On the last trading day of 2016, Sapphire Corp announced that it had entered into conditional sale and purchase agreements (collectively, the “SPAs”) with China Vanadium Titano-Magnetite Mining Company Limited (“CVT”) and Toe Teow Heng (“TTH”) relating to its mining services business, Mancala.
Is this a positive or negative development? What are the implications? Let’s take a closer look.
Disposal of Mancala and its implications
CVT and TTH have agreed to acquire 49% and 32% of the issued and paid up capital of Mancala Holdings for HKD38.2m and HK$25m, respectively. Please refer to the SGX announcement for more information on the SPAs (click HERE).
In my opinion, there are several takeaways:
- Sapphire announced on 6 Jan 2016 and 15 Jul 2016 its intention to secure strategic investors for Mancala. Thus, Sapphire has managed to “deliver” what it set up to do. It also sends a message that Sapphire is focusing on its infrastructure business in China and other emerging markets in Asia. Consequently, Sapphire’s valuation may re-rate closer to other infrastructure players. For example, Midas trades at 23x FY16F and 15x FY17F PE. Sapphire, being an asset-light company, trades at an annualised FY16F PE of only around 10x;
- With this disposal, Sapphire adopts a “passive investing strategy” by retaining a minority stake of 19% in Mancala and some shares, amounting to approximately 0.9% of the enlarged share capital in CVT, listed on HK Stock Exchange. Thus, Sapphire may still benefit from a recovery in mining / commodities market.
- Sapphire’s independent valuer, RSM Corporate Advisory Pte Ltd, estimates the indicative value range of 100% of Mancala to be A$11.0 to A$16.1m as at 30 June 2016. Thus, the sale consideration for the entire Mancala valued around the entire Disposal Group for the Proposed Transaction is AUD13.1m. Furthermore, the deficit of the sale proceeds over the book value of the Mancala is estimated to be S$0.9m. Thus, this is NOT a fire sale. In addition, based on Sapphire’s announcement, including the fair value adjustment for the amount of the Final Tranche Consideration, the net accounting effect of the Proposed Transaction as a whole is estimated to be a net gain of S$0.2m. Thus, there is unlikely to be write-offs due to this transaction.
- With this SPA and disposal of Mancala largely completed in 2016 (subject to conditions precedent), Sapphire’s management will have more management time to focus on its infrastructure business in China and other emerging markets in Asia.
Next, let’s review Sapphire’s recent developments.
Other developments
Bright industry prospects
Despite concerns about China’s economy, its spending on infrastructure, especially railway investments, continues unabated. In a press conference on 29 Dec 2016, China’s vice minister of transport, Yang Yudong, said that China has budgeted RMB3.5t for railway construction from 2016 – 2020. This underscores China’s continued focus on railway and infrastructure development and bodes well for Sapphire.
Ranken secured RMB2.6b of contracts since acquisition by Sapphire in Oct 2015
Besides the supportive macro picture, Sapphire, through its engineering, procurement and construction subsidiary, Ranken Infrastructure Limited, has secured a whopping RMB2.6 billion of contracts since its acquisition by Sapphire in Oct 2015. As at 30 Sep 2016, Sapphire was sitting on a record order book worth RMB2.8b.
Promising 3QFY16 results
When Sapphire acquired Ranken, there was considerable scepticism as to whether Sapphire can execute well with Ranken. In addition, the market has doubts on Sapphire’s evaluation of acquisition targets as Sapphire's ex-management had made some poor investments. However, based on Table 1 below, Sapphire’s new management (i.e. Mr Teh) seems to have acquired a sustainable business with considerable potential.
Readers should note the following points on Table 1. Firstly, Ranken only started its contribution in 4QFY15 as it was acquired by Sapphire on 1 Oct 2015. Secondly, Ranken’s revenue is recognised by percentage of completion method, thus it may be lumpy in nature. Notwithstanding this, management said that 1Q is usually the weakest quarter, based on historical trend. Coupled with its strong order book, it is likely that 4QFY16F should perform in line with historical trend.
Table 1: Ranken - sustainable and growing operations
| S$ (m) | 3QFY16 | 2QFY16 | 1QFY16 | 4QFY15 |
| Revenue - Ranken | 61.8 | 46.8 | 44.0 | 61.8 |
| Net profit from Ranken | 3.5 | 3.6 | 1.9 | 2.5 |
Source: Company; Ernest’s compilations
FY17F results may surpass FY16F
Sapphire announced in Jul 2016 that it is in talks with governments in South Asia. Any contract secured is likely to have positive contribution in FY17F. Furthermore, as Ranken secures more contracts, it is likely that Sapphire will expand its production capacity to cater for the demand. In view of the above, the profit to be generated in FY17F is likely to surpass FY16F, which is by itself likely to be the highest since FY11.
