Dutech Holdings Limited: Initiation Report

 

Business Model of Dutech Holdings Limited (‘Dutech’)

Dutech Holdings Ltd is a global leading manufacturer of high security products and operates in a niche market that is generally recession proof. It is headquartered in Shanghai and has about 2,500 employees globally. It serves a global customer base and has factories in Europe and Asia. It is led by Dr Johnny Liu, a respected figure in the Chinese engineering fraternity. Its principal activities can be categorised into 2 business segments:

1. High Security Products such as ATM safes, commercial safes and weapons safes

2. Business solutions such as auto ticketing machines, gaming machines, money changers.

Its high security division contributed to about 69% of Dutech’s revenue in 2015, and also enjoyed a higher gross profit margin compared to the business solutions division. Given the strategic importance of the high security division, this initiation report by Heartland Boy shall devote more attention to it.

As shown in the flow chart above, as a tier 2 supplier, Dutech supplies ATM safes to Diebold and Wincor Nixdorf, the world’s second and third biggest ATM manufacturer by market share. It is also an Original Design Manufacturer (ODM) for Winchester and Liberty, 2 reputable companies in the United States that produce weapons safes.  Following a brief explanation of its business model, Heartland Boy is going to put Dutech through his FA Criteria and assess whether it is a fundamentally strong and undervalued stock.

Investment Merits of Dutech

1. Solid Track Record

Dutech’s revenue has increased rapidly since 2012. The net profit and net operating cashflow have also increased in tandem. These are largely attributed to the successful integration of the 2 German companies that Dutech had acquired in 2011 and 2014 respectively.

2. Superior Operating and Net Profit Margins

Dutech’s operating and net profit margins have all risen since 2012 as steel prices, a major component of production cost, started to fall. Readers should also not be alarmed by the fall in Dutech’s margins for 2015 as the exceptional one-off gain (negative goodwill) had inflated margins in 2014. More importantly, its net profit margin is superior to Gunnebo, a direct competitor listed on the Sweden Stock Exchange.

3. High and Growing Return on Equity (‘ROE’)

In addition, its ROE reached over 20% in 2013 and 2014, although this dropped to 17% in 2015 due to an increasing amount of shareholder’s equity. Nevertheless, its ROE easily clears the 12% benchmark that Heartland Boy sets for all his stocks.

4. Net Cash Situation

Dutech is in an enviable net cash position, largely due to its strong net operating cashflow generation capability. It has more cash than debt and this net cash position translates to $0.114 cents per share or roughly 24% of the current share price. That is a significant amount of net cash to hoard.

5. Increasing and Regular Dividend Yield

At a stock price of $0.48, it has a current dividend yield of 2.1%. While this is not a dividend yield to shout about, do note that its dividend yield was a respectable 3.4% before its prices started running up after March 2016. In fact, it has already returned S$0.085 cents since it IPO at a price of 33 cents in 2007. With a strong balance sheet, consistent net operating cashflow, and the strong first half financial performance, Heartland Boy is looking at an increase in dividends as a potential price catalyst in 2017.

 6. Sustainable Competitive Advantage

Dutech’s first-mover advantage and strong emphasis on Research & Development (R&D) has enabled it to carve out a sustainable competitive advantage. It is one of the few safe makers in Asia with both UL (Underwriters Laboratories) and CEN (Comite Europeen de Normalisation) certificates. These certificates are important as they are often the key criteria in the customers’ selection of suppliers. As a result, it has established long-term relationships with reputable global customers. For instance, Dutech is recognised as best supplier by Wincor and is also awarded the Golden Award by Diebold. Despite the emergence of more competitors in China, these competitors are generally just starting to apply for certification. In contrast, Dutech has already achieved CEN Grade 5 certification!

7. Good Growth Story

Over the years, Dutech’s management has also displayed a fine acumen in purchasing smaller rivals in the industry and turning them around. For instance, it acquired loss-making Format in 2011, and successfully turned it around by 2014.  It continued to grow inorganically by acquiring Deutsche Mechatronics and Krauth in 2014 and 2016 respectively. The successful integration of these companies has allowed Dutech to not only grow its customer base, but also increase its intellectual property. Dutech’s management also shared that it is looking to acquire some companies in the US in the near future. Given its track record in acquisition so far, Heartland Boy is optimistic that the acquisitions will create synergies with existing operations.

Beyond the micro-factors, Dutech is also riding on the tailwinds of certain favourable macro-economic factors benefitting its industry. For instance, negative interest rates due to an expansionary monetary policy by global central banks have spurred increase in demand for safes. The increase in domestic shootings in USA has also led to increase in sales of gun safes.

Investment Risks Of Dutech

1. Dutech Carries The S-chip Burden

Dutech has the unfortunate burden of being an S-chip, a segment that the local investment community has come to associate with accounting frauds and trading suspensions. Therefore, even if it is a financially sound company with good corporate governance, the risk remains that investors may expect a discount on its share price.  When it comes to S-chips, Heartland Boy threads with greater caution.  Heartland Boy was comfortable with Dutech after learning that CIMB had verified Dutech’s shipment records by obtaining data from Datamyne. Further, as CIMB had pointed out in its initiation report, Dutech’s exposure to global blue-chip customers is a strong validation of its corporate governance.

Heartland Boy’s only other experience with S-Chip was with China Merchants Holdings Pacific Limited. That had a happy ending and he is hoping for the same outcome with Dutech.

2. Dutech’s Margins Are Sensitive To Steel Prices

Given that steel forms almost 40% of Dutech’s total production cost, changes in its price will have a direct effect on Dutech’s gross profit margins.

As seen in Diagram 4, the good news is that steel prices have plummeted from Rmb 5000 per metric tonne to around Rmb 2700 per metric tonne today. This dramatic fall in steel prices has benefited Dutech tremendously as evidenced by the increase in its gross profit margins since 2012. Given its sensitivity to steel prices, Heartland Boy closely tracks the price of China’s domestic rolled steel here.

It is forecasted that steel prices are likely to remain at the current level as the supply overcapacity is a structural issue. Moreover, demand for steel is on the wane as China gradually slows down its infrastructure investment. Even then, the management of Dutech is being prudent by typically hedging up to 6 months of steel requirements.

Conclusion Of Heartland Boy’s Review On Dutech

Heartland Boy has personally kept Dutech under his watch list since May 2016. He had targeted to purchase Dutech at $0.38 in the aftermath of BREXIT but the price only dipped fleetingly to $0.40. Heartland Boy waited patiently and continued to keep his powder dry. That was the lowest it would go in the next 2 months and Heartland Boy finally took a small nibble at $0.44.

Heartland Boy has a personal price target of $0.88 on Dutech.

Vested at an average price of 44 cents since August 2016

This article was published on 18 Sep 2016.