When I first saw the name of Multi-Chem Limited (AWZ.SI), I thought that it was some sort of producer of chemical products, but the company is in a very different business. Multi-Chem is a Singapore-listed company that is primarily in the business of IT distribution. The company also has a small PCB segment. The PCB business is a value added supplier to PCB manufacturers. This segment has been unprofitable for the last couple of years. Fortunately, management has recognized the problems that were developing in the PCB business and have done the right thing by shrinking this business, and selling off excess machinery (drilling machines). They have focused the company’s resources on the business that has been very successful over the last decade, IT distribution.
The IT distribution business is carried out through a 76.75% owned subsidiary called M.Tech. M.Tech focuses on cyber security and network performance products. I think the focus on cyber security products is smart, because it is an area that looks certain to continue to grow in the coming years.
M.Tech distributes IT products to multiple countries, primarily in the Asia Pacific region. Revenues have steadily grown each year, from $138m SGD in 2008 to $456m in 2019. Singapore accounted for 40% of revenues in 2019, and Greater China (11.4%), Australia (12.4%) and Others (35.9%) are the other contributing regions. The “Others”-category includes countries like Malaysia, Thailand, Indonesia, India and Vietnam.
Some financial information to start things off:
Share price: $1.25
Outstanding shares: 90,095,268
Market cap: $112.6m SGD
Cash & deposits: $77.7m
Book value (June 30, 2020): $112.9m
Net income 2019: $7.8m
Net income H1 2020: $7.3m
PCB vs IT Distribution
The PCB segment might be obscuring the attractiveness of the IT distribution segment somewhat. The PCB segment showed a loss of $2.5m in 2019 and a loss of $0.7m in 2018. Moreover, this segment historically has seen a lot of capital investment relative to the IT distribution segment. In the years 2011 and 2010, capital expenditures for the PCB segment were $9.2m and $11.5m respectively. Depreciation charges for the 2012-2015 years for just this segment were elevated due to this and were in the $4.0m – $4.8m range.
Meanwhile, the IT distribution business has required far lower capital expenditures that have averaged around $1.2m for the 2012-2019 period.
So I think there’s a “good business / bad business” element within this company, where the less attractive PCB business has become a much less important part of Multi-Chem, while the IT business has steadily grown in importance.
Net income for 2019 was $7.8m. The company has almost earned matched those earnings in the first half of 2020, with net income of $7.3m.
Part of the strong earnings for the first half were due to a Job Support scheme:
An increase in other gains of $1.4m from $800,000 in 1H2019 to $2.2m in 1H 2020, mainly due to Job Support Scheme payout received from the government during COVID-19 pandemic”
But Multi-Chem’s distribution business has also seen increased demand due to the pandemic:
The IT Distribution business achieved revenue of $225.0m in 1H2020, an increase of 13.9% or $27.4m, from $197.6m in 1H2019. The increase in revenue for 1H2020 was mainly due to the increase in customer demands arising from the push in and increased reliance on digital technologies during COVID-19 pandemic.
It remains to be seen how much of this growth is sustainable. Undoubtedly the pandemic has led to a bunch of customers pulling orders forward and they won’t be buying more, or not as much, as in this past half year period. But part of the increase could prove to be sustainable. New customers that didn’t have a relationship with the company before might have found it and remain a customer. Think businesses that have set up remote work arrangements for their employees and that decide to keep some of that in place even after the pandemic subsides.
For the time that the pandemic remains a threat, business should be pretty good for Multi-Chem, I think. Shareholders won’t be able to see the next set of results for a while. After a rule change by Singapore Exchange, the company has decided to cease quarterly reporting and to choose for half-yearly reporting. This means there will be no Q3 report and that the company will be reporting their full year results next. Last year they announced these in mid-February.
Inventory Levels and Obsolescence
For a distributor, I think one of the important things to track is inventory and the allowance for inventory obsolescence. The game for a distributor is to figure out which products will be in demand in the (near) future and to try to partner with relevant manufacturers. Buy products that prove to be duds and you’re stuck with them. That will be reflected in either much higher inventory levels on the balance sheet, when the company isn’t yet aware of this, or when it refuses to acknowledge the problems. Ultimately it should result in the company writing off these obsolete products.
The company’s inventory levels have increased, but at a similar rate as the increase in sales. The allowance for inventory obsolescence has averaged 2.3m for the years 2009-2019, with 2013 being the highest year with $4.5m. This looks pretty reasonable to me given the company’s growth during this period.
One other small point of concern is some customer concentration. There are two customers that accounted for 13.6% and 10.9% of revenues in 2019. I don’t think that is an extreme level of concentration and it probably wouldn’t be a big disaster if the company lost its largest customer, but it would obviously have a negative impact.
The CEO, Foo Suan Sai, owns 36.6m shares directly or 40.6% of the outstanding shares. His wife and board member, Han Juat Hoon, owns 25.3% of the outstanding shares. So together they are firmly in control of the business.
One of my main concerns is that the controlling shareholders will try to take the business private at some point at a relatively small premium. This is fairly common in Singapore. Usually retail investors in Singapore don’t fight an inadequate offer and management gets away with it.
There is one other large shareholder called Yaowalak Phoowarachai, holding 11.8% of the shares. The float of the company was only 18.9% at the end of 2019.
The issue just noted above often goes hand in hand with poor capital allocation. If management hoards cash, this often leads to investor frustration and a low share price. If a cash hoarding, low yielding company gets punished by investors and gets awarded a low share price as a result, it becomes a more likely candidate to be taken private at a small premium.
At Multi-Chem I think the picture is a bit mixed when it comes to capital allocation. The company pays a reasonable dividend every year. I also think it was very good that management recognized that the PCB segment wasn’t producing sufficient returns and decided to scale it down aggressively. And it is true that the growth of the business has been impressive and that this does require extra working capital. It could be reasonable for management to take this into account when looking at their future growth.
But I do think that the company’s cash position of $77.7m as of June 30, 2020 is very high. This might be a somewhat seasonal effect, because the final quarter of the year tends to be a bit busier. But in prior years, cash levels have mostly been in the $45m-$50m range at year-end. The absolute amount of debt has remained pretty stable at over the last eight years or so, around $20m-$25m at year-end, despite the increasing sales. Other distributors I’ve looked at operate with far lower cash levels and more debt to finance their working capital needs.
I think management could return a substantial part of the current cash balance to shareholders if it wanted to do so. Their incentive might be to do just that, but only after the business has been taken private.
I invested in Multi-Chem, because I thought it was a cheap way to own a Corona resistant business. I did this before the recent positive developments about the vaccines were published. The company is cash rich, trades at book value, has a long history of growth and it should continue to do well after the pandemic subsides. Insiders have bought a little at these levels as well, so that might also be a sign that sales are holding up well.
Most Covid beneficiaries in the US were quickly trading at nose-bleed valuations, but Multi-Chem looked quite cheap, despite the run up in share price from ~0.85 to $1.25 currently. It still looks attractive to me today.
Disclosure: long Multi-Chem (AWZ.SI)