I first took notice of Sarine Technologies (“Sarine”) in early 2014. What captured my attention, aside from its skyrocketing share price ($0.10 in 2009 to $3.20 in 2014), was its stellar financial performance ever since the company changed its business model in 2009 from one-time sales to one that is more recurring in nature. However, like what Warren Buffett famously said, “Price is what you pay, value is what you get”. Sarine was trading at S$2.80 (32x P/E) which valued the business at about S$1bn. It was quite clear that most of the future growth prospects of the company was already priced in. I placed Sarine under my watchlist and kept a close eye on the company, hoping that one day something bad (but temporary) would occur and allow me to own a stake in the business at a much fairer price. As soon as decided not to invest at such valuations, Sarine went from S$2.80 to S$3.20 (up 14%) in just 6 months.
Lo and behold, in the last few months of 2014, things turned south for Sarine. A series of unforeseen external and cyclical events hammered the profitability of Sarine; net income declined by 87% in FY15. As a result, Sarine’s share price went from an all time high of S$3.20 to S$1.30 in 10 months.
Daniel Glinert, Executive Chairman of Sarine made the following statements in the 2015 Annual Report:
“Regrettably, 2015 was anything but a record year due to the extreme negative industry conditions, which started manifesting themselves in the last four months of 2014 and peaked mid-year.
“The combination of overly aggressive rough diamond pricing, with stagnant polished diamond prices, mostly due to slowing growth in demand from China, in particular, resulted in unsustainably low manufacturer margins. The much higher than normal polished inventory levels at FY2014 year’s end, mainly due to pipeline skewing driven by extended certification times, and the aforementioned unsustainable margins, complicated further by reduced working capital credit lines available to our customers, led to polished diamond manufacturing activity dropping significantly…As a result of ongoing lack of profitability, with rough diamond pricing remaining too high, conditions in the diamond industry polishing and cutting segment (the “midstream”) further deteriorated mid-year with DeBeers’ sightholders refusing unprecedented quantities of offered diamonds (at some sights up to 80%) and manufacturing activity dropping further to below 50% of normal.
Given this background, with little to no incentive to acquire new technology, our sales of new equipment dropped by some 55% year over year.”
While the market was derating Sarine for its temporary poor performance, the company continued to grow and expand its product offerings (i.e. Advisor, Meteor, Sarine Profile).Hence, one can reasonably come to 3 conclusions:
- The intrinsic value of the business is marginally affected at best
- The share price of the business has overreacted to the negative short-term news
- Current circumstances allow the investor to purchase shares in the company at a significant discount relative to its long-term intrinsic value.
Being a kiasu Singaporean, I had to make sure that the problems were actually temporary and waited for signs that things were turning around. And turnaround they did, though I had to pass up on the opportunity to enter at S$1.30 THRICE, I entered into a long-term relationship with Sarine at S$1.60 in May 2016.
Sarine develops, manufactures, markets and sells precision technology products for the processing and trade of diamonds and gemstones. Basically, Sarine’s products increases profits at all stages of the diamond trade from purchase of the rough stones to the sale of polished diamonds. For example, Sarine’s inclusion mapping and planning technology allows diamond manufacturers to achieve maximum value from their rough stones. Once you get past all the terms and jarons of the industry and company (this will take awhile), you’ll find that the business is relatively simple and understandable.
From my research, I found the following positive characteristics about the business and operating environment for Sarine as well as potential catalysts that will propel the company’s share price upwards for many years to come.
- 70+% Market Share in Diamond Planning & Grading Products. The combined market share of competitors in this area is still smaller than Sarine’s. There is effectively no real competiton for the company. Given the synergy between Sarine’s products, management has clear indications that not only did the company retain dominant market share in 2015, but have actually increased market share in all its markets.
- Servicing a Massive US$108 bn Diamond Market (excl. Rough Diamond Mining). Sarine have been serving companies that are involved in rough diamond sales (US$13.3bn) and polished diamond output (US$19.2bn). In recent years, the company entered into the retail sales of diamond jewellery market (US$75.8bn) (i.e. Sarine Profile, Sarine Light, Sarine Loupe).
- Expanding into Gemstone Market. The product, Allegro, which has no competitor, will address the new market with proven Sarine technologies. The gemstone market has a large volume although lower dollar value compared to diamonds. The product will be offered an an inexpensive per-stone service and will expand the recurring revenue base of Sarine.
