Thursday, November 22, 2007

My first foray into fundamental analysis: Aztech



Aztech systems ltd is a manufacturing firm that provides OEM/ODM design and manufacturing services, contract manufacturing and retail distribution. Their products include data communication devices (like modems, routers, wireless products), voice communication products (IP telephony, skype products), homeplugs, TV receivers and even RC helicopters for hobbyist.

Shiro Corporation is a subsidiary of Aztech. It’s a brand that sells mp3/mp4 players, skype phones, wireless modems. Basically, I think it’s just a product arm of Aztech (not sure about that). Incidentally, I used to own a cordless Shino phone. ‘Dieded’ after a few months and since then, have a bad impression of Shino phone products.

Aztech has its own manufacturing plant at Dong Guan, China, with close proximity to airports (HK, Shenzhen, Macau and Guangzhou) and sea ports (Yantian and HK).

I’m not really a techie, but from the awards Aztech won in 2007 for its wireless router, it seems they are at least coming out with the right products that people wants. Whether that translates into profits, we shall examine it in detail.

This year, Aztech won the SIAS investor choice award for being the most transparent company and silver award for best investor relations. While it’s hard to forget that Sembcorp marine also won some award from SIAS before its downfall in fx losses, I do agree that Aztech investor PR is a notch above the other companies I’ve seen. Their website is well updated, information is presented clearly. I never had such an easy time digging out information from any company. Their accounts is so transparent and written so clearly that it really spoils me! This wine smells good before I even tasted it.

While analyzing, I notice that I do not have a framework to scrutinize a company. I need to find out from books how to dissect a company in bits to analyse. I’ll work on it. In the meantime, I’ll do an analysis of the company itself for the past 5 years. A good analysis should also include comparing Aztech across its peers but this would be another day, another fight.

While compiling the information from the past 5 years of annual reports from their website, I noticed that I have to grapple with different numbers even though the items are the same. An example is that the administrative expenses in the 2005 annual report is different from the same item in the 2004 annual report. Quite often I have to cross reference 2 sets of annual reports and do some detective work before I can discover what is the new thing that they included inside the same item. There’s a lot more such examples. When in doubt and the figures do not match up despite my sleuthing, I always take the latest figure.

I can’t emphasize it enough. In the course of just compiling data from the past 5 years of annual report, I learnt a lot of things. I wanted to find out the R&D expenditure of the company and the problem is that they do not state it explicitly. Even much sleuthing, I managed to deduce that the R&D expenditure can be found from the cash flow statements, under deferred expenditure (from 2003 to 2005) and intangible assets (from 2006 onwards). A sense of satisfaction envelops me :)

If it was hardwork compiling the data, it was harder digesting the data and the various ratios that are supposed to help to feel the company. Here's my compilation and some ratios:

The data above is compiled using the annual reports available from its website. I doubt the above is of any use to anyone, cos it's too messy. I'll do a better job next time. Here are a few pointers worth mentioning:


It’s a remarkable feat to see the net profit growing steadily from 2003 to 2006. Net profit margin is increasing from 2.4% in 2003 to 8.4% in 2006. 2007 might have some problem maintaining the growth momentum (I annualized the net profit, turns out to be $16.8 million, a far cry from $20 million in 2006). Their 4Q is traditionally stronger so it should be able to push the net profit up to at least match 2006 net profit. There's quite a couple of factors that would push up 4Q earnings too, which I'll touch on later.

Their newly opened manufacturing plant in Dong Guan, supposed to multiply their capabilities and steamline their cost, does seems to work. We see an immediate jump in operating profit margin from 5.7% in 2005 to 9.5% in 2006. I think it’s important to see how this figure goes as when we look at the full year results in 2007. So far, the rising wages and appreciating renminbi is causing them some trouble in 3QFY07.

What I do suspect is that 2006 is a very strong year for them; hence the results might be hard to beat this year.

With increasing wage and rising reminbi, I think it’s a good choice that the management is transforming their manufacturing plant towards automation with less dependence on manual work. Moving forward, China will no longer be a cheap place to situate their manufacturing plant. Aztech will have to find ways to grapple with rising labor and overheads in China, together with rising renminbi. In 3Q 07, they are already reporting higher turnover but lower net profits. Can see this happening in their administrative expenses and the cost of goods solds, both reporting a rise of 12.1% and 24% respectively.

It’s important to keep a lookout for their operating margins as a result of this, looks like it’s going to drop from 9.5% to around 7-8% this FY07, a cause of worry.

