Trio-Tech International (TRT): Undiscovered Stock, Strong Fundamentals, Positive Outlook

This is an undiscovered stock from the information technology sector, given that the most recent article on Seeking Alpha about this name was published in 2016. This is why we decided to write an article about Trio-Tech International (NYSE:TRT) whose shareholders have been handsomely rewarded over the last twelve months. Micro-cap stocks are frequently overlooked by institutional investors, so a big advantage of investing in micro-cap stocks is the opportunity to beat institutional investors.

TRT currently stands at about $6.50 per share, so the key question now is: Does further upside still exist?

Brief Overview

TRT is a provider of semiconductor testing and burn-in services for more than 40 years, so its core business is in the semiconductor industry. Besides servicing the semiconductor industry, it also services the automotive industry, avionics industry, defense sectors, medical industry, research institutes, as well as OEM / ODM manufacturers. The major customers are concentrated in Asia and they are either semiconductor chip manufacturers or testing facilities that purchase testing equipment. TRT operates its business in four segments: manufacturing, testing services, distribution and real estate.

When it comes to the manufacturing segment, TRT derives revenue from the sale of both front-end and back-end semiconductor test equipment and related peripherals, maintenance and support of all these products, installation and training services and the sale of spare parts. It operates two manufacturing facilities: one in the U.S. and the other in Asia.

The testing services are rendered to manufacturers and purchasers of semiconductors and other entities who either lack testing capabilities or whose in-house screening facilities are insufficient for testing devices in order for them to make sure that these products meet certain commercial specifications. Customers outsource their test services either to accommodate fluctuations in output or to benefit from economies that can be offered by third party service providers. TRT uses its own proprietary equipment for certain burn-in, centrifugal and leak tests, and commercially available equipment for various other environmental tests. The company operates six testing service facilities: one in the U.S. and five in Asia.

When it comes to the distribution segment, TRT distributes both its proprietary products and complementary products made by manufacturers mainly from the U.S., Europe, Taiwan, and Japan. The products include environmental chambers, handlers, interface systems, vibration systems, shaker systems, solderability testers and other semiconductor equipment. Besides equipment, it also distributes a wide range of components such as connectors, sockets, LCD display panels and touch-screen panels. The range of products are mainly targeted for industrial products, the life cycle of which can last from three years to seven years, rather than consumer products which have a shorter life cycle. Its distribution segment operates primarily in Asia.

When it comes to the real estate segment, TRT has invested in real estate property in Chongqing, China, which has generated investment income from the rental revenue and investment returns from deemed loan receivables.

The Balance Sheet

TRT was not immune to the COVID-19 pandemic and experienced a difficult year during FY 2021 that ended in June 2021. Specifically, revenue in FY 2021 declined 6%, or $2 million, to $32.5 million compared to $34.5 million in FY 2020.

On that front, TRT generated 99.9% of its revenue in FY 2021 from its three core business segments (i.e. manufacturing of test equipment, testing services, distribution of test equipment), with the Real Estate segment contributing only 0.1% to the total revenue, as illustrated below:

	For the Year Ended June 30,
	2021	2020
Manufacturing	40.5%	33.7%
Testing	42.7	43.0
Distribution	16.7	23.1
Real estate	0.1	0.2
Total	100.0%	100.0%

Despite the $2 million YoY decline in revenue, gross margin improved 2.5% in FY 2021 being 23.6% of revenue compared to 21.1% of revenue in FY 2020, as illustrated below:

	For the Year Ended June 30,
	2021	2020 (Restated)
Revenue	100.0%	100.0%
Cost of sales	76.4	78.9
Gross Margin	23.6%	21.1%
Operating expenses:
General and administrative	21.3%	20.5%
Selling	1.4	2.0
Research and development	1.1	1.0
Impairment loss on long-lived assets	–	0.4
Total operating expenses	23.8%	23.9%
Loss from Operations	(0.2)%	(2.7)%

Gross margin improved thanks to the company’s establishment of effective cost control programs for its testing services operations, which helped the company generate positive operating cash flow and positive free cash flow in FY 2021, as illustrated below:

