A HOLISTIC ANALYSIS OF “LUXCHEM (5143): LUXCHEM CORP BHD” – MOST UNDERVALUED STOCK WITH A FAIR VALUE OF RM1.34: [PART 2/6] VERY GOOD FINANCIAL METRICS ((by THINKING-MAN))
THINKING MAN
PART 2 – VERY GOOD, WONDERFUL AND ENCOURAGING FINANCIAL REPORT/METRICS
(THIS IS PART 2 OF 6)
(3) WELL THEN, WHAT IS THE PROFITABILITY OF LUXCHEM? WHAT IS THE EVIDENCE? CAN YOU SHOW ME THE PROFITS GAINED BY LUXCHEM? THE PROVEN RESULT FROM THE LATEST FINANCIAL REPORT?
((PROVEN PROFITABILITY AND GROWTH – FROM INCOME STATEMENT))
FUNDAMENTAL ANALYSIS (FA) IS VERY IMPORTANT WHEN ANALYZING A STOCK OR SHARE. It provides more safety and security to investors when buying or selling a share. Thus, we have less risk when investing. Of course, this doesn’t mean it is TOTALLY RISK-FREE. Just like technical analysis, fundamental analysis serves as guideline, however it is a method of analysis which has a very strong, concrete and stable foundation. Fundamental analysis is reliable and beneficial. In this analysis, PROFITS matter and count when buying a share! All profits and important figures will be shown. All calculations would be presented in detail.
REVENUE = 191,260,000 (GOOD - increases from 140,292,000 for current year previous quarter)
REVENUE GROWTH RATE = Revenue increments/Revenue for current year previous quarter x 100
= 191,260,000 – 140,292,000/140,292,000 x 100
= 36.33% (healthy revenue growth)
Revenue is the rough figure one firstly see in the income statement. There is an increase of RM50,968,000 in revenue. The revenue growth rate of 36.33% indicates a healthy growth of LUXCHEM.
GROSS PROFIT = 25,097,000
GROSS PROFIT MARGIN = Gross profit/Revenue x 100
= 25,097,000/191,260,000 x 100
= 13.12% (good profit margin)
With revenue, one continues to look at gross profit margin. Gross profit margin of 13.12% is a good figure in the context of growth. It is an important indicator before continuing to look at net profit. If gross profit margin is good, its net profits would most likely be fine as well. Companies with a low gross profit margin would find difficulties and challenges to have acceptable, healthy net profits. Gross profit margin and net profit margin are closely related. High gross profit margin enables companies to make good and smart decisions in allocating its resources or capital.
NET PROFIT (PROFIT AFTER TAX - PAT) = 14,169,000 (EXCELLENT - increases from 7,581,000 for the current year previous quarter)
NET PROFIT GROWTH RATE = Profit increments/Profit for current year previous quarter x 100
= 14,169,000 – 7,581,000/7,581,000 x 100
= 86.90% (more than 10% - a very high profit growth)
Net profit is the company’s “bottom line.” This is the final profit available to all shareholders after all expenses have been deducted. We can see that there is an INCREASE OF RM6,588,000 PROFIT (to 14,169,000 from 7,581,000) – equivalent to 86.90% profit growth rate compared to the previous quarter of the current year. This is much higher than the usual standard of 10% growth rate for growing company. This was contributed by higher profit in the trading activities of LUXCHEM.
NET PROFIT MARGIN (NPM) = Net profit/Revenue x 100
= 14,169,000/191,260,000 x 100
= 7.41% (increases from 5.40% for current year previous quarter – the highest since 4 years ago)
Net profit margin is also encouraging at 7.41%. It is the highest since 4 years ago.
EARNINGS PER SHARE (EPS) = Net profit/Number of shares outstanding
= 1.59 cent (increased from 0.85 cent for the current year previous quarter – the highest since 3 years ago)
Earnings per share (EPS) is popularly and widely used by investors to see how much profit is earned from the outstanding shares in the market – measuring amount of profit for each share. LUXCHEM’s EPS has an increase of 87.06% compared to the last quarter. With EPS of 1.59 cent, it is the highest EPS since 3 years ago – this is a positive and good sign.
RETURN ON EQUITY (ROE) = Net profit/Shareholders’ equity x 100
= 14,169,000/322,219,715 x 100
= 4.40% (increases from 2.41% for the current year previous quarter - the highest since 3 years ago)
Apart from using the increasing EPS for each quarter (or year) as a sign of success, we should also look at return on equity (ROE). ROE measures the depth, extend of profit earned compared with total amount of shareholders’ equity in the balance sheet. ROE takes into account the retained profits from previous quarters (years) and let you how effectively its capital is being reinvested. It acts as a much better acquirement of company’s fiscal management skill than EPS. One should look for companies with consistently acceptable ROE over a long period such as 5-10 years, as some companies’ profits have high fluctuation – rendering them too risky and volatile to be invested.
