DBS Group Research is keeping its "fully valued” call on Sarine Technologies U77 at a reduced target price of 25 cents against 30 cents previously, as economic uncertainties continue to cloud the diamond industry’s outlook.
Following the company’s 3QFY2023 results ended Sept 30, analysts Sachin Mittal and Amanda Tan lowered their target price, which is now pegged to 21x FY2024 earnings. This is below the historical mean due to the continued softness in diamond markets.
They write: “Accordingly, we reduce our FY2023 and FY2024 revenue estimates by 14% and 15% respectively. We also cut our earnings forecast for FY2023 and FY2024 by 89% and 16% respectively, on weaker-than-expected 9MFY2023 results for FY2023 and a top-line reduction in FY2024.”
The analysts understand that inclusion mapping comprises around 60% of Sarine’s total sales and the company retains market dominance in this area, with over 90% of the market share for stones over 2.5 carats.
They add: “Sarine also leverages its strong presence across the supply chain to roll out new higher margin offerings beyond diamond manufacturing, which could enhance its growth prospects.”
In 3QFY2023, Sarine’s revenue of US$ 10.4 million ($13.9 million) was a 28% y-o-y fall, due to the continued weakness in midstream manufacturing activities.
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Scanning revenues were comparably less impacted and overall recurring revenues rose to 72% in the quarter, against 60% in 1HFY2023.
Mittal and Tan write: “The trade-related services business is, however, gaining good traction, comprising 32% of sales at US$ 3.3 million in 3QFY2023, against 17% at US$ 4 million in 1HFY2023. 3QFY2023 fell into a net loss position at -US$ 1 million, below expectations.”
Meanwhile, Sarine’s gross profit margin contracted in 3QFY2023, to which the analysts attribute to a lower revenue base and product mix.
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The company has also introduced an off-market share buyback offer, and will purchase up to 4 million shares at 34 cents each, approximately 1.15% of its issued capital base.
“Sarine has committed $1.4 million to the share buyback, which will be funded by company profits accrued over the past two years,” note the analysts.
Industry view
Mittal and Tan note that India’s call for a two-month freeze on rough imports from mid-October to mid-December to stabilise the demand-supply dynamic reflects weakness in the diamond midstream.
They write: “We believe that this is indicative of slow demand in diamond markets in light of sluggish sales in the US, new sanctions expected in early 2024, and cannibalisation from LGDs (lab grown diamonds), particularly in the price-sensitive segment of smaller diamonds. This is clearly evident in India’s 9MFY2023 polished exports, which are down 24% y-o-y to US$ 14.05 billion.”
The analysts continue that they do not expect a complete cannibalisation of natural diamonds, given the “fundamentally different propositions” in social and emotional value against LGDs, writing: “Sarine also has several offerings targeted at LGD, that could cushion the impact of natural diamonds cannibalisation.”
Outlook
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The effect of India’s existing sanctions have “somewhat been circumvented” according to Mittal and Tan, as Russian diamonds that are substantially transformed in India continue to flow into the global diamond markets.
They add that new sanctions, which are expected in early 2024, if implemented, could “help close loopholes” and drive increased demand for Sarine’s traceability offerings.
Meanwhile, the analysts see that the Israel-Gaza conflict will likely be an overhang on sentiment, though no material direct impact is expected for now.
“We understand that Sarine is working at maintaining business as usual despite the ongoing conflict. Operations are continuing but could see a slowdown with 10% of staff mobilised. For now, Sarine looks to be more impacted by the sluggish diamond markets than the Israel-Gaza conflict,” they add.
Despite the unpredictable nature of current macroeconomic conditions, Mittal and Tan observe that diamond prices appear to be stabilising with the IDEX diamond Index at the 107 level since mid-October.
They believe that it is too premature to conclude that diamond markets are recovering, but continue to watch for signs of recovery, indicated by a sustained uptrend in polished diamond prices, growth in diamonds entering the pipeline, and lastly higher retail sales in major diamond markets, such as the US and China.
As at 3.37pm, shares in Sarine Technologies are trading flat at 28 cents.
