Profit deferred... again
The latest results for 3Q09 showed a marked improvement over the previous
two quarters and a major improvement on 3Q08, yet the company still posted
a net operating loss. Cumulatively, while the results for the 9 month period to
30 June 2009 show revenue to be 32.2% ahead at C$2.16m and gross profit
38.1% better at C$901k, the operating loss widened from C$897k to C$1.75m.
Our estimates indicate that the company will incur a further loss for 4Q09,
even though revenues should be over C$1m.
New personnel, waiting for the cavalry
New key sales personnel were appointed at end of April in an attempt to
reduce the long sales cycle involved in its custom-engineered products and in
early May Michel Brisson assumed the role of President and CEO. Although
these changes are positive for the company, we don’t see them making much
impact until the broader economy improves. Over the last two months, there
have been the first signs that the housing market in the US is starting to
stabilize and could be the harbinger of better news in 2010. However, the
capital goods cycle is likely to lag and so Sofame may not benefit until later.
In any case, a higher gas price would act as a more immediate galvanizer to
persuade wavering customers of the cost benefit
No distribution without representation
Four new SMRs have been added in North America since October 2008
and one SMR in Mexico. North America now has a total of 18 SMRs. Where
organizations have multiple plants, Sofame has tried to increase effectiveness
by developing relationships at head office as well as local level. Initiatives
to reduce the sales cycle by supporting SMRs directly with Sofame’s own
technical personnel are likely to become evident from 4Q09 onwards.
Patent pending
A previous patent on the Sofame steam pump expired and is in the process of
being upgraded. Management thinks this could make a major difference to the
business given that the product has a price tag of around US$750k, a gross
margin of 40 percent and wide application. However, this is not likely to make
any impact before 2011.
Capital raising deferred... but not forgotten
The C$5m capital raising that was to have gone ahead in July has been shelved.
However, on the basis of our core forecasts it is but a plan postponed - only on
the basis of our most optimistic forecasts will the company not require further
funding; either new equity, further bank lending facilities, or a mixture of both.
Management has put the infrastructure in place (and the costs associated that
go with that) in order to secure some highly impressive revenue growth but
these ‘orders’ have yet to translate into sales.
With a fundamental deterioration in its cost structure (the true fixed element of
its administrative and selling and marketing expense is in excess of C$2m but
probably nearer C$3m), the business will have to run exceedingly fast just to
stay still. Its cost structure seems to imply breakeven sales of around C$7.0m in
2010, more than double likely 2009 sales.
Highly geared operationally, there does not appear to be a Plan B. The step
change in revenues promised in its business plan in 2008 are now not an
option, they are a necessity.
Earnings, earnings…
On the basis of our core projections we estimate 2010 earnings of C$24k and
EPS of C$0.00024 (C$0.00019, fully diluted). Our core 2011 earnings are
estimated at C$1.1m and EPS of C$0.0107 (C$0.0084, fully diluted) , i.e. 2011
P/E ratios of 7.5x and 9.5x, respectively.
“Do ya’ deliver?”
In terms of valuation, the current share price actually reflects our reduced
expectations but not the effect of further equity dilution should management
decide to go down that funding route. The risk at this juncture is that if sales do
not materialize as envisaged and the cost of new funding is prohibitive i.e. too
dilutive, both could severely punish our core valuation estimate. On a brighter
note, there is also considerable potential upside in the value of equity but the
rub is whether management can actually deliver the sales in 2010.