Generally, a higher ROE company has the competitive advantage. A low ROE means poor capital allocation and this will possibly make the company losing its market standing or position. ROE of 4.40% is very acceptable – showing it has increased and it is also the highest since 3 years ago. In addition to this, its ROE is also very consistent for the last 10 years. We can also calculate ROE for the cumulative period of the first 3 quarters in 2020.
ROE for cumulative 3 quarters = Cumulative net profit/Shareholders’ equity x 100
= 30,792,134/322,219,715 x 100
= 9.56% (good – a very acceptable rate)
Given that the order for glove chemicals is fully booked until next year, the coming quarter (December 2020) would most likely see the maintenance or increase of ROE at around 4-5% (or more). With this, we can get ROE estimated for year 2020 (a rough estimation only and not exact calculation. The same goes for ROA and ROIC calculation later):
ROE estimated for year 2020 = 9.56% + 5%
= 14.56% (more than 12% - indicates very encouraging return on equity)
If that is the case, the annual ROE for year 2020 would possibly be 14-15% or even higher.
This high ROE indicates that LUXCHEM has competitive advantage in its business. It means there is good capital allocation and this makes LUXCHEM gains its market standing or position.
(4) IS THE COMPANY STABLE IN TERM OF ITS BALANCE SHEET - ASSETS AND LIABILITIES?
((ASSETS, LIABILITIES AND EQUITIES IN GOOD STANDING – FROM BALANCE SHEET))
TOTAL ASSETS = 420,040,552 (fine – small decrease and no major concern)
INVENTORIES = 47,276,774 (good - decreases from 68,944,796)
TRADE AND OTHER RECEIVABLES = 127,787,111 (good - decreases from 135,610,389)
TOTAL LIABILITIES = 97,820,837 (good - decreases from 124,284,702)
TOTAL EQUITY = 322,219,715 (good - steady increase from 308,378,363)
LUXCHEM’s balance sheet is also in tip top condition. Both inventories, and trade and other receivables have decreased compared to the previous year – a good sign. In theory, huge amount of inventories signals large stock amount (product) kept by the company and which have not translated into sales. Huge amount of trade and other receivables means the company is yet to receive payments from the customers. In the case of LUXCHEM, these do not happen - both values decrease. This is a positive sign to the cash flows of LUXCHEM since there is less amounts of cash tied up as working capitals for its operation. Its total liabilities decreases while its total equity increases – this is also good for the company.
DEBT-TO-EQUITY = Debt/Equity
= 52,632,406/322,219,715
= 0.16 (less than 0.5 – debt is very much manageable)
If you want to invest in a company, apart from profit, you also need to look at its debt. If the company has huge, serious debts, you might think twice whether you really want to invest in it. Some amount of debts is fine since many companies do have debts, however too high debts rings the bell. That is why you need to look at its debts in the balance sheet. Serious debt increases the risk of bankruptcy if the company makes heavy losses and is unable to settle its debts.
For LUXCHEM, it has debt (bank borrowings and lease liabilities) of RM52,632,406. To see whether this debt is manageable or too much, we can calculate debt-to-equity ratio. Debt-to-equity ratio measures the amount of debt in relation to its equity. Debt-to-ratio that is less than 0.5 is good since the debt amount is manageable. For LUXCHEM, debt-to-equity ratio is 0.16 – much lower than 0.5. Therefore, the debt level is very much under control and less risky – debt is manageable.
CURRENT RATIO = Current assets/Current liabilities
= 308,516,860/95,206,149
=3.24 (more than 1.5 – in good standing since it has very low liquidity risk)
QUICK RATIO = (Current assets – Inventories)/Current liabilities
= (308,516,860 - 47,276,774)/95,206,149
= 2.74 (more than 1.0 – also in good standing with minimal risk)
To measure liquidity risk, we need to calculate current ratio and quick ratio. For LUXCHEM, the current ratio is 3.24 (more than 1.5). This means that LUXCHEM’s current assets is more than 3 times its current liabilities. It has low current liabilities and this is a good sign. For quick ratio, LUXCHEM has a value of 2.74 (more than 1.0). This is also a good situation since its inventories amount is small, meaning there is not much tied up capital in its inventories. So, LUXCHEM has good liquidity and there is no risk in its liquidity issue.
EQUITY RATIO = Total equity/Total assets
= 322,219,715/420,040,552
= 0.77 (more than 0.5 – it has strong financial strength - stable and fine)
For measuring LUXCHEM’s long term financial strength, we can use equity ratio. It is 0.77 (more than 0.5), indicating that 77% of its total assets come from the equity, while only 33% comes from total liabilities. This means that its assets is mostly from the backup of its equity. Its liabilities portion is small and LUXCHEM has strong financial strength as it doesn’t depend much on the liabilities. It shows low financial leverage, which means it relies more on equity (and less on debts) to finance its assets. In long term, LUXCHEM is stable and fine in its financial ability.
