and the selldown since 1H11 reflects those that bought into Spindex extrapolating results to infinity and looking for quick returns.

I’ve learnt my lesson. Spindex, despite being a company with long operating history (since 1981), is operating in a very difficult environment. They basically have no moat to speak of with the exception of Chairman and founder, Tan’s relations with various actors in the industry that have been established over a long time.

As stated in the commentary of their 4Q/FY11 results annoucement, sales have slowed down towards the end of the financial year. Therefore, expect 1H12 results to be ugly given the slowdown in the  global economy thus far. If most of the developed world officially falls into a recession before end of the year, expect things to get much uglier before they get better.

Spindex’s management needs to be commended for doing a decent job in a difficult environment and I won’t take that away from them. I’ve pared down my position on Spindex some time back even though Spindex is one of the few stocks that look cheap as cheap can get cheaper.

At this time, cheap is still not cheap enough.

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