Let me start by saying I like the business, and am adding it to my scorecard. (only wish I'd acted sooner). I think Wini has made a clear and well reasoned Bull Case which I agree with.
So rather than repeating the core investment case, I'm going to play devil's advocate and try and present a Bear case -- mainly to highlight to myslef the potential risks (even though I'm bullish on the stock).
Although the growth potential looks good, it's worth remembering that XRF capital sales will likely be lumpy -- these products have long replacement cycles, and customers can often delay purchase of new equipment if times are tough.
Consumables sales are also dependant on customer activity, and most are in highly cyclical industries.
XRF is susceptible to raw materials prices and FX changes (lithium is a major input to their consumables). Operating margins don't need to change a whole lot for profit to take a material knock.
They are pursuing M&A opportunities. With $2.7m in cash, they may need to do a capital raise or increase debt, with potential for shareholder dilution. A poorly executed or overpriced acquisition could erode shareholder value.
Also, upcoming product launches are encouraging, but may not sell as well as hoped.
Finally, with trailing 12 month EPS of 2cps, the current PE of 13 seems undemanding, but XRF has never really attracted a high multiple, and has often been below 10.
21/2/20 Appendix 4D Half Year Report
A very good 1H report from XRF, headline numbers of 5% revenue growth to $15.7m and 53% NPAT growth to $1.6m. Some nuanced thoughts from digging deeper in to the result:
Consumables continues to grow at double digits, with growth in all geographies but 32% growth in Canada and 23% growth in Europe the highlights. Australia is still 83% of Consumables revenue and will drive short term results but commentary remains positive.
Precious Metals is now beginning to shine through as the growth engine over the next couple of years, with 17% revenue growth and margins growing from 7% to 10%. The incremental PBT margin was 25% which is promising as recent capacity expansion likely allows several million dollars worth of incremental revenue to be generated before further capex is required.
Further to that point, commentary that "technical breakthroughs" at the Melbourne factory has expanded the potential product lines is interesting and further sets up Precious metals to be the growth engine moving forward.
Capital Equipment revenue was the only negative of the report, driven by a 30% fall in sales to Australian customers. Unfortunately this is just a feature of the business model where Capital Equipment sales will be lumpy over time. Despite that weakness, the positives were 170% growth in Canada and 46% growth in Europe suggesting further improvements in Consumables sales in the future from the international geographies.
Also, despite the fall in revenue, a shift in product mix and more direct sales to customers (rather than through distributors) meant that the Capital Equipment segment was able to grow margins from 7% to 9%. Commentary that two new products are due to be released in the 2H is interesting, as it potentially drives an upgrade cycle and one of the products is in a new industry (likely non-mining/materials reducing cyclicality).
At first glance cashflow looked weak but commentary from management clarified it was largely timing issues with a large receivables balance received after the reporting date. The company has never had issues with bad debts in the past but it is good to get that explanation.
Management discussed a couple of ways they are looking to further drive shareholder value such as M&A and capital returns to utilise their large franking credit balance ($5.8m).
Finally the most impressive part of the result was the overall scalability of the business with total costs and invested capital both almost exactly flat on the prior year. This is key to my investment thesis as the company exits a period of heavy investment and depressed profits. This result was the perfect example of the incremental scale in the business now with 91% of the revenue growth falling through to the PBT line.
Based on commentary from management on production capacity, potential for capital returns and increased payout ratio suggests they are comfortable that another heavy period of investment is several years away with only maintenance capex in the short term ($367k this half on $9.3m PPE). If this is the case, we should see strong incremental returns over the next couple of years and the share price should re-rate accordingly.
As discussed in my Bull Case straw, XRF operates with three segments; Capital Equipment, Precious Metals and Consumables. It is important to understand these three segments and what drives their profitability, as XRF books very little costs to corporate overheads (~$500k a year).
Capital Equipment: Capital Equipment involves the manufacture and sale of x-ray fusion machines and some other general weighing/measuring laboratory equipment. Historically, this division has grown revenues consistently with some lumpiness of large orders in the peak of in the mining boom in FY12/FY13. Margins have varied but historically were anywhere between 5-10%. This changed in FY16 however when the company embarked on some large R&D projects which resulted in the release of half a dozen new/updated machines. Speaking with management, this R&D to update the product suite is now largely behind them, with on-going R&D to offer more incremental improvements.
