“Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity.  The safest and most potentially profitable thing is to buy something when no one likes it.”

Howard Marks 

ECS ICT Bhd is involved in the distribution of information and communication technology (ICT) products, the provision of ICT systems and services, as well as the provision of management, financial, accounting, warehousing and logistic services. The Company offers its products to its resellers, including personal computer (PC), notebooks, printers, scanners, software and other peripherals. The group has recently established its smartphones distribution channels. Its ICT distribution serves a network of more than 2,000, and ICT system, 500 resellers in Malaysia. Its ICT services include hardware support, maintenance and repair, as well as system integration, including consultation, designing of networks, installation of hardware and software, and implementation and management of ICT systems.

For the trailing twelve month (ttm) ended 30^th September 2015, the group has achieved its best-ever top line of RM1.86b since inception in 1985. Three quarters of revenue are from ICT distribution with two thirds of total profit of RM32m. The rest of the revenue are contributed from the other two major divisions of enterprise systems and ICT services.

Price Chart

Figure 1 below shows the adjusted share price movement of ECS since 19^th April 2010. Speculators would have no interest in this stock as there is not much movement in its share price for the last 6 years, except for a slow and steady rise with little volume and hence does not present any excitement investing in this share. ECS closed at RM1.57 today on 18^th January 2016.

Figure 1: Share price movement of ECS

Financial Performance

Since public listed less than 6 years ago, its annual revenue has increased by 46% to RM1.86b, with most of the growth from the last two years. Net profit, however, has not improved in line with its rise in revenue. The bottom line has been staying in the range of RM27m to the best of the latest ttm of RM32m as at 30^th September 2015. This translate to earnings per share (EPS) of 17.8 sen.

The group’s new mobility distribution segment (i.e. smartphones and tables) has performed exceptionally well contributing 20% to the group’s total turnover in 9M15 with a gross profit margin that is higher than its traditional ICT distribution division of 4%-5%. The strong performance was mainly driven by stronger demand of the mid-to- lower end smartphones ranger carried by ECS.

From the perspective of profit margin, ECS doesn’t look appealing with a miserable overall net profit margin of just 1.8%. This is because of the nature of its main business; distribution of products. What matters is the volume of distribution products, or more precisely the sales volume in relation to its total asset. Its total assets are turnover 4 times a year. Its return on equity, boasted by its high asset turnover, is a commendable 13.3% despite the low profit margin, and absence of any debt.

The beauty of ECS’s business is it doesn’t need much fixed asset to carry out its business. Its sales volume is 300 times its fixed assets.

ECS’s balance sheet is squeaky clean with no debts, but a massive amount of cash of RM124m, or 69 sen per share. Taking away this cash, the return on invested capital (ROIC) is very high at 26%, about three times its cost of capital. Think about a business giving 26% return a year for the capital you have in the business. Isn’t that a wonderful business?

Actually ECS impresses me most with its ability to generate cash. ECS generated an average of RM27m of free cash flows (FCF) for the last 5 years. For the three quarters of financial year 2015, FCF is already RM39.5m. The high level of FCF is because it doesn’t require much in capital expenses in its trading business.  FCF averages above 20% of invested capital a year, in hard cash, not dicey earnings. It is this high level of internally generated cash, or FCF that ECS is able to pay out a high dividend of 8 sen a share in the most recent year. Isn’t that a good business?

We have deduced from the past performance that ECS is a good company. But what is the market valuation of ECS? Is it a good investment?

“Wonderful companies become risky when people overpay for them.” Peter Lynch

There is only Kenanga Investment Bank covering this stock with a target price of RM1.94 based on a relative valuation using price-to-earnings of 10 times, in line with the FBM Small Cap Fwd PER of 10.4x.

http://klse.i3investor.com/servlets/ptres/33187.jsp

I think it would be more appropriate to look at the valuation of ECS from different angle, rather than purely base on the simplistic PE ratio.

““Successful investing requires thoughtful attention to many separate aspects, all at the same time. Omit any one and the result is likely to be less than satisfactory.” Howard Marks

Some simple valuations of ECS ICT

In this analysis, we attempt to use some simple but more useful market valuation techniques to value ECS. The valuation metrics of ECS were worked out based on its trailing twelve months’ financial performance ending 30^th September 2015 and as summarized as shown in Table 1 below.

Table 1: Some simple ratios of ECS for 2015

All valuation metrics above show at RM1.57, ECS is selling cheaply in all aspects. ECS is cheap with a PE ratio of just 8.8 and P/CFFO of 10.4, both below or about the benchmark of 10. P/B is also inexpensive at 1.3, bearing in mind that large part of its assets is quality asset in cash.

ECS is particular cheap selling at an enterprise value of just 3.8 times of its earnings before interest and tax Ebit), or at earnings yield of 26%, almost twice above my requirement.

Warren Buffett has mentioned that he is willing to pay an enterprise value of 7 times its Ebit for a business with 5%-7% growth potential. ECS is selling 45% below that benchmark.

What about its cash yield for equity shareholders, or FCF/Price, which I emphasized lot and have articulated about it at length here?

http://klse.i3investor.com/blogs/kcchongnz/76694.jsp

At RM1.57, the cash yield (FCF/market cap) of ECS is about 10%, twice that of my personal requirement for an investment to be a no-brainer investment.

"First-level thinking says, ‘I think the company’s earnings will fall; sell.’ Second-level thinking says, ‘I think the company’s earnings will fall less than people expect, and the pleasant surprise will lift the stock; buy.’ "
Howard Marks

Conclusion

ECS seems to have an attractive business model with some moat. It has produced excellent operating performances with stable earnings, high return on capital, and good free cash flows. Its balance sheet is squeaky clean. Yet some simple market valuations show it is now trading at a good price. wide margin below its intrinsic value. ECS has also been rewarding its shareholders well with dividend of 8 sen per share, or a dividend yield of 5.1% last year, more than what one can get from fixed deposit.

ECS appears to be a low risk investment with good upside potential at the present price of RM1.57.

K C Chong            ckc14training2@gmail.com