ZGL is made up of three main entities - I'll label them the Good The Bad and the Ugly.
The Good:
The services to the oil industry is the cash cow of the entity. It appears to have a shallow moat (ie 10 years of above average returns), with very strong profit margins shown. This entity completes the manufacture of specialised equipment on offshore oil rigs - hydraulic drives etc. Over recent years they have expanded into the deep sea rigs. Few competitors given the specialisation required. The entities results fluctuates with the capital spend on the oil industry, with last 6 months results booking a circa $7m profit contribution for the group. This was on the back of the winding up of a large order from a Chinese backed consortium. Overall the entity provides on average circa $5m profit contribution pa. If it was just this entity, the stock would be a fantastic investment, albeit on the understanding of how the low oil price will affect the results in the coming years.
The Bad (or mediocre)
2nd entity in the group manufactures concrete mixer bodies for the Australian and Thailand market. No moat, with small profit margins shown. Entity is reliant on the construction industry and this has been subdued over recent years. Overall entity returns circa $2m pa profit contribution to the group (last 6 months results were breakeven).
The Ugly
3rd entity is the precision engineering section, manufacturing parts for hand held devices (smart phones etc), as well as other precision manufacturing of devices for the medical industry. No moat with small profit margins. Entity was founded (I believe) by Mr Sims youngest son, with initial strong growth and reasonable profits. Overall profit margins are small. 3+ Years ago turnover slumped and entity has been a loss making drag on the group. Management blamed the industry conditions for the slump, however I would speculate it was probably the loss of a major contract. Prior to the slump entity was returning $1m pa profit on average to the group. Over the last two years it is averaging a loss of circa $5m pa ($3m loss contribution in the last 6 months). However it must be acknowledged that some of the losses are due to the gestation costs of the 3 new projects (refer following).
Management
Mr Sim is the managing director of the group. Engineer by trade - he is in his late 60's. Self made man, I believe he founded ZGL (entity 1 above), then completed a reverse acquisition of ASX listed entity 2, which is the reason ZGL is listed on the ASX and not on the Singapore Exchange. Takes a more hands off operation approach with the group (which is reasonable for a CEO), concentrating on the new projects and long term capital management. Holds 39% of shares in the company and over the last couple of years has continued to purchase additional shares (on and off market). Has never sold shares. Both sons (who are in their 30's) work in the business in high-up operational roles. Refer last annual report for full details. Basically operation is run as a family company. Benefits are that the strategy is usually more long term focused for shareholder growth. General negatives to a family run operation is there can be issues of nepotism.
Strategy
In 2010/11 Mr Sim made the strategic decision to invest in 3 new projects, which manufactures machinery used in the healthcare, pharmaceutical and electronic chip manufacturing business. Prior to this, entities large cashflow was directed back to shareholders in the form of increasing dividends and share buybacks. Investment was a long term plan to move away from contract precision manufacturing (entity 3) making 2% margins to owning the machinery itself and making 20% profit margins. Long term, group wanted to rely less on the oil servicing part (given oil will over the long term decline given renewables) and create a new large moat in the health care industry. Basically he wants to have a strong long term operation that his sons can take over in due course. Strategically this is considered a good move, however getting the new machines to market has been a long and costly process.
New Investments
Biobot is a robot utilised in the diagnosis of prostate cancer. It has major health advantages over current practice. Presently entity has been setting up Çentres of Excellence to showcase the machine in major hospitals around the world (usual industry practice). Has started making sales in Germany. Half yearly reports state that this investment should be breakeven in 2017. Up to this, it has incurred large gestation costs (I would presume) expensed in the precision engineering entity. Main benefit is the recurrent sales for the machine which will have a high profit margin.
Drop Array - machine utilised for the pharmaceutical industry for the discovery of new drug compounds. More efficient than current machines. Entity has re-engineered machine and investment is now breakeven and should be profitable in coming years (as per half year reports).
Flip Chip machine - utilised to be a more efficient manufacturing process for the chip manufacturers. Group needed to re-engineer machine as is currently being utilised in a large manufacturer for their assessment. Probably still operating on a cost to the business in the coming year.
Financial metrics
ROE has been low for a number of years. Basically it has been affected by the large investments in the three projects above (circa $15 - $20m to date), with profits yet to show. Further, downturn in the precision business has affected overall group results. Prior to this, group had a few lean years with the oil servicing entity following the large CAPEX finalising, from new rig investments when oil price was very high. Further client carries no gearing, with large cash at bank holdings offsetting debt, with cash generating little return (however large cash holdings justified in this company given the nature of the capital industry).
Balance sheet is very strong, which as above, no net debt and over $20m in cash on hand (Singaporean dollars).
Note - group reports in Singapore dollars, which at current exchange rate is close to parity with AUD.
Future prospects
Group is coming up to an interesting point in their future. The large Chinese project is coming to a close (refer paragraph 1), with this income historically offsetting the losses on the precision manufacturing entity in the last year or so. With the low oil price, new CAPEX will be minimal until commodity price increases. If historical losses continue in the precision engineering group, there is a likelihood of a overall group loss in the next year (2017) - say up to $3m after deprecation etc. Group has been cutting overheads in the precision manufacturing operation and decreasing dividends to preserve cash. Note that the balance sheet appears to be strong enough to cover a number of years of losses before it affects the overall viability of the operation. Group needs to transition the new investments into profitability and have the 3 main entities, reporting normal /average profits.
On average group should be returning $8 - $12m net profit pa, with additional profit from the new investments (best case $20 - $25m net profit). TNA is a strong 35 cents a share compared to current share price of 15 cents.
Vested interest - I own shares in ZGL and I'm not a financial adviser. I don't offer any recommendations on this share.
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