IQ-Group (KLSE: 5107) is involves in the manufacture and sale of security and convenience products worldwide. The company is also involved in trading of security lighting systems, passive infrared detectors, and motion sensor light controllers. In addition, IQ Group Holdings provides original equipment manufacturers and original design manufacturing services, and distribution services. Some of its products are as follows:
Recently, its share price has fallen from a high of RM4.83 per share in August 2017 to as low as RM2.79 per share at the time of writing. That is about 73.1% loss of capital if you invested in it back then. The sharp fall is mainly due to selling pressures by investors as a result of poor quarterly results.
As value investor, I usually see this as an opportunity as what Howard Marks always said “To achieve above average market return, one must be able to act unconventionally”. But you don’t just simply jump right in. In-depth research must be done to analyse every part of the company (i.e. business, the industry the company is in, its financial position and performance, etc.) before deciding to invest in it. So here are the 5 key insights I learned from studying this company:
#1: RIDING ON THE WAVE OF SMART LIGHTINGS
According to a market report published by Lucintel, the global smart lighting market is expected to grow at a CAGR of 23.9% from 2017 to 2022 driven by the increasing awareness of energy saving, increased usage of wireless technology and growing demands of Internet of things (IoT) technology. Europe is seen to be the largest market due to increasing standard of living and increasing automation in Germany, France and United Kingdom. Question is how do these benefit IQ-Group?
IQ-Group is in the smart lighting industry, thanks to its technology in PIR Sensors which incorporated into LED lights allowing these lightings to automatically lights up when there is motion. Thus, saving energy costs. In addition, European countries is the company’s largest revenue contributor (approx. 54%); growing at a CAGR of 8.44% over the past 5 years, followed by Asia Pacific (33%) and United States (13%) in the year 2017. A quick check on IQ-Group’s prospectus show that most of its customers are under the European countries such as the following:
With such long-term customer relationships of up to 15 years, it somewhat provide IQ-Group a recurring demand. Moving forward, I believe the European countries will continue to be IQ-Group’s largest revenue contributor.
#2: MOVING UP THE VALUE CHAIN
In view of the fast growing smart lighting market, the Management did the right thing to create its own brand of smart lighting (“Lumiqs”) in year 2015 rather than relying on its traditional business model (i.e. Original Equipment Manufacturing – “OEM” and Original Design Manufacturing – “ODM”). Creating own brand may certainly provide IQ-Group a higher profit margin. However, this segment have not bear fruit yet. For the year 2017, the CEO mentioned that about 87% of the company’s total revenue is derived from ODM segment.
Going from OEM/ ODM to Original Brand Manufacturing (“OBM”) is a whole new business model. I’m talking about creating brand awareness among consumers at the same time managing your production efficiency to control your production costs. The main question here is “Can IQ-Group succeed in creating brand awareness?” It is still uncertain at the moment and the Management has been quite tight lips on the revenue contributed by its Lumiqs product in its 2017 Annual Report apart from being optimistic that Lumiqs product will achieve a 30% revenue contribution by year 2020.
In addition, IQ-Group will have to face fierce competition against key players of smart lighting and some of it are large multinational companies such as Philips Lighting, General Electric, Schneider Electric SE, etc. This is another area which the Management of IQ-Group have to worry about.
#3: LACK OF ECONOMIC MOAT
While researching IQ-Group, I noted the company does not have real economic moat. In view of the growing industry, threats of new entrants is inevitable because everyone wants to have a piece of the pie if it taste good. Apart from being at the forefront of PIR sensor technology for over 25 years which lead to the company being a global leader as claimed in its website, how will IQ-Group compete against its competitors? My guess is depending on the long-term relationship with its customers as mentioned above.
#4: HEALTHY FINANCIAL POSITION
On a brighter side, IQ-Group’s financial position has been very healthy with its cash building up to approx. RM57.2 million as at 30 June 2017. This accounts for about 23.3% of the company’s market capitalisation. Another good thing to note is that the Management has been very conservative in taking on debts. Over the past 10 years, the Company have little to no borrowings (see above chart). The large cash pile could act as a cushion particularly when it faces some downturn such as the recent bad quarter result due to lower sales volume in ODM segment as a result of focusing too much on OBM segment.
#5: HIGH CASH CONVERSION CYCLE
However, I could not help but noticed that over the past 3 years IQ-Group’s receivable days have been increasing. This suggest that the company is facing some difficulties in receiving payments from its customers. One of the disadvantages of being an OEM/ ODM is that you will always be bullied by your customers particularly when majority of the company’s revenue comes from only a small number of customers. As evidence, below is an extract of IQ-Group’s 2017 Annual Report:
In addition, inventory turnover days have also gone up to a crazy 211 days which eventually leads to a high cash conversion cycle of 166 days. This will definitely affect the company’s working capital. However, I do not foresee any problems in funding the working capital considering the company has a huge cash pile of RM57.2 million. But this does not mean that the company should keep its cash conversion cycle high, it is extremely inefficient. Unfortunately, I’m unable to find the reasons for such high cash conversion cycle.
On the side note, while I was reading IQ-Group’s 10 years of Annual Reports, I noticed the Management shares little information about its business performance (most of the time is just general explanation about its business performance). This lack of transparency is definitely an area of concern for me.
Overall, I believe IQ-Group is operating in a fast growing industry and the Management has made the right decision to move up the value chain by creating its own brand product – Lumiqs to ride on the wave of smart lighting market especially in Europe. However, the lack of economic moat increases the possibility of IQ-Group not being able to compete with its competitors. So is this a good company to invest in? I would say it is a fair company and so, a higher margin of safety is required before you invest in it. Your valuation should take into account all the above highlighted uncertainties.
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