RETURN ON ASSETS (ROA) = Net profit/Total assets x 100
= 14,169,000/420,040,552 x 100
= 3.37% (a very acceptable rate)
Return on assets (ROA) looks at its profit gained on total assets owned by the company. It measures how effective the company is using its assets to make profits. For LUXCHEM, ROA is 3.37%, indicating its use of assets to produce profits is very acceptable. With this, we can also calculate ROA for cumulative 3 quarters and ROA estimated for year 2020 (just like what is done on ROE before - assuming ROA of December 2020 quarter is 3-4%) and we get:
ROA for cumulative 3 quarters = Cumulative net profit/Total assets x 100
= 30,792,134/420,040,552 x 100
= 7.33% (a very acceptable rate)
ROA estimated for year 2020 = 7.33% + 4%
= 11.33% (more than 7% - indicates efficiency in using assets to produce profits)
The estimated ROA is 11.33% - higher than 7%. This means that LUXCHEM is very effective in using its assets to produce profits. It has the ability to utilize assets to bring more earnings to the company.
RETURN ON INVESTED CAPITAL (ROIC) before tax = EBIT/Invested capital x 100
EBIT = EARNINGS BEFORE INTEREST AND TAX (OPERATING PROFIT)
INVESTED CAPITAL (IC) = Fixed assets + (Trade and other receivables + Inventories – Trade and other payables)
= 62,884,398 + (127,787,111 + 47,276,774 - 39,603,476)
= 198,344,807
ROIC before tax = EBIT/Invested capital x100
= 19,359,725/198,344,807 x 100
= 9.76% (GOOD - higher than its ROE of 4.40%, implying it has advantage and stability in business – a very acceptable rate)
ROIC is a figure used in addition to ROE to understand a company better. ROE can under-mentions or over-mentions the amount of resources a company has. ROIC corrects this situation. ROIC looks at its profit on the invested capital (by the company) both by shareholders and lenders. It evaluates how good and how well the management of a company in using its cash to produce profits. Company with low profit margin and huge debt would have its ROIC lower than ROE. The reverse is true for LUXCHEM. For LUXCHEM with a lot of cash in hand and low debt, the ROIC is 9.76% - higher than its ROE (4.40%). LUXCHEM’s ROIC of 9.76% indicates that it has excess cash with an advantage in its business. It has stability since it has less debt, which is a good thing.
Similarly, we can get ROIC for cumulative 3 quarters and ROIC estimated for year 2020 (assuming ROIC for December 2020 quarter is 9-10%). Take note also that this estimated ROIC is only a rough calculation.
ROIC bt for cumulative 3 quarters = Cumulative EBIT/Invested capital x 100
= 44,355,414/198,344,807 x 100
= 22.36% (GOOD – much higher than ROE of 9.56%)
ROIC bt estimated for year 2020 = 22.36% + 10%
= 32.36% (more than 15% - EXCELLENT, indicating it has a moat, it is very efficient in using its invested capital to generate profits – got advantage in business)
LUXCHEM’s estimated ROIC for year 2020 seems to be truly high and fantastic. It stands at 32.36% - much, much higher than 15%. This indicates that it is really excellent in using its cash money to produce profits. With high profit margin, high cash and low debt, LUXCHEM is able to manage its company operation wisely. It has the capability to use minimal cash as invested capital to bring in larger earnings.
(5) DOES THE COMPANY HAVE ENOUGH “CASH FLOW” DESPITE HAVING SUPERNORMAL PROFITS?
((VERY HIGH, GOOD CASH FLOWS – FROM CASH FLOWS STATEMENT)
While it is definitely good for a company to earn supernormal profits, its cash flow in relation to net profit is also very important in running its business. Though the company earns a lot of profits, at times the company might give credit to customers – buyers would pay later after purchasing a product from the company. In short, though the company’s profit is stated in the income statement, the (profit) amount doesn’t necessarily mean ‘cash payments received’ from the customers. The customers would pay at a later date (30 days, 60 days, 90 days, etc.) – sometimes they will pay, sometimes they don’t. There are also times customers pay a partial amount of money first. This means that profit stated in income statement doesn’t mean ‘profit amount already received in cash.’ Since that is the case, we need to look at the cash figures in cash flows statement – to ascertain that the profit recorded has been translated into hard, physical, solid cash - which is the true, realized and received profit.
