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Sunday, August 13, 2017

Why it makes sense to invest in RGB International?

Why it makes sense to invest in RGB International?

RGB International deserves to be in the watch list for our investment after it has shown a strong turnaround story in 2008.
In 2008, the government in Cambodia has ordered all slot machines at entertainment clubs to be removed, resulting in the reduced in profit margins. The regulatory requirement at that time require slot clubs to be located in approved hotels.
Under the current management, revenue has grown by more than two times in its financial results 2016 to RM253.5 million from RM118.2 million in 2011. The net profit for the Group has also recovered from its losses in 2011. Compared to 2012 when it first turned black, the net profit has grown by more than 300% to RM25.3 million from RM6.0 million.

TSM segment – the recurring income segment is key

I think what is important is how RGB has managed to tap into recurring income through its Technical Support and Management (TSM) segment, that helps with maintenance of the slot machines.
The revenue for the segment has grown by 48% to RM93.2 million in FY2016 from RM63.0 million in FY2011. Back in FY2011, the segmental 
results was in the red but has turn into black in FY2012. The profit margin has also grown from about 10.7% to about 29.9% in FY2016. In FY2014 and FY105, the profit margin was at about 27%. While the segment is not the largest revenue contributor to RGB International, it is not the largest contributor to the Group’s segmental results, consisting more than 50% of the Group’s total segment results.
Currently, the Group has exposure in different geographical areas including Malaysia, Macau, Philippines, Singapore Vietnam and Cambodia. There are also operations in Laos, Timor-Leste and Nepal.
Besides the TSM, the Group’s sales and marketing (SSM) segment is also doing. The first quarter of 2017 saw a decline in revenue for both the segments but RGB International has targeted a 20% growth in its revenue for FY2017. So far, the decline in revenue in the SSM is due to the delivery of the slot machines that have been slightly delayed.
It is worth noting that the management has shared plans to expand into South America and this should translate into higher revenue and bottom line for the SSM segment first, and then the TSM, albeit, it might only be seen in the financial results after FY2017, giving it a positive outlook for the future.

Strong balance sheet

Balance sheet is also strong, from net debt in 2008 when it was struggling with regulatory issues, RGB International has consistently reduce its debt level until it has finished paying off all its borrowings in FY2016. Currently debt level is at very low level with net cash, which translates to about more or less 5 sen per share.

In terms of cash flow, things are also favourable to the Group. RGB International has maintained its positive operating cash flow in the past couple of years, something that helped them to reduce their debt level to its current level.
I believe the management has learned the lesson from 2008 of the danger of high borrowings, and has also taken measures to reduce cash flow risk. For example, in its SSM business, RGB International is selling its machines via two methods, one on cash and another on commission based. By selling it with cash, the Group has an upfront money, reducing its cash flow risk while the commission-based help RGB International to have a higher margin in the long run. (casino slot machines tend to profitable). On this ground, I think it is safe to say that the risk of how a higher interest rate hike or tougher business environment could affect RGB international is lower.

Growth Catalyst is ASEAN and emerging market

With more market opening up casinos, RGB International definitely stand in a good position to profit from this. Whether they could win more customers or not remain uncertain but the company has shown a pretty strong track record, giving them an edge in the slow machines and equipment industry.

I believe if RGB International could maintain its projection of 20% revenue growth to RM304.2 million for FY2017, assuming the margin remains at the same level, the Group’s net profit and EPS would be at RM30.4 million and 2.27 sen per share respectively. At that level, based on PE of 15 times (which is lower than the average 5-years of KLCI), its fair value should be somewhere around 34 sen, translating into a potential gain of 19.3% from current level of 28.5 sen.

A more aggressive projection would be assuming a higher profit margin by the same magnitude in its previous year, which could see net profit and EPS grow to RM32.9 million or 2.46 sen per share. Under the same PE assumption, the fair value for RGB International should be at 36.9 sen per share, translating into a potential gain of 29.4%.

Downside risk
1) Regulatory risks
2) Exposure to emerging markets like South America, ASEAN, which is not as well governed as a developed countries.
3) Geopolitical tension in some countries which might affect the prospect of casino business.

My call would be to buy in at current level. If you want a clearer signal and indicator of a buy call, it will be safe to wait for the quarter results to be announced before going in (but at the right price in case if share price move).

DISCLAIMER: This is just an analysis of the stock based on our own opinion. We do have a bit of holding in RGB International.

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