Silver Chef Limited (ASX:SIV) is a company I’ve been following for a while, and one that I believe the market is over-hyped about. My concerns are mainly around the sustainability of its future growth, the opportunity cost of investing in the stock accounting for the returns I could have gotten in other peers, and its cash-to-debt management. Whether a company has a good future, in terms of its business operation and financial health, is an important question to address.
Silver Chef Limited engages in the rental and financing of commercial equipment in Australia, New Zealand, and Canada. Founded in 1986, it currently operates in Australia at a market cap of AU$142.94M.
The first thing that struck me was the pessimistic outlook for SIV. A consensus of AU trading companies and distributors analysts covering the stock indicates that its revenue level is expected to decline by -25.31% by 2020, negatively impacting earnings, with an upcoming bottom-line growth rate expectation of -25.97%. In addition to this, at its existing earnings level, SIV lags its industry peers in terms of returns to shareholders (1.82% vs. 8.09%), which concerns me. One reason I’d expect a company to produce below-industry returns right now is if it’s in a reinvestment phase, and gains will become evident in the future. However, for SIV this clearly isn’t the case, and leads to a big question mark around the sustainability of its current operations.
Investors tend to get swept up by a company’s growth prospects and promises, but a key element to always look at is its financial health in order to minimize the downside risk of investing. A major red flag for SIV is its high level of debt, which has been increasing over the past five years, exceeding its total level of equity. However, cash generated from its core operating activities makes up a decent portion of debt (0.43x), and it generates enough earnings to cover its annual interest payments. But there’s still room for improvement on the debt level front, which could be lowered to a more prudent amount. The current state of SIV’s financial health lowers my conviction around the sustainability of the business going forward. SIV has poor near-term liquidity, with short term assets (cash and other liquid assets) unable to cover its upcoming liabilities in the next year. However, one reason I do like SIV as a business is its low level of fixed assets on its balance sheet (0.50% of total assets). When I think about the worst-case scenario in order to assess the downside, such as a downturn or bankruptcy, physical assets and inventory will be hard to liquidate and redistribute back to investors. SIV has virtually no fixed assets, which minimizes its downside risk.
The current share price for SIV is AU$3.64. At 39.27 million shares, that’s a AU$142.94M market cap – which is about right for a company that has a 5-year cumulative average growth rate (CAGR) of 21.97%. With an upcoming 2018 free cash flow figure of -AU$191.10M, the target price for SIV is -AU$21.35. Therefore the stock is priced around its fair valuation. But, comparing SIV’s current share price to its peers based on its industry and earnings level, it’s overvalued by 211.28%, with a PE ratio of 53.5x vs. the industry average of 17.19x.
SIV is a fast-fail research for me. Good companies should have good financials to match, which isn’t the case here. Given investors have limited time to analyze a universe of stocks, SIV doesn’t make the cut for a deeper dive. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.