Capital Equipment generated $7.1m revenue in FY18 and $4.9m in 1H19. Reading between the lines of the March quarterly update I suspect Capital Equipment sales were a bit weaker in the 3Q19 but should still report strong growth over FY19. Assuming $9m revenue in FY19, I think Capital Equipment can maintain double digit revenue growth on the back of new products and do $10m revenue in FY20 at a 10% PBT margin (up from 7.3% in 1H19).
Precious Metals: Precious Metals now consists of two key activities. The first is the historical business of selling new platinum laboratory products that are used with Capital Equipment machines, along with a relatively steady revenue stream of re-manufacturing old platinum products as customers send them back to be melted down and re-manufactured as they wear down over time.
This core business was historically very steady, generating anywhere from $8-10m revenue with 15-17% margins and generating $1.4-$1.5m PBT like clockwork. However again in FY16, XRF embarked on a large expansion activity into “precision” platinum products. Unlike general labware, these products are customised for clients and used in areas such as aerospace, medical devices and high-tech manufacturing.
This expansion has come at a cost, with my estimate being $5m expensed over the last few years across new offices, R&D and operating losses. While management are expecting “material” contributions from this new division over the next 1-2 years it is difficult to forecast exactly how much it will contribute in FY20. My assumption is that with the new German office reaching breakeven at the very least we can model a return to the consistent $1.4-1.5m PBT from the core business. My forecast is for $15m revenue in FY20 with 10% PBT margins. Speaking with management they wouldn’t confirm exactly what margins they expect from precision platinum products at scale but confirmed they wouldn’t be dilutive to the core business (15-17%). This represents the greatest upside post FY20.
Consumables: Consumables are the sale of “flux”, a product used in the Capital Equipment machines. Consumables have historically been the key earnings driver for XRF, with margins of 30%+, with highs of 39% in the peak of the mining boom. Like Capital Equipment and Precious Metals, margins took a hit starting in FY17 from two key factors. The first was the acquisition of Canadian flux producer Scancia, which resulted in additional costs from shifting their manufacturing from Canada to Perth. Secondly, and more importantly, a key input material for flux is lithium, which saw a boom in prices beginning in FY17 and peaking in FY18: https://tradingeconomics.com/commodity/lithium
This brought margins down to 25% in FY17 and 21% in FY18, despite strong revenue growth. However, these two factors are now moderating as we look forward. Consumables did $7.5m revenue in FY18 and $6.3m through 3Q19. Assuming $9m for FY19, I think double digit revenue growth can continue on the back of market share gains from the Scancia products, so I have forecast $10m revenue for FY20, with 30% PBT margins, up from 27% in 1H19. This is due to continuing fall in lithium prices and further scale benefits.
FY20: Putting the segments together we get $10m revenue, $1m PBT from Capital Equipment, $15m revenue, $1.5m PBT from Precious Metals and $10m revenue, $3m PBT from Consumables. This is $35m revenue, $5.5m PBT for the group.
Subtracting the $500k in corporate overheads leaves us with $5m PBT and a tax rate of 27.5% would leave $3.6m PAT. With 134m shares currently on issue this results in 2.7c EPS. While I think XRF should trade at 10x earnings at a minimum, there is substantial upside here particularly as the company shifts away from a reliance on cyclical mining earnings to new industries, geographies and in particular a focus on high margin precision platinum manufacturing.
If XRF can achieve a multiple of 15x earnings it would result in a price target of 40c for FY20.
Good results - management continues to knuckle down and quietly just get on with things.
Besides the headline uplifts in revenue, earnings and profits - other positives I like in the half-yearly include:
Strong cash generation
Margin expansions across all segments
Mergers and acquisitions opportunities
I think it is very hard for anyone to accurately predict on a macro level how long the current downturn lasts for and the long term effects of it. What we can and should do though is look at individual businesses and assess the impacts to them from the coronavirus, positive or negative.
For XRF I recently spoke with the CEO Vance Stazzonelli who said they have yet to see any impact from the coronavirus with business remaining as usual. XRF's main clients are in mining and construction which have been deemed essential industries even in countries with full shutdowns. The company's offices in Canada and Germany are sales offices with employees able to work from home and sales closed over phone and email. This is assisted by the fact majority of sales are from existing clients.
Vance sees the big short term risk to the business being a forced closure of their Melbourne factory. If the Victorian Government did implement Stage 4 restrictions Vance hoped they could claim an exemption given their products are critical to the mining industry which would be deemed essential.