- Scalable, Low CAPEX, and Recurring Business Model. Sarine’s unique business model allows it to scale/grow easily with little CAPEX (see The Financials). For FY 15, recurring revenue constituted 45% of Sarine’s total revenues. The company’s per-use charge model provides the recurring revenues which minimises customer churn and builds brand loyalty.
- Improving Quarterly Revenue Trend. As seen below, Sarine’s revenues have made a significant turnaround over the past 3 quarters. The worst seems to be over, and better days are to come.
Sarine’s Quarterly Revenue Trend (US$m)
Sarine is led by a management with significant stakes in the business. The board of directors (executive and non-executive) collectively hold a 30% (approx. S$200m) stake in Sarine. This is positive for shareholders as the management will be more inclined to act in the interests of its shareholders.
The management came across as candid, competent, prudent allocators of capital, and pro-growth. I have noticed that whenever the management announces/mentions something, through SGX or The Edge, with regards to the future plans of the company, it has always delivered. Furthermore, the management constantly update investors with the latest news regarding the company (profit guidance, M&A, etc) and hold quarterly meetings with analysts and investors in Singapore. The management also openly discusses its failures (i.e. sales targets) as much as its success, which I very much admire.
Sarine has been debt-free since 2006. From 2009 to 2013, Sarine’s dividend increased 1,000% from US$0.0064 to US$0.06. Furthermore, Sarine constantly conducts share buy backs each year.
Cognisant of the abundance of opportunities in the diamond value chain and gemstone market, the management is not resting on their laurels and is constantly seeking ways to grow, both organically and inorganically.
Since 2009, the management made the strategic move to change its business model to one that is recurring in nature. Here’s how things have changed since:
Recurring Revenue Contribution and Number of Installed Systems
FY10: 10% – 20 systems
FY11: 12.5% – 50 systems
FY12: 25% – 95 systems
FY13: 30% – 140 systems
FY14: 35% – 190 systems
FY15: 45% – 215 systems
Despite being in a highly cyclical industry, Sarine’s financials are solid, which validates the strength and sustainability of its business and the management’s competence in allocating capital, managing costs, while pursing growth. It may be worth noting that during the 2008-2009 recession and the recent industry downturn, Sarine generated positive cashflows and remained debt free. With such a robust balance sheet and operating history, shareholders can sleep easy at night holding on to this high growth cyclical enterprise.
Since 2009, Sarine has been generating increasing positive cashflow from operations and free cashflows (excl. FY2015). This enabled management to fund its growth plans while increasing dividends, conducting share buybacks, and remaining debt free.
From 2010 to 2015, Sarine’s total number of installed systems increased at a CAGR of 60%. While this rate of growth is clearly unsustainable and will trend down in the coming years, I find the growth rate in systems installed to be a more reliable gauge of Sarine’s long-term enterprise value compared to earnings growth rate which is cyclical.
Since 2011, Sarine’s ROE has consistently been above 30% (excluding FY2015). The sources of the ROE comes from high net profit margins and return on assets. This further reinforces the effectiveness/efficiency of the management.
At S$1.82 a piece, Sarine is trading at a P/E of 82.37x. However, due to the industry downturn, this ratio is overstated. Using the 3-Year average net income (FY12-14) of S$30m, Sarine is trading at a more palatable P/E of 21x.
Assuming Sarine can capture just 0.10% (US$108m) of the diamond market (excl.rough diamond mining) in revenues for FY17, net profit margin of 30% (2011-2014 average), at 20x P/E, USD/SGD = 1.36; Sarine would be worth S$881m or S$2.51 per share. This assumption does not include any revenue contribution from the gemstone market mentioned above.
- 70+% Market Share in Diamond Planning & Grading Products
- Servicing a Massive US$108 bn Diamond Market (excl. Rough Diamond Mining).
- Expanding into Gemstone Market.
- Scalable, Low CAPEX, and Recurring Business Model
- Improving Quarterly Revenue Trend
- Management is candid, competent, prudent allocators of capital, and pro-growth
- Debt free since 2006
- Positive cashflow from operations despite economic recession and industry downturn
- Potentially worth S$2.51 in FY17
- Synthetic Diamonds may reduce profitability for diamond manufacturers which in turn negatively affect Sarine
- Diamonds are intrinsically worthless
- Highly Cyclical Industry. Profitability depends on price differentials of rough and polished diamonds as well as credit facilities provided to diamond manufacturers by banks.
- Geographical risk: 71% of Sarine’s revenues comes from India
- Liquidity risk: Sarine’s shares are thinly traded. But it shouldn’t be much of a concern to long-term investors.