Monday 22 October 2018

A simple fundamental view on Design Studios. Is it losing its competitive edge?

Design Studios released its profit guidance on Friday night.
This is its 2nd profit guidance in 2 years, having released one for Q4 of FY 2017 citing the 3 reasons as follows for it.

-Deterioration from forecast due to commercial judgements on revenue and cost for residential projects (Related to project cost overruns, prolongation on project construction durations)
-Write-downs made on inventories
-Impairment of doubtful receivables

The profit guidance for 3Q FY 2018 are for the following reasons
-Cost-overruns from delays and a provision made on a project in United Arab Emirates
-Provision made for restructuring costs associated with the manufacturing facilities in the Group

Having said that, it seems like project overruns are looking at a norm, which is definitely not a good thing for any order book company.

 Having changed their way of reporting in financial statements, the 2018 quarter results reveal much more details. A snippet of the 2Q 2018 results is seen below. Full file can be found here.

On first glance, the key takeaway would be subcontractor cost has increased tremendously when compared to revenue.

From 33.34% in 2Q 17 to 52.89% in 2Q 18, it seems like more of the work is being done externally, if more work are being done by others, profits can only increase IF their own staff are doing lesser.
Which is not the case as staff cost has increased 10% year on year.

Although it would be quick to jump to conclusions, I would say there could be a few reasons such things happened.

Do note that these are just pluck from the clouds idea and are from my own imaginations only. :)

1) Someone key left the company and the work needs to be outsourced as they can't do it internally. This could explain how revenue increased 30.1% but staff cost went up only 10.4%.

2) They have always been outsourcing but now face price pressure as the companies they outsource to demand for higher prices.

3) Outsourced companies did not do the job well, forced to employ more companies to do the job, leading to higher cost.

Either way, this outsourcing has seems to erode value of the company such that higher revenue resulted in much higher outsourcing cost.

Moving towards its 3Q 2018 results, i would want to take a closer look at its quarter on quarter outsourcing cost/ revenue which has been increasing year on year.

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