27/2/20 Synertec FY20 Appendix 4D and Interim Financial Report
SOP released a disappointing half year report, with revenue falling from $12.8m to $7.3m and profit before tax falling from $121k to a loss of $968k. While revenue falling wasn't unexpected given the prior period had the benefit of large low margin construction work, higher margin engineering services revenue also fell from $3.1m to $1.7m.
However the most disappointing aspect and ultimately thesis breaker for me was the huge negative working capital with a $2.9m operating cash outflow compared to $1.2m inflow from the period before. Management commentary suggested some of this may be timing with one particular contract, but glancing at the balance sheet doesn't suggest a large receivables build-up but rather a general degradation across the receivables/payables and contract liabilities/assets balances.
One of the main reasons I was attracted to SOP originally was it appeared they were under-earning on reported profits but a strong focus on working capital meant cash results were strong. This may change in the future and I will keep SOP on my watchlist but removing it from my scorecard for now.
8 Jan 20: Revenues and profits are tied to the winning of new projects. There is little in terms of recurring revenue when the projects are completed. Currently margins have been sacrificed to win new projects to increase their IP to win more projects and hopefully obtain a better margin. The validity of this thesis is yet to be proven.
It is important to note how SOP's deferred revenue balance masks the company's underlying profitability. Since FY17, SOP has received ~$45m in cumulative cash receipts vs ~$39m in cumulative revenue recognised. This has led to the growth of the company's deferred revenue balance from $51k in 1H17 to $5.1m in 1H19.
As an example of what this conservative accounting means is 1H19 EBIT was $64k, while 1H19 operating cash was $1.25m. While the deferred revenue balance is not entirely profits, if you net off the work in progress asset balance (opposite of deferred revenue) and adjust for tax, you come very close to the $2.5m growth in the company's cash balance since FY17.
This means the business has produced roughly $1m in "cash profits" each year since FY17, despite reporting very low operating profits. While the company is growing I expect the deferred revenue balance to grow with it, but management's focus on working capital should mean cash profits remain strong and capital returns become a possibility.
On another note, while the cash balance is reported as $4.7m at 1H19, there is an additional $1.5m term deposit held as Other Asset, meaning the company currently has over 60% of it's market cap in cash. The company is also very capital light as you would expect, with only $421k in PPE.
Small provider of engineering consulting services to customers operating in complex, high risk or regulated industries. Reverse listing in August 2017 saw them come onto the market with little fanfare, but founders hold 43% of the business with one continuing on as Managing Director.
Since listing have continued to win large contracts across various industries, with comments at last year's AGM that the order book is the largest it has ever been across all target industries and into new geographies (10% of revenue earned overseas last year).
Reported profits have been masked by costs associated with the reverse takeover as well as a conservative revenue recognition policy that sees cash received before revenue is recognised, resulting in a large deferred revenue entry on the balance sheet. On a cash basis, company has seen their cash balance grow from $3.7m since listing to $6.2m at 1H19.
Despite being a consulting business, the company has some strong IP with their proprietary LNG custody transfer system which has been successfully rolled out to the Gorgon and Wheatstone LNG plants, both owned by Chevron. Management see a global market for the system, and have partnered with global engineering group Trelleborg to drive further sales.