ISDN Introduction
ISDN is an integrated engineering solution provider principally focusing on motion control, industrial computing and other specialized engineering solutions. The following are descriptions of each segment that are presented in its financial statement.
Engineering Solutions - Motion Control
As a motion control solution provider, in addition to distributing products, ISDN also designs, customises and assembles motion control systems which enable their customers to reduce costs and to better improve production efficiencies. Their motion control systems are typically used for factory automation in a broad range of industries.
Other Specialised Engineering Solutions
Other than motion control solutions, ISDN offers their expertise to provide engineered hardware for customers, including standard modular construction components for use in industrial automation systems, and high-grade components such as industrial locks, fasteners, hinges as well as aluminium profiles and related accessories.
Industrial Computing Solutions
As part of ISDN's suite of industrial engineering offerings, the company also provides cost-efficient industrial computing solutions (such as “Wonderware”) and custom builds of required structural hardwares (i.e industrial computers).
Others
There isn’t a write up on this segment in the Annual Report, but this would include a plethora of exploratory sectors that ISDN is invested in. The majority would come from the company’s investment in Aenergy which in turn is invested in 3 hydropower dams in Indonesia. In its 2020 announcement, it was also mentioned that “The Group also expects to progress its clean energy hydropower business towards commercialisation in 2021”. Another part of this segment would be its JV with Erst Project Gmbh that distributes a range of coatings that is developed by the latter. The emphasis in this pandemic would be the Erstotizer and Waterliq which you can derive more information from the link together with other distributed products.
Breakdown by segment and country
The following diagrams from the company’s announcement would provide the breakdown in revenue and country exposures that we should be focused on.
93% of the revenue is made up of Industrial Automation Solutions Business.
67% of the revenue is from China, and another 13% from Singapore.
Its clear then that we should be looking at Industrial Automation in China and other South East Asian countries with Singapore having the most significant share of revenue.
Analysis of 2020 Preliminary Results
To establish a baseline on how the company is performing, we have to look towards the 2020 financial results that the company has just published recently. Looking at the net profit attributable to shareholders, the company seems to have lodged an impressive 115% growth from S$7.047m in FY2019 to $15.139m in FY2020. This is marred by several non recurring provisions or losses made seemingly in 2H2020.
1.) S$1.5m in Legal Compensation risk related to previous announced litigation against GM in 2H2020 and FY2020 (Related Announcement)
2.) S$4.5m impairment on long held receivables in 2H2020, S$4.2m in FY2020, due mainly from 2 non-operating investee companies (Related Announcement)
Extract from AR2019
“In prior years, ISDN Resource provided a total funding of US$2.9 million (equivalent to S$3.9 million) under the mining operation agreements entered into with two investee companies in Indonesia to which ISDN Resource will provide financing and other management related services for the investee companies’ mining business. This funding is secured by unconditional personal guarantee of the shareholder of the investee companies.
The Group has proceeded with arbitration against the investee companies in Singapore. The
arbitration is on-going. Management is of the view that the repayment amount is not credit impaired based on the financial standing of the guarantor.”
3.) S$3.5m in 2H2020 on Foreign Exchange Loss, S$2.4m in FY2020
From the above, I would assume that 1) and 2) are 100% attributable to shareholders due to the first being an indirectly held wholly owned subsidiary and second being funding provided by ISDN. I would assume that 3) comes from the "other" segment since the segment registered an eye popping $(8.396)m in losses for FY2020 and comes from the Hydropower Plants business. If I were to work back to the increased equity interest in Aenergy, I would hazard a guess that the attributable FX loss to shareholders is 44.3% of the full amount.
Having all these come in for 2H2020 and FY2020 have heavily distorted what the actual adjusted financials look like. 1H2020 net profit attributable to shareholders is S$9.572m. 2H2020 might look like a simple $5.567m net profit attributable to shareholders. With the assumptions derived from announcements relating to 1 to 3 above and excluding those losses, the net profit attributable to shareholders should look more like $21.9m for FY2020 and $13.1m in 2H2020.
Armed with the above, and keeping in mind that the world probably was in lockdown mode for a large part of 1H2020, we would be looking at the following key statistic. Market Cap at point of writing was 435,337,894 * 0.615 = S$267.7m. FY2020 PE will be at about 12.2x adjusted profit attributable (removing deemed non recurring losses) to shareholders.
So now comes the crux of the question. Is the company fairly valued at 12.2x PE?
Let us try to look at it from 3 aspects. Prospects of ISDN in its largest countries of exposure. How are the other companies in related sectors performing and where they are trading. The perceived non-recurring nature of the business.
