Elsoft Research Bhd Has Shown Great Growth But There Might Be Risks Ahead

Elsoft Research Bhd (Elsoft) is involved in research, design, and development of automated test equipment (ATEs), burn-in systems and also application specific embedded control systems for the optoelectronics industry in Malaysia. Elsoft’s market capitalisation as of 20 November 2019 stands at RM 636.64 million. In this article, I’ll cover on its financial results, future outlooks, and valuation ratios. As such, here are 9 things to know about Elsoft before you invest.

• Revenues
  Elsoft had achieved substantial growth in revenues, increasing from RM 5.9 million in 2009 to RM 78.2 million in 2018. It is attributable to a rise in orders from its main customer, a leading multinational corporation in the optoelectronics industry. This customer only has accounted for 75% of Elsoft’s total revenue in 2018, which poses a high dependency risk of Elsoft onto a single customer for its financial results.

Year	2014	2015	2016	2017	2018
% of Key Customer to Group Revenue	84%	66%	74%	74%	75%

Source: Elsoft’s Annual Reports

Profitability
Elsoft has achieved better margins for the past 10 years. Hence, Elsoft’s earnings have grown up from RM 1.6 million in 2009 to RM 39.8 million in 2018. Return on Equity (ROE) has risen from 3.61% in 2009 to as high as 35.21% in 2018. This means, Elsoft has made RM 35.21 in earnings a year from every RM 100 it has in shareholders’ equity in 2018, up from RM 3.61 in 2009.

Source: Elsoft’s Annual Reports

• Cash Flow Management
  From 2009 to 2018, Elsoft has generated RM 162.2 million in cash flows from operations and as much as RM 5.6 million in dividends from other investments. Out of which, Elsoft has incurred about RM 12.8 million in net capital expenditures (CAPEX), has purchased RM 54.0 million in net other investments and paid RM 109.4 million in dividends to reward its existing shareholders.
  
• Balance Sheet Strength
  As of 30 June 2019, Elsoft has no interest-bearing debt and hence, have zero in gearing ratio. It has RM 86.0 million in current assets and a total of RM 12.1 million in current liabilities. Thus, its current ratio is 7.10. Its total amount of other investments is RM 48.1 million. It is mainly made up of money market funds and fixed income funds.
  
• 12-Month Results
  Elsoft has started to experience slower orders from its major customers for its ATE products in Q4 2018. This has caused a sharp dip in revenues and earnings from Q3 2018 to Q4 2018. The slowdown had persisted in 1H 2019 (Q1 & Q2 2019), resulting in a sharp fall in quarterly profits for the six-month period.
  

Period	GroupRevenue(RM ‘000)	Shareholders’ Earnings (RM ‘000)	Earnings per Share (EPS) (Sen)
Q3 2018	24,459	13,649	2.06
Q4 2018	13,049	6,167	0.93
Q1 2019	10,110	4,890	0.73
Q2 2019	12,333	6,288	0.94
Latest 12-Month	59,951	30,994	4.66

Source: Elsoft’s Quarterly Reports

• Research & Development (R&D) Initiatives
  Moving ahead, Elsoft had revealed its expectation that its situation will remain ‘challenging’ and will be focusing on R&D activities to develop a series of new products. For the past 5 years, it has spent around 10% of its revenue on R&D expenses. In 2019, Elsoft’s R&D initiatives would be focused on these key areas:
  
  – ATE for infrared / laser devices testing.
  – Next generation ATE for smart devices industry.
  – New ATE for automotive industry.

Year	2014	2015	2016	2017	2018
% of R&D Expenses to Group Revenue	9%	11%	10%	11%	11%

Source: Elsoft’s Annual Reports

• Major Shareholders
  As of 29 March 2019, Elsoft’s five largest shareholders are as follows:
  

Shareholders	Leadership Position	Total Shareholdings (%)
Tan Chiek Eaik	Executive Director & CEO	24.23%
Tan Ai Jiew	Non-Executive Director	13.71%
Koay Kim Chiew	Executive Director	11.43%
Tan Ah Lek	Non-Executive Director	9.46%
Tan Chiek Kooi	Finance & Admin Manager	7.26%

Source: Elsoft’s Annual Reports

Notes:
Tan Chiek Eaik, Tan Ah Lek, and Tan Ai Jiew are siblings.

• Associates
  Elsoft has two associate companies namely,
  
  
  Leso Corporation Sdn Bhd (Leso)
  It has a 30% interest in Leso, a company that sells test & measurement equipment and provides supply chain management solutions to Elsoft’s suppliers and customers. After having achieved RM 3-4 million a year in earnings from 2013 to 2016, Leso’s earnings dropped in 2017 and 2018 due to additional labour costs as Leso is hiring more staff to support its expansion plans starting in 2017.

Year	2014	2015	2016	2017	2018
Revenues	12,454	23,268	22,557	18,590	20,036
Profits	4,006	4,760	3,953	170	920

Butterfly House (PG) Sdn Bhd (Entopia)
It has a 30.91% interests in Entopia, a butterfly farm in Penang that has commenced its operations in 2014. Revenues have grown. But, to-date, Entopia remains unprofitable.

Year	2014	2015	2016	2017	2018
Revenues	657	3,167	12,366	13,831	14,183
Profits	61	(6,400)	(4,909)	(4,673)	(1,847)

• Valuation Ratios:
  As of 20 November 2019, Elsoft is trading at RM 0.96 a share. Its latest 12 months earnings is 4.66 sen. Hence, its P/E Ratio is 20.60. As of 30 June 2019, Elsoft’s net asset value per unit is RM 0.17. Hence, its current P/B Ratio is 5.65. Its adjusted dividends per share (DPS) for 2018 is 5.84 sen and thus, its dividend yield is 6.08% per annum. 

VIA’s Verdict

Elsoft has delivered a substantial growth in revenues, earnings and dividends to its shareholders for the past 10 years. Presently, it has a 0% in gearing ratio and 7.1 in current ratio. The board has revealed a handful of key risks moving ahead and they are:

– Dependency on One Major Customer for Revenues, Profits, and Dividends.
– Ongoing Losses from Entopia.

Earnings 1H 2019 had fallen by 44% from Earnings 1H 2018 due to a huge fall in orders from its major customers. Hence, investors should decipher and assess if Elsoft is able to maintain its DPS in 2019 at levels paid out for year 2018 and for years beyond. 

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