The other point Vance stressed was how conservative the company's balance sheet was, net cash and the small debt on the balance sheet backed by the company's Melbourne land and factory. On top of this, the $9m of inventory is roughly six months worth of operations in case supply chains are disrupted with a big chunk of that being pure platinum. With no changes to business operations Vance said the company would release their planned third quarter update in mid-April and saw no need for a specific corona virus update.
17/4/20 March 2020 Quarterly Trading Report
XRF released their 3Q report which was in line with the 1H with low single digits revenue growth and ~40% NPBT growth as margins continue to expand rapidly back to pre-investment levels. The company confirmed that the majority of their business has been operating as normal, with the majority of revenue from mining customers remaining unchanged. There has been some small impact from the international sales offices in Germany and Canada largely because employees have been forced to work from home causing delays closing sales over email and phone.
The one area that will take a hit is new Capital Equipment sales which isn't unexpected as discretionary capex will be wound back across the customer base. Short term this isn't a large concern as it is such a small contributor to profit, but can impact longer term as new sales are a lead indicator to ongoing Consumables and Precious Metals sales.
Management highlighted the strength of the balance sheet with $3.7m cash (an extra $1m since mid-Feb at the half year report) and minimal debt which is asset backed by the Melbourne factory and equipment. Speaking on a conference call after the results, the CEO highlighted the strength of the balance sheet could support M&A activity as conditions normalise.
While management was understandably reluctant to provide 4Q guidance, I wouldn't expect major hits to profits particularly as industry starts to return in key geographies (even if restrictions remain around hospitality and leisure). Given 4Q is seasonally strongest for XRF I suspect they could add another $1-1.2m in NPBT in the 4Q and do ~$3m NPAT for the full year or 10x earnings. Given the defensiveness of those earnings in the current environment that could be cheap, but market may now be looking ahead past the margin revision thesis to where the longer term growth comes from.
H1 2020 results released today.
Good result on bottom line (NPAT = $1.6M ie 51% growth) suggesting management paying particular attention to cost structure.
Only question relates to revenue (5% growth). This suggests either (i) customer demand is poor or (ii) management are holding back on driving growth preferring to focus on operational improvements. I am betting on the latter.
Assuming NPAT can be repeated in H2 then FY2020 NPAT = 3.2c per share.
Currently PE ratio is weighed down by small company size and investor sentiment that XRF is a cyclical mining service provider. The challenge for the company will be riding the vicissitudes of the commodities cycle and its capability to maintain steady earnings growth.
On a 12x PE (which is highly conservative) the business is worth 38c per share.
17-Apr-2020: XRF Scientific March 2020 Quarterly Trading Report
Market like! XRF were up to as high as 22 cps (+33%) earlier today, and they're still up at 19.5 cps (up 3c or +18.2%) on the back of this report. They had peaked at 26.5c on Feb 21, then dropped -47% in 4 weeks to close at 14c on March 24. So far, they've climbed about half way back up.
'Real' revenue growth may be hidden by the increasing shift towards a trailing revenue model via the consumables business and already flagged new contract wins within the German business for the next quarter. A degree of scalability has also shown through with YTD revenue growth of 18% vs NPAT growth of 113%.
Given the new contract wins already flagged within the coming quarter, and assuming margins are able to be maintained a full year NPAT of $3m seems somewhat conservative. At a price to earnings ratio of 12 = $36m MC / 133.8m shares implies a valuation of ~26.9c.
If revenue growth and scale trajectory continues, a PE of 12 might in fact be snapped up quite quickly (think LaserBond, $LBL). Current levels of cash generation (~$1m per quarter) may support an increase in payout ratio as a potential catalyst for re-rating also.
Obviously exposed to the mining sector as well as continued investment in precious metals and laboratory work - discount accordingly!
HY20 Results: Very good. Stock is going to go up.
Quick valuation 23/5/2019
FY2019 NPAT target = $1.8M (80% growth on FY2018)
PE ratio = 20x (conservative considering growth rate)
Gives market cap target = $36M
Shares on issue (fully diluted) = 133.8M
Gives share price target = $0.27
XRF is a manufacturer of equipment used to measure the composition and purity of metals, materials and chemicals. Majority of revenue is mining related (58%), but this has been falling as non-mining revenue grows (generally construction materials).
The business operates with an attractive razor/razorblades model, as their low margin Capital Equipment sales feed into high margin recurring Consumables sales. For 1H19, Capital Equipment grew revenue 28%, driven by demand for new products and exited the period with a record level of orders. Consumables grew 29%, though the prior period was impacted by the integration of a Canadian acquisition. Interestingly, management are also expecting to grow their market share beyond just their own equipment.