Macro Policies
In the macro policy backdrop, the top 2 markets that makes up the revenue of ISDN’s integrated automation solutions are China and Singapore. Suffice to say, the policies are very accommodative towards growth in industrial automation in both countries.
In China, the unveiled Made in China 2025 plan includes improving manufacturing innovation, integrating technology and industry, and advancing restructuring in manufacturing that is tied into what ISDN is providing as solutions.
In Singapore, the recently announced ten-year plan to increase manufacturing by 50% and bringing in advanced manufacturing techniques. Needless to say, this would quicken the transition to Industry 4.0 automation and benefit ISDN.
During the research into this company, I have found the released figures for domestic production of industrial robots in China (Source: http://www.stats.gov.cn/) to be a reasonable proxy statistic for adopting industrial automation. This might not be a direct comparison for motion control solutions but I do believe that it works well enough.
You would notice that for production figures, the Jan-Feb amounts tends to form a baseline for production in later months (Jan and Feb figures are released as one number due to the Chinese New Year, and I have conveniently divided the figure by 2). Subsequent months of production tends to jump by 30% or more from Mar onwards, with the exception for 2020 due to Covid 19 lockdowns. If this is any indication of how the industry will perform, subsequent months should see activities that surpasses Dec production figures. If we work out the 2020 Q4 performance for ISDN both revenue and profit wise from the announcements, it bodes well for what is coming in 2021. I will leave this exercise to you.
Performance of related companies
Next, we should look at how companies in the industry are doing, which includes both manufacturers and solution providers. In the manufacturing side, you would see a common theme that China is the bright spot in exports.
Yaskawa Electric – If we look at the results presentation for 2Q and 3Q, we will see the jump in exports to China which is really the only bright spot in all its markets. Other regions are recovering sequentially over the 3 financial quarters as well with Yaskawa Electric revising up its full year forecast in each results announcement. They are so bullish on China that the company is spending 4-5 billion yen to build a plant in China to produce servo motors and controllers. China only makes up 25.8% of its 9 month revenue compared to 67% of ISDN’s revenue for FY2020.
Omron - Similar story with Greater China powering its growth. Note its business outlook on page 11 that allude to China twice for strong industrial automation demand
Fanuc – Growth in Greater China in line with Yaskawa and Omron
Hiwin – Taiwan based competitor that does not break down its exposure to China and consolidates it under Asia region. As you can see in it 1H2020 presentation, its share in Asia is powering ahead, which I would hazard a guess that its largely due to China. The company is also required to report its monthly revenue figures, which you can see is doing exceptionally well.
The PE ratios of the above discussed names are obtainable through websites like Yahoo Finance, so I would not dwell further. Go check them out!
Non recurring nature of the business
There have been discussions that I have seen in online forums about the project nature in ISDN’s businesses and how that is unsustainable. From my understanding of how companies go through industrial automation, the production lines are upgraded in turn so that overall production level is not significantly impacted. An acquired client thus basically has years of runway in providing business to ISDN, at the end of which new technologies might have appeared again to warrant further improvements. From my personal experiences combing through financial statements of Ten Pao Group Holdings as an example, the automation has been ongoing for several years across factories in different regions, and the cost savings are starting to bear fruit. In any newly set up manufacturing plants, automation would be a necessity going forward. With all that’s going on, the Total Addressable Market for ISDN is likely to grow in the next 10 years. If you are a Cathie Wood fan, the ARK Invest Big Ideas for 2021 lists Automation and 3D printing (which ISDN is researching on) as 2 of them for the US.
Novo Tellus
Last bit of takeaway is the developments in one of its most notable shareholders, Novo Tellus. On 21 January 2021, Novo Tellus has announced the closing of its second Southeast Asian fund at $250m. I believe that Temasek has taken up 40% of subscription into the fund according to this disclosure on HKEX.
This seems to be a requirement from HKEX listing rules that does not apply for SGX, which gives beneficial insight into the fund’s investors. Novo Tellus has not hesitated in putting the funds to use by making a partial offer to acquire an additional 27.91% of Procurri shares. This would be a probable source of funding if ISDN management finds a need for it.
In conclusion, is the current 12.2x TTM PE (based on my calculations above on adjusted recurring profits) expensive? What are your thoughts?
I am vested in ISDN holdings and intend to hold onto this until at least it hits 15x FY2021 PE. I believe the company would be able to hit S$30m in net profit attributable to shareholders in the next fiscal year after analysing the above trends. S$30m * 15 /435,337,894 = S$1.03. That would be when I would start re-evaluating and reviewing the investment. This is a very discounted multiple compared to where Yaskawa, Fanuc, Omron and Hiwin are trading at.
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