Scott Technology shareholders score bonus

By David McEwen

Friday 15th November 2002

Although it has a relatively low profile, Scott Technology is one of New Zealand's export success story.

It occupies a unique niche, designing and building automated lines for the international appliance industry. Almost all sales are from exports, with markets in the US, Central and South America, Europe, Australia, and, recently, also in China, Mexico and Canada.

From 1998-2000, its earnings climbed steeply as the company made deeper inroads into overseas markets.

But in 2001, it came off the rails when overseas factories started delaying plant renewal and cutting down on capital expenditure. A couple of large one-off orders were also completed about then. Earnings per share collapsed from 18c in 2000 to 2c in 2001, and with it the share price fell.

Scott then realised that it was far too reliant on the fickle appliance industry and started expanding into other industries where its technical skills could be applied. And some key acquisitions followed.

The latest annual report for the year ended August 2002 reflects a sharp turnaround. Comments by the directors are extremely upbeat and brimming with confidence. And there is good cause.

The company's net profit recovered to $3.7 million, from $415,000 in 2001. Group sales were $29.2 million from $16.6 million previously. Net operating cash inflow was a healthy $7.2 million.

"Scott Technology must rank as one of the country's most conservative listed companies, with no debt, substantial short-term cash investments and no intangibles in its balance sheet," chairman Graeme Marsh writes.

Investors have rediscovered the company, pushing its share price from $1.90 in October to $2.50 now. Many have noted the comments in the annual report, which reinforce the view that last year's recovery will be stepped up.

The company has forward orders to take it through to 2004, CEO Kevin Kilpatrick says.

"The North American market has emerged from the downturn, as signified by the contracts both secured and pending. The Chinese economy continues to grow rapidly and is expected to provide a substantial market for the company in the future, with greater long-term potential than even the US."

The managers are making progress on a new strategy, built around the notion that Scott needs to diversify away from its narrow focus in appliance manufacturing. Scott Automation was established to spearhead the move into new industries, and cemented that move with the acquisition of CBS Engineering, which has a strong history in the automation of package handling.

With continued diversification into less cyclical industries, Scott is reducing its risk profile.

Earlier this month, Scott announced it had entered into a joint venture with meat processor PPCS to develop a new automatic boning process, and a robotic system had been successfully tested and patented.

These moves could do much to smooth out the earnings of Scott, which traditionally has generated its sales from a handful of large customers in a single industry.

The directors say they are rewarding shareholders by making a 1:8 bonus issue of shares to acknowledge "shareholders' commitment to Scott Technology over the past two years when the company's performance was affected by a downturn in its markets."

Whether there is real value in a bonus issue is a moot point, because in theory the share price of Scott should fall by the amount of the dilution, thereby cancelling the benefit.

However, the share price has not fallen and has actually risen on news of the bonus issue. This often happens with bonus issues, particularly where they are accompanied by good news and undoubtedly Scott has a good story to tell at present.

Shareholders should be aware that, like all small companies that deal with big orders from huge customers, further earnings volatility is possible.

David McEwen is publisher of The McEwen Investment Report, www.mcewen.co.nz

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