Sapphire’s “understated” award won on 25 Nov 2016
In a brief announcement on 28 Nov 2016, Sapphire announced that it has received Hong Kong-based Capital Weekly (資本壹週) "Listed Enterprise Excellence Award 2016” - the first public listed company not quoted on the Hong Kong Stock Exchange to secure the prestigious accolade. This is a very significant announcement on several fronts. (See Picture 1 below)
- This acknowledges the success of Sapphire’s corporate turnaround strategies under the leadership of its Group CEO and Managing Director, Mr Teh since his appointment in Oct 2013;
- Capital Weekly is a widely-followed Hong Kong-based financial publication under the South China Media Group (南華傳媒). Based on South China Media Group (see its website HERE), it is the largest publication Company in Hong Kong on magazine publication and print media;
- Other companies which won this prestigious award are “giants”, compared to Sapphire. For example, The Hong Kong and China Gas Company Limited (Towngas), founded in 1862, also won this award. It is listed on HK Stock Exchange (see ticker symbol of 00003.HK - click HERE for company info) with a market capitalisation of HKD173b;
- Sapphire is the first company not listed on HK Stock Exchange to secure such a prestigious award. This accolade boosts Sapphire’s profile and reputation among the HK investment community. This may arguably pave the way should Sapphire decide to do a secondary listing on HK Stock Exchange.
Picture 1: Mr Teh, one of the 15 winners to clinch the award
Source: Hong Kong Foreign Financial Institutions Association
(Mr Teh is in the 2nd row, 2nd from the left)
Chart outlook
Based on Chart 1 below, after touching a high of $0.365 on 10 Oct 2016, Sapphire dropped 25% to an intraday low of $0.275 on 18 Nov 2016 with no announcement of adverse information. Notwithstanding the 25% drop since 10 Oct, Sapphire has not closed below its 200D exponential moving average (“EMA”) which is a positive development. 20D, 50D and 100D EMA have reversed their declines and inching upwards. 200D EMA continues to rise. Amid positively placed directional indicators, ADX has also just turned upwards and closed at 22 on 30 Dec 2016, indicative of a trend. Sapphire has been trading within a tight range of $0.275 – 0.305 since 14 Nov 2016 and it closed at the top of its trading range (i.e. $0.305) on 30 Dec 2016. Despite the tight trading range, indicators such as RSI and MACD are strengthening amid bullish divergences. Overall, Sapphire’s chart looks positive. A sustained break with volume expansion at $0.275 / 0.305 points to an eventual measured technical target of around $0.245 / 0.335 respectively.
However, it is noteworthy that due to Sapphire’s illiquidity where average 30D and 100D volume amounted to 239K and 828K shares respectively, its chart observation may be less accurate. Sapphire closed at $0.305 last Fri. (See Chart 1 below)
Near term supports: $0.295 / 0.290 / 0.275
Near term resistances: $0.305 / 0.315 – 0.320 / 0.340
Chart 1: Range bound between $0.275 – 0.305 since 14 Nov 2016
Source: Chartnexus as of 30 Dec 2016
Valuations
By annualising its 9MFY16 results, Sapphire is trading at approximately 10x FY16F earnings. It is noteworthy that Midas trades at 23x FY16F and 15x FY17F PE. Sapphire’s valuations are likely to be lower next year if it continues to deliver on results and execution.
Usual risks apply
Notwithstanding the above points, there are risks involved in Sapphire. Below are some examples of the possible risks. This is not an exhaustive list.
Execution risks
Although business execution risks have diminished with its four quarterly results which show that Ranken is progressing steadily, it does not mean that there are zero business and execution risks.
Illiquidity
Sapphire is illiquid and it is difficult for investors with significant positions to exit without selling down several levels. Such selling, if it occurs, may result in Sapphire suddenly dropping several levels without any negative news. On the contrary, Sapphire may also surge if there is buying demand.
SPA conditions precedent
The SPAs signed have conditions precedent such as CVT’s successful completion of due diligence on Mancala with satisfactory results; approvals from the Board of Mancala, Sapphire, CVT etc. before the proposed transaction can be completed.
No rated analyst coverage
Furthermore, as there is no rated analyst coverage, it may take a long time before Mr Market recognises the investment merits in Sapphire. Nevertheless, since my first write-up on Sapphire in Feb 2016, Sapphire has seen increased enquiries (or interest) from the investment community, such as fund managers, analysts and private investors. There is also increased interest in stock forums such as InvestingNote and ShareJunction.
Conclusion – re-rating is a matter of time
Notwithstanding the potential risks in Sapphire, Sapphire’s business seems to be gaining traction with reference to its past four consecutive quarters of earnings delivery. My personal view is that if Sapphire continues to execute on its focused strategy on infrastructure and deliver on results, it is a matter of time before it is re-rated by the market.
Ernest Lim, CFA, CA SingaporeP.S: Readers who wish to know more about Sapphire can refer to their informative website HERE. You can also refer to my write-ups on Sapphire below
a. Sapphire – profit taking likely to taper off (17 Oct 2016) (click HERE);
b. Sapphire’s substantial shareholders increase stake in Sapphire at $0.265 (19 Sep 2016) (click HERE);
c. Key takeaways from Sapphire’s 2QFY16 results briefing (12 Aug 16) (click HERE);
d. Sapphire’s order book hits a record high (15 Jul 2016) (click HERE);
e. Sapphire’s chart strengthens (5 May 2016) (click HERE);
f. Sapphire – proxy to infrastructure growth (5 Feb 2016) (click HERE).
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