CASH FLOW FROM OPERATIONS - CFFO (OPERATING CASH FLOW) = 49,430,921
NET CASH FLOW (NET INCREASE IN CASH) = 11,372,731
CASH AND CASH EQUIVALENTS AT THE END OF REPORTING PERIOD = 131,834,651 (HUGE CASH - additional 5,360,565 increase from 126,474,086 in 2019)
OVERALL CASH FLOW GROWTH RATE = Cash flow increments/Cash flow for the previous year x 100
= 5,360,565/126,474,086 x 100
= 4.24% (a good increment – signifying better, higher stability in overall cash flow)
The cash flow for LUXCHEM (until September 2020) is very positive and stable – it is very liquid with HUGE cash amount. There is no risk of running out of cash. Operating cash flow is high at 49,430,921 - its net cash flow is 11,372,731. Cash flow at the end of reporting period is very huge at 131,834,651 – it is a cash rich. This is a good increase in cash flow of 5,360,565 from 126,474,086 in 2019. This is 4.24% overall cash flow growth rate for LUXCHEM. This cash amount is only for 3 quarters, the figure would be even higher when December 2020 QR is released). LUXCHEM is good in managing its cash. Imagine if most customers take credit from the company and do not pay cash following their purchases (in some cases the company is unable to collect the cash), this will result in low cash flow by the company. Company with low or negative cash have higher risk since they have no cash money to run their business. But LUXCHEM does not have this problem – IT HAS A LOT OF CASH – HUGE, POSITIVE CASH. Cash is truly important, and LUXCHEM succeeds in having huge cash amount.
QUALITY-OF-INCOME RATIO = CFFO/Net profit
= 49,430,921/30,792,134
= 1.61 (more than 1.0 – very good because profit is fully backed up by operating cash)
To further evaluate its financial condition, we can calculate its quality-of-income to compare its cash flow with net profit. This is to make sure whether its profit (as reflected in income statement) is really backed up by cash (in cash flows statement). The quality-of-income ratio evaluates how much money (dollar) of operating cash flow produced for each dollar of net profit. If a company has a ratio of more than 1.0, this means that the quality of income is high – it is a good company.
This ratio can also be compared to ROE. If a company has high ROE, but its quality-of-income ratio is always less than 1.0, we can say that its ROE is of lower position, standing and quality since the profit gained (in income statement) is just a “paper-gain” without real money. This is due to the fact the company has difficulties in collecting cash payments from customers – making it not having sufficient cash. Cash flow is always important in managing a business. It is no use to have high profits without sufficient cash flow.
For LUXCHEM, it has quality-of-income ratio at 1.61 – much higher than 1.0. This means for every dollar of net profit it earned, it generates operating cash flow of RM1.61. It is more than 1 time of its net profit. Therefore, LUXCHEM has more than sufficient operating cash flow. And it is a good company with high position, standing and quality of ROE. Its profit is real money with hard cash.
FREE CASH FLOW (FCF) = CFFO – Net capital expenditures
= CFFO – (Purchases of PP&E – Disposal of PP&E)
= 49,430,921 – (12,853,282 - 11,000)
= 49,430,921 – 12,842,282
= 36,588,639 (a high number – an enriching, good free cash flow position which can be used to support the company’s business activities)
Free Cash Flow (FCF) is an important figure that reflects the amount of extra cash a company has from its operating activities after taken into account of all expenses which include capital expenses for growth. This FCF can be used to reward and benefit shareholders with shares buyback, dividend, to settle off debts and/or invest in other businesses. FCF is one of the most important figures to determine the company’s ability to reward its shareholders. To get FCF, it has to take into account of its capital expenditures (CAPEX). CAPEX is necessary to keep the company growing in its business, however the amount cannot deplete its cash flow.
For LUXCHEM, its CAPEX is only 26% (RM12,853,282) of its CFFO – showing that it only reinvests a small portion of its cash flows for growth – with its remaining retained as cash. This is a good standing for LUXCHEM. As for FCF, it is quite high at RM36,588,639. With this, LUXCHEM presents itself and stands out as an enriching investment opportunity. It is a company with good, stable and consistent cash position. FCF is pure hard cash, which is more “dependable and tangible” than net profit.
DISCLAIMER: Please read and understand this disclaimer. This article is written upon observations and it is intended to be a SHARING – for informational and educational purpose only. The intention is to share knowledge with you all. None of what is written here is to influence your decision to buy or sell shares. REMEMBER, IT IS NOT A BUY CALL, IT IS ALSO NOT A SELL CALL. This article is from one’s point of view – consisting of various opinions. You are welcome to read this article, however you need to do your own research first before buying or selling any shares. You should be aware that you buy or sell shares at your own responsibility and risk. This article doesn’t recommend any buy or sell call decision in shares. Share market investment comes with risk, and no one can guarantee everything. It is only a sharing. AS ALWAYS, you need to do your own diligent and prudent research before investing. To buy or sell any shares ENTIRELY DEPENDS on your own decision, judgment and choice. You make your own call either to buy or sell.
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