Spectra Systems

 

ZULU REPORT

Whilst there are several Investing strategies it seems fair to me to say that most seasoned Investors, with maybe at least one eye on retirement and/or a future income stream steer well clear of ‘blue sky’ story stocks with a risk-balanced portfolio. A further risk is mitigated by a spread across sectors whilst homing in on the growth, the security of earnings and cash generation for dividends. So, following the same vein why would such Investors risk their cash in any Company with a subjective secretive board of directors with little investor interaction or communication, covert products and supply chains which are next to impossible to understand, who have failed to hold an AGM for years because it '' it does not have enough shareholder votes to achieve a quorum'', who had to reduce the number of board members due to concerns from one of its customers, and, at least from the outside, appears to be a ''one-man-band'' who seems able to invent things on a whim? 

Allow me to throw another issue directly related to today's feature report, and perhaps save you some time if you believe cryptocurrencies are the future, this company is not for you. I do not believe cryptocurrencies will replace physical cash, gold or even electronic money. Joshua, my oldest son, thinks his father is a dinosaur, and perhaps I need to wake up and pay attention. Here is my problem with cryptocurrencies in a nutshell! They remove control from banks and governments. Unless the cryptocurrency is a bank and controlled product, then neither the bank nor the government will allow the cryptocurrency to flourish until it replaced fiat. 

The Elephant Crypto-fans Ignore

Cryptocurrencies allow crooks and ordinary people to avoid taxation and also allows for easier money laundering. The latter steps on the toes of the biggest money-laundering thieves on the planet, the bankers with licenses to bend the rules and launder money without going to jail. The former will not implement or normalise technology that allows taxation to be avoided by the ordinary working class. Oh, that privilege is for the wealthy elites, not the chattering working-classes. 

If you agree with me, then perhaps this company is for you after all. 

Welcome to Spectra Systems (AIM SPSY) Market Cap £82 million at 178p. Highly illiquid. CEO Nabil Lawandy who owns 5.02% of the Company.

As you can see from the graph below, SPSY suffered like most companies in the first quarter of 2020 as Covid-19 struck the V-shaped recovery and the continuation of the upward trend, be it in a relatively wide range due to the illiquid nature of the company's shares.

In the hunt for ''Zul'' or ''Zulu-Esq'' type stocks, SPSY does start to fit the criteria. Add in a lovely 6 year upward trending chart, rising dividends and no debt then it starts to appeal. Forecast figures are clouded as only high % confirmed models are used; therefore, SPSY has a long history of ''exceeding market expectations'' RNS, with the odd but lovely sounding ''significantly exceeding market expectations'' rearing its head occasionally. Obviously, that needs to continue. £20 million or so was previously spent on R&D which is now benefiting shareholders but will the trend and the cash-generating growth continue? 

What does Spectra do? 

Spectra Systems is an established world leader in providing security technology that includes software and advanced materials for banknotes, product authentication, and gaming. Spectra’s solutions are also used to authenticate and track well-established consumer-branded products such as energy drinks, shampoo, wine, spirits, and tobacco. Spectra’s security software also provides secure Internal Control Systems to the U.S. and international lotteries, including Norsk Tipping in Norway, Puerto Rico, Malaysia, and 15 U.S. lottery jurisdictions. Spectra Systems is an associate member and active participant in the North American and Provincial Lottery Association (NASPL) and the World Lottery Association (WLA).

• $1m of lottery and gaming transactions processed by Spectra every day, 
• 800m banknotes passing its authentication systems annually, 
• 950m of energy drinks sold per year containing its materials, 
• 10m bottles of wine protected by its technology over the past three years, 
• 155m American passports protected by its materials in the last 10 years, and 
• 45bn banknotes in circulation containing SPSY materials.

Hence the covert nature of its business and the secretive strategy for obvious reasons. However, are not banknotes a thing of the past? Seemingly not ''discussions with central banks during H1 have reinforced our belief that worldwide demand for banknotes will be significantly higher this year than last year and that this will positively impact our earnings in H2 of this year''. It also seems that according to the BoE there are twice as many notes in circulation today than 6 years ago. It’s also worth noting that some of Spectra’s contracts are for 10 years.

Year ending 2019 Authentication Systems - $11.83m of revenue (89%) and $5.07m of adjusted EBITDA (92.5%), and Secure Transactions Group - $1.41m of revenue (11%) and $0.41m of adjusted EBITDA (7.5%) 

Short-term opportunities:

• Fulfilment of large orders for materials to a central bank customer 
• Additional funding beyond the currently contracted research program with a central bank customer 
• A multi-million dollar sensor development contract with a central bank customer 
• Increased number of tobacco packs sold in China with TruBrand materials and smartphone App 
• Adoption of phosphors for use by a supplier of products to a major Asian central bank
• Expansion of the optical materials business with compostable K-cup customers 
• Sales of Spectra’s newest patent-pending phosphor product 
• Sale of its first Aeris banknote decontamination system to a gaming casino. 

The longer-term opportunities are: 

• A licensing and supply agreement for polymer-based technology developed with a major central bank; Supply of further upgraded sensor capability to a central bank customer following the contracted development phase
• Sale of secure polymer substrate to central banks, which combines high security and a durable substrate in one product

Broker forecasts have not been increased or amended since the last ‘’exceeding market expectations’ RNS although no figures exist yet for 2022. Hopefully, as results will be out in March, it's probably better to leave forecasts until a later date. There is also a grey area as to if the last contract win with a Central Bank has been factored into any forecasts at all.

As for future development, the Company stated Over the past four months, the Company has continued to explore possibilities of diversifying the business beyond authentication in areas where we can support this initiative with our world-class core competencies in optics, engineering, physics and chemistry. We have identified certain intellectual-property owned by another company obtained academic feedback from Harvard University on this technology, and are now having the issued patents valued through an independent third party with expertise in this area. The current candidate technology has applications to biotech assays, point of care testing and metrology. 

Zulu criteria (not set in stone for this site as other filters are added) A brief summary:

• PEG<1. Fail. However, if we factor in a 10% beat of expectations from the last trading update, then it’s a Pass. 
• A prospective PER <20, with 4 years >15% growth. Fail. It has commanded an x20 p/e/ for some time. 
• Strong cash flow with cash flow per share over EPS for the last reported year and the average of the previous 5 years. Pass 
• Low gearing preferably under 50% or, even better, positive cash balances. Pass. No debt 
• High relative strength in the previous 12 months coupled with high relative strength in the preceding month or 3 months. Pass 1 year. 1 month flat 
• A strong competitive advantage. Pass. True brand as an example and length of some contracts 
• No active selling by a cluster of Directors. Pass, although a Director has been reducing.
• Accelerating EPS, preferably linked to the capacity to clone the company's activities. Pass Several directors buying shares. Fail Market Cap between £25m and £400m. Pass A dividend yield. Pass 

Bonus factors 

1. A low price to sales ratio (PSR). Fail 
2. Something new. Pass see the web site. 
3. Low research and development costs. Pass 13% review 
4. A reasonable asset position (if gearing is high) N/A Intangibles 23% of Equity

Finally, consolidation is required in this particular space. De la Rue (DLAR) is a well-established competitor to SPSY; until recently, DLAR seriously considered its survival after a woeful period just a coup of years ago - Perhaps SPSY benefits from any consolidation. 

The author holds shares in SPSY.