I've noticed that there are several debates in the forum over ARB Berhad (7181) on whether this company is truly a good company, or just another value trap. As an investor who studied ARBB for quite some time now, I would like to list several points for debate on the company. 

Hopefully, this would clarify investor's questions in mind.

Profitability

The golden rule of investing in value stock is the profitability of the company. Although that might not be the case from some market leader, but commonly, a company needs to be profitable before it could reward shareholders. So, is ARBB profitable? Let’s take a look at their 5 years revenue and net profit trend.

Revenue

FYE2016 – RM35.0 million

FYE2017 – RM11.4 million

FYE2018 – RM15.3 million

FYE2019 – RM102.6 million

FYE2020 – RM219.5 million

1QFY2021 – RM49.5 million

For those who are new to ARBB, the increase in revenue is mainly caused by a shift in core business model. ARBB had evolved from a traditional lumber upstream player to an enterprise solution provider as well as IoT player. But again, revenue doesn’t prove anything. What about their bottom line?

Net Profit After Tax

FYE2016 – (RM15.6 million)

FYE2017 – (RM3.6 million)

FYE2018 – RM4.2 million

FYE2019 – RM32.8 million

FYE2020 – RM42.9 million

1QFY2021 – RM6.8 million

It seems like the turnaround of core business from timber to a technology company had really paid off. But unfortunately, the company suffered a minor setback in their 1Q results due to lagged overview of the market. The next quarter is likely to be stumped by the Movement Control Order too. However, based on their performance since FYE2018, I believe there is a good chance for them to back on track for growth.

Dilution

Dilution has always been a hot topic for discussion for ARBB due to their complex derivatives structure of ICPS. Let’s take a look at the number of shares from FYE2016 to date.

FYE2016 – 61.1 million shares

FYE2017 – 61.1 million shares

FYE2018 – 67.2 million shares

FYE2019 – 289.8 million shares

FYE2020 – 454.9 million shares

1QFY2021 – 588.4 million shares

Before we proceed, I would need to explain the structure of their ICPS. In order to fund their conversion of business, ARBB issued up to 15 times of their initial share base of 61.1 million in order to raise funds. Due to the unique characteristic of ICPS, ARBB per share value was not immediately diluted – but instead, only dilutes whenever there are conversions from ICPS to the common share.

In short, ARBB did 2 rounds of funding – one via issuance of ICPS and upon conversion, ARBB would receive funds from shareholder on the basis of 20 cents per conversion.

However, there is a maximum dilutive effect of these ICPS. For starter, there are approximately 419.8 million ICPS left in the market. If these ICPS were converted, the maximum number of shares for ARBB would be 1008.2 million shares.

Based on 1QFY2021 results and if we average it by 4 quarters and discount it by 20%, a very conservative net profit figure would be RM21.8 million, or 0.0216 in EPS. By using the closing price on LDP 25.5 cents, this would translate to an approximate PE ratio of 11.81 times.

Peer comparison

Sadly, we do not have too much great software-based technology companies in Malaysia. The closest peers I could find would be the newly listed RAMSSOL, CENSOF and probably MICROLN. The PE ratio for these companies are 42.44 times, 10.20 times and 19.38 times.

On average, ARBB should deserve an 18.00 (conservative basis) times PE ratio to 24.01 times PE ratio (fair value) and 30.00 times in bull scenarios. Thus, the share price should be:

18.00 times PE ratio under maximum dilution – 39.0 cents

24.01 times PE ratio under maximum dilution – 52.0 cents

30.00 times PE ratio under maximum dilution – 65.0 cents

In order words, ARBB is currently trading at a bare minimum of 34.6% discount, and it ranges up to 60.8%. There is plenty or margin of safety left for ARBB.

Trade Receivables

One last key concern of investors on ARBB is the trade receivables. I totally agree that after the SERBADK incident, investors should keep an eye on trade receivables. Also, this might be the only weakness for ARBB thus far.

Under the financial period of FYE2020, the company had a total of RM132.4 million in trade receivables. It is important to point out that out of the RM132.4 million had not past due the “grace period” of the company, given to its clients. There is potential risk, however, on the remaining RM30.1 million which has past due between 31-120 days and RM27.3 million which past due between 121-210 days.

Should you be worried? Yes. But to be fair to ARBB, let’s find out why the trade receivables are increasing.

ARRB is principle involved in enterprise solution, which to be more specific, that would ERP for business. ARBB focuses on delivery customised ERP solution for small and medium businesses. However, ERP is known for a very high entry costs for small and medium businesses. The solution given by ARBB is a profit-sharing scheme where they would enjoy the growth of these businesses.

 In the year of 2020, most businesses suffered loss – some even shut down for good. The trade receivables are mainly coming from their client and not ARBB itself directly. Hence, we should expect that once the economy turns over, ARBB should see a sharp decrease in trade receivables.

Also, the auditors had done an impairment test on the trade receivables for ARBB in FYE2020, but the results are positive towards ARBB.

Conclusion

To conclude, ARBB might not be the best company you can find in the market, but it is certainly not what people claim it to be – a conman company. I had done a throughout study and due diligence, and I could proudly say that ARBB seems to be undervalued for now.

Of course, the ultimate to choose to invest, or not to invest is on you (wink). Make your own call!

Disclaimer:

This content by swimwithsharkss, is in no way a solicitation or offer to buy or sell securities or investment advisory services.

Readers should always seek the advice of an appropriately qualified professional and perform due diligence before making any investment decisions.

We shall not be liable for any errors or inaccuracies, regardless of cause.