The third operating segment is Precious Metals which is the sale and re-manufacture of platinum laboratory equipment. This segment has been significantly under-earning for the past couple of years as XRF has invested over $2.5m since FY17 expanding with a new German office and upgrading the existing Melbourne factory. This investment is largely complete as the German office is now profitable (January 2019 first profitable month of $5k) which provides an interesting inflection point for the business. Management expect "material" profit from the segment over the next 1-2 years.
With the period of heavy investment behind them, 1H19 saw strong growth in EBITDA margins from 10% to 14%, thought still well below the historical highs of 25% back in FY11. Management expect to see further margin growth in 2H19, with a goal of getting margins back to those historical highs over the next 3-5 years.
28/10/19 2019 AGM CEO Presentation
XRF gave a 1Q20 update at their AGM presentation. Revenue only increased 2% to $7.39m however PBT increased 41% to $913k. Note that XRF expensed a one off cost of $103k in the 1H19 last year transitioning their banking to HSBC, and if this fell in the 1Q it has obviously inflated the PBT number. Assuming it did fall in the 1Q19, PBT only increased 22%.
The big highlight from the update was Consumables growing 17% to $2.49m. Unfortunately segment level PBT was not broken out, but given double digit growth and a stable AUD and lithium price since FY19, it is safe to assume there has been further margin expansion.
Capital Equipment was the victim of cycling a strong PCP with the 58% growth in 1Q18 saw revenue fall 25% to $1.70m. The segment can be very lumpy but management did note they exited the quarter with strong orders and have a new machine on track for release in FY20.
Precious Metals was also solid, especially the German office which increased revenue 61% to $789k. There was no comment on profitability, however given further revenue growth it would be close to breakeven at these levels. Total Precious Metals revenue grew 12% to $3.21m, and adjusting for the German office means core labware revenue only grew by 3%, but again commentary was positive on current order levels.
PBT of $913k leaves XRF on track to hit my estimate of $5m for FY20, but it does rely on the German office reaching breakeven (or a small profit) which looks achievable given the rapid rate of revenue growth.
Annual Report to Shareholders
XRF released their annual report which overall was a fantastic result. Record revenue of $29m led to EBITDA of $4.1m and NPAT of $2.1m.
Looking at the segments more in-depth, Precious Metals was the standout with 19% revenue growth and the first signs of scalability after years of investment with a 7% PBT margin. The outlook remains extremely strong and I expect the segment will beat my initial FY20 expectations for $15m revenue and $1.5m PBT as the German office turns profitable.
Consumables was slightly weaker than I expected with the 1H/2H seasonality skew being stronger than previous years. Revenue fell from $4.4m 1H19 to $3.6m 2H19, however promisingly the PBT margin stayed at 27% as lithium prices continued to fall over the year. Outlook was positive and although I have downgraded my FY20 revenue expectations from $10m to $9m, there is more comfort with the 30% PBT margin.
Capital Equipment also had a great year with revenue growth 29% and 7% PBT margin, with management commenting they are seeing a replacement cycle after years of lower capex with some new customers as well. While I am not sure exactly how long the replacement cycle will last, I suspect there is another year or two of solid growth.
Finally, the true highlight of this report was the sharp increase in free cash flow as management confirmed that the major capex investments of the past two or three years is complete with the "team, equipment and facility all in place". Capex + R&D fell from $1.9m in FY18 to $630k in FY19 and free cash flow increased to $3.3m from -$1.1m in FY18. As a consequence, the dividend payout ratio increased from 39% to 63% for a final dividend of 1c (note XRF does not pay an interim dividend).
On my forecasts, if the payout ratio is maintained the FY20 dividend could increase healthily again to 1.7c which would help support my 40c valuation.
18/4/2019 March 2019 Quarterly Trading Report
XRF provided an update after the 3Q19. Revenue growth was 6% to $6.7m on the prior year, while profit more than doubled to $710k. Despite the March quarter seasonally being the slowest, all three divisions positively contributed to profit.
The highlight from the update was the $1m in cash generated over the period, taking the cash balance to $2.2m. The Germany office contributed a small loss after a profitable January, suggesting that growth may not be as linear as I first expected. This is perhaps explained by a comment of additional "marketing costs from international trade shows" being incurred during the quarter.
However commentary was positive stating that several new customers had been won and will come online in the June quarter. Capital equipment orders remain high, with commentary about a new product set to be launched in 2H20. Finally, high margin Consumables sales remaining strong, up 19%.