R&D expenditure

R&D expenditure is increasing in dollars, but R&D spending per revenue seems to have reached a peak in 2003. But the management promised to spend more on R&D in 2005, which I think is paying off in the form of new products that is well received by the market, judging from the good vibes generated in industry magazines. I think for their products, there are so many brands all with similar specifications, so it’s important to know what makes it sellable. What truly differentiates their product could be positive reviews in magazines. I’m speaking from my own point of view – I won’t buy tech gadgets without first browsing through reviews.

Their R&D% increased steadily since 2004, but question: is the expenditure too low? I have no idea without comparing this figure to its peers. With 4 R&D centres found in Singapore, HK, Shenzhen and Dong Guan (china), the expenditure on R&D is only less than 2% of net sales? Hmm… In order to maintain the innovation and strong R&D presence in Aztech that they keep saying they are, I think coming up with new innovative products is a must for it to maintain a good lead among its competitors. I would love to see greater increase in R&D expenditure in 2007 (so far for 3Q, it’s spending with respect to net sales is quite good at 1.9%).

While their strength is traditionally in data and voice communication, in 2005, they ventured into multimedia like MP3 players, multimedia speakers and power conversion products. This is after they identified in 2005 that the multimedia sector has the potential for growth (I agree – even handphones with mp3 are the norm nowadays).

I wonder what’s the margin like for selling each individual product. No way they are going to put it in their report for fear of competitors… but I would very much like to find out from people in the business.

Segment growth

They did very well in M’sia and Singapore, which happens to be the place where they get the most awards and accolades. Aztech did very well in M’sia in the wireless networking and products area. Can see that they are trying to increase their market share in Europe and other parts of Asia pacific by taking part in trade fairs to showcase their products.

I tried to manually calculate their turnover by business segment but the figure I got was a little off. It didn’t help that in 2004 to 2005, they reclassified their business segment to form the present 3 segments – retail distribution, contract manufacturing and ODM/OEM sales AND further reclassified some of the 2005 turnover for ODM/OEM sales to retail distribution. I’m left puzzled and confused. My rule still holds – use the latest figures when in doubt (it is more conservative in the analysis too). Due to these changes, I’m unable to come out with similar turnover by business segments for FY2003 and FY2004.

There’s a slowdown in contract manufacturing because of slowdown in orders for a complex high end product from key customer in Asia Pacific. I wonder if it’s serious.

I did it for turnover by geographical segments for all the years though. Interesting trends can be observed. Aztec is increasing its turnover in other regions (I think they are referring to Egypt, South Africa and Australia specifically), while turnover in Europe is dropping. Did the trade fair they attended in United states contribute to the great increase in turnover in America for 2007 (judging by 3Q turnover)? I saw their 2H07 report saying that they are venturing into new markets in South America and eastern Europe. Do hope to see more contracts wins in those two areas – hopefully a rise in turnover in America and Europe.


Okay, I admit, I’m not good at analyzing this but I’ll work on it. Aztech EPS increases year on year, that’s all I can comment now.


Aztech had a history of holding inventory for long – 70 plus days. I need to see comparative figures for other company in the same business before I can comment. 2 months plus of inventory in their warehouses, is that risky? They are dealing with tech products so my impression is that tech products have very short lifespan and becomes obsolete fast. Good sign is that the inventory to current assets is actually decreasing over the years, so maybe it isn’t a worrying trend.

In 3QFY07, their inventory rose up a lot. Possibly a result of delay in the key customers. It is confirmed when they breakdown the inventory and it showed more than half of the inventory comes from the contract manufacturing projects. They mentioned this increase in inventory level was due to the purchase of major components for the confirmed order of 1.5 million units of ADSL 2/2+ broadband modem from a key customer in North America. Hmm, I thought their 3Q07 presentation said the delay in orders is from Asia pacific region? Another customer? Interesting.

Anyway, the keyword here is confirmed order. So, it shouldn’t be a problem. I took notice of an inventory provision of $1.03 million made for obsolete items – so it’s true that the inventory do gets outdated.


Gearing goes from 24.6% in 2003 to a peak of 67.4% in 2005. Wow, isn’t that pretty high? I guess it’s their manufacturing plant built in 2005 that requires them to borrow. However, they did a sale and leaseback agreement on Aztech building in Ubi for $23 million with a lease of 7 years in 2006. This move improved their cash flow in 2006 and improved their gearing to 24.8%, a more acceptable figure.

The good part is that they should have enough cash flow to repay their interest. Cash flow is steadily increasing yoy. Their cash conversion cycle ties down closely to their inventory turnover, which is near 2 months plus. This means that they have little trouble collecting debts from customers. This company pays steady and increasing dividend, so that should show something about its strong cash position. Not too worried about Aztech, since it had survived from 1994 till now, going though the tough times and good times.


