Saturday 12 December 2015

Sarine Technologies - Suriving the Diamond Downturn

The Singapore stock market has had a particularly rough year, along with it, Sarine Technologies has suffered a torrid year. Year to date, its share price has fallen by half and is at the 1.30 levels due to a slump in earnings.

Overview
The company is in the business of providing technology-related products to manufacturers which turn rough diamonds into polished ones. Despite being an "IT company", Sarine Technologies have demonstrated why it is important to analyse factors that are beyond the company's control such as its customers and the state of the diamond industry.

The diamond industry especially in India, is experiencing a diamond crisis. Market demand for diamonds has been muted in both China and India and many Indian diamond manufacturers are struggling. This has affected Sarine. Its earnings have fallen 90% and it is unlikely Sarine will report a 3 cents EPS for this FY, let alone last year's 7.8 cents. This event shows how dependent Sarine is to the diamond market thus it can be known as a derived demand support company. On the sgx, there are many such companies such as Penguin and Sembmarine who have products supporting certain niches of an industry.

Will Sarine Survive?
Fortunately for Sarine, it has little competitors to its specialized service. Its Galaxy products have a dominant market position and its business model has moved to a recurring revenue base (similar to Silverlake's) which is wonderful. Aided by a balance sheet with little liabilities and good cash flow generation.

Furthermore, Sarine is trying to branch out beyond diamond to other gemstones by having new products like Sarine Loupe and Allegro. However, as these are new products, it will take a while for Sarine to diversify its revenue dependence away from diamonds.

To conclude, Sarine is likely to survive this diamond crisis; however the question is the length and terror of this slump which will hurt Sarine's earnings in the near to mid term. Sarine may have to resort to debts to continue its innovation and survival; but given its pristine balance sheet, it should be able to borrow.

Valuation
At a forcasted EPS of 1 SG cents, Sarine is trading at an eye-watering forward P/E of 133x. However, what matters is the recovery of earnings when the diamond industry turns up. Should it regain to last year's earnings of 11 SG cents, current valuation may not be too shabby.

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