A hasty conclusion, yes. There’s so much more things to find out, so much more things to sleuth that I could go on writing on and on. Any longer I feared I’ll be doing a thesis on Aztech already – so pardon my hasty stop. I found out that I would have to specialize in certain fields or sectors to be good in these as there is absolutely no way to plow through the fields of information that floods me daily. And I haven’t even done the comps (comparative studies of peers). No wonder analyst no need to sleep, everyday run model run until die man…

Aztech looks good on its balance sheet. It shows a healthy growth in its net profit margins and have the cash flow and steadily increasing dividends to boast. On accounts of its financial statements, I’m pretty satisfied in the way they run their business. A few pointers:

1. Is their inventory levels too high? How is their inventory supply compared to industry average? An investor needs to know this as tech products become obsolete very fast, maybe once every 3 months? An inventory supply of 70 odd days is worrying to me from my amateurish views.

2. What is the competitive advantage of Aztech? I know they won multiple awards for their wireless technology in M’sia prestigious magazines. Is it their strong R&D research? Are they spending enough on research compared to their peers? To me it seems a little strange to know that they have 4 R&D centres but their relative expenditure on it compared to net sales is only 1-2%. In the cutthroat world of tech products, one needs to be on the move both in design and function in order to beat the many competitors that will come to take one’s market share. I have problems seeing what is so good about their products – what’s their economic moat that prevents future competitors from stealing their profits? Can they raise their prices when they want to increase their margins – I doubt so because the competition in their product range is fierce.

3. Their manufacturing plant in Dong guan, China, is facing higher costs and appreciating renminbi that is threatening to lower down their margins. I don’t think renminbi would be going down anytime soon, and I read that they are mitigating this risk by hedging a fixed amount of US dollar against SGD and China Yuan. Is that safe? They already suffered from an exchange loss of SGD 0.44 million due to depreciation of US dollar against SGD. I’ll love to see their transformation to automation that relys less on manual labor.

4. On a closer note, it’s exciting to see if their 4Q can push up their lackluster 3Q performance. From research reports I’ve read, it seems that the delay in their contract manufacturing will be resumed in 4Q, so all seems to be well. Their long awaited product will also be launched in 4Q, possibly coinciding with the traditionally stronger 4Q for tech sales. This might be factors that could at least be on par with FY06 earnings. They stated the order book as of 24th October secured to date hits SGD 270 million, compared to a total of SGD 239 million in FY06. A good sign and reward for their continued expansion into new regions.

Based on FY06, their EPS is 4.9 cts. At the current price of 30.5 cts, Aztech is just trading at 6x FY06 earnings. I'll work on the dividend discount model one gosh, so many things to do.

adjusted the PER after protonoid advised me - see comments

5. To me their gearing is a bit on the high side – but I could be wrong since this is the first time I’m doing this. I’m comfortable with their ability to pay off their debts from their strong cash flow, just a little worried in bad times. Their products isn’t exactly necessity products, so earnings might drop when times are lean. Can they repay their interest when recession hits?

Their quick ratio is always near 1 (lower side of 1), which is a good figure I believe. As long as earnings generate cash, not a problem.

That’s all I can say. I know it raises more question than it answers, but hey, I just started ok? Haha :)

PLS PLS post comments about anything on this hardwork I've done! I spent 2 days plus one looonnggg night sleep now


Protonoid said...

Haven't read thru the whole thing completely, but I noticed something a little off, isn't it rare/uncommon for EPS to be above current price?

"Based on FY06, their EPS is 4.9 cts. At the current price of 3.05 cts, Aztech is just trading at 1.6x FY06 earnings, a bit undemanding isn’t it?"

I thought 3 cents was a little low, so I took a look at ChartNexus. I believe you mean to write 30cents?

That would mean that Aztech is trading at about 6.1x FY06 EPS.

la papillion said...

Hi protonoid,

Thks for proof reading for me, i appreciate that!

You're right - I meant 30.5 cts. So that means Aztech is trading now at around 6x FY06 earnings. I also used the formula the other way around, should be price per share divided by earnings per share.

U taught me something - using common sense to feel for the numbers :)

Thks again!

la papillion said...

Hi protonoid,

Thks for proof reading for me, i appreciate that!

You're right - I meant 30.5 cts. So that means Aztech is trading now at around 6x FY06 earnings. I also used the formula the other way around, should be price per share divided by earnings per share.

U taught me something - using common sense to feel for the numbers :)

Thks again!

la papillion said...

As mentioned by protonoid, the allowance of doubtful trade receivables in 3Q07 should be -579, not 579. This is due to Aztech's provision of bad debts for 2 customers.

As a result, bad debts jumped from 0% in 2006 to 1.3% in 3Q07