	Year Ended
		June 30,
	June 30, 2021	2020 (Restated)
Net Cash Provided by Operating Activities	1,638	3,011
Cash Flow from Investing Activities
Proceeds from sale of assets held for sale	–	1,167
Proceeds from disposal of property, plant and equipment	–	39
Withdrawal of unrestricted deposit	2,335	–
Investments in restricted and unrestricted deposits	(1,790)	(2,806)
Addition to property, plant and equipment	(1,112)	(1,017)
Net Cash Used in Investing Activities	(567)	(2,617)

However, the improvement in gross profit margin was not enough for achieving profitability and TRT recorded a net loss for FY 2021 of $591K, as linked above.

On the positive side, backlog rose 45% to $13.5 million at June 30, 2021, up from $9.3 million at June 30, 2020, as illustrated below:

	For the Year Ended June 30,
	2021	2020
Manufacturing backlog	$5,040	$5,010
Testing services backlog	3,775	2,915
Distribution backlog	4,648	1,409
Real estate backlog*	40	6
	$13,503	$9,340

* Real estate backlog is based on the rental income from a non-cancellable lease

The effects of the COVID-19 pandemic receded in FY 2022 that began in July 2021. As a result, TRT’s revenue for the first six months of FY 2022 increased 40% to $21.1 million compared to $15 million for the same period in FY 2021.

On that front, TRT generated again 99.9% of its revenue in the first half of FY 2022 from its three core business segments (i.e. manufacturing of test equipment, testing services, distribution of test equipment), with the Real Estate segment contributing only 0.1% to the total revenue, as illustrated below:

Revenue Components		Three Months Ended								Six Months Ended
		Dec. 31,				Dec. 31,				Dec. 31,				Dec. 31,
		2021				2020				2021				2020
Manufacturing			32.3	%			43.5	%			33.6	%			41.2	%
Testing Services			45.4				43.4				45.4				43.3
Distribution			22.2				13.0				20.9				15.4
Real Estate			0.1				0.1				0.1				0.1
Total			100.0	%			100.0	%			100.0	%			100.0	%

As a result of tight control over operating costs, gross margin for the first six months of FY 2022 increased to $6.1 million compared to $3.4 million for the same period in FY 2021 and increased to 28.8% of revenue compared to 22.5% in the same period last year, as illustrated below:

		Six Months Ended
		Dec. 31, 2021				Dec. 31, 2020
Revenue			100.0	%			100.0	%
Cost of sales			71.2				77.5
Gross Margin			28.8	%			22.5	%
Operating expenses:
General and administrative			18.6	%			22.1	%
Selling			1.4				1.5
Research and development			1.0				1.3
Gain on disposal of plant and equipment			–				–
Total operating expenses			21.0	%			24.9	%
Income / (Loss) from Operations			7.8	%			(2.4	)%

Furthermore, TRT generated positive operating cash flow and positive free cash flow in the first half of FY 2022, as illustrated below (in thousands):

Six Months Ended
		Dec. 31,				Dec. 31,
		2021				2020
		(Unaudited)				(Unaudited)
Net Cash Provided by Operating Activities			837				315
Cash Flow from Investing Activities
Withdrawal of unrestricted deposit			1,957				520
Investment in unrestricted term deposits, net			(320	)			(409	)
Additions to property, plant and equipment			(795	)			(217	)
Net Cash Provided by/ (Used in) Investing Activities			842				(106	)

Thanks to the aforementioned strong revenue YoY growth and gross margin expansion, TRT recorded profits too. Specifically, net income for the first half of FY 2022 increased 681% to $1.8 million compared to $227K for the same period last year, as linked above.

On top of these excellent results, backlog has remained strong, according to the CEO’s statement below:

Compared to the same quarter last year, the significant increase in net income primarily reflects the strong second quarter performance of our testing services and distribution operations. While backlog remains strong and the Company is focused on expanding our service offerings, we remain cautiously optimistic regarding the current fiscal third quarter ending March 31, 2022, typically the weakest quarter of our fiscal year, due to holidays and vacations related to the celebration of the Chinese New Year.”

Outlook And Growth

We believe that outlook is positive thanks to sector-related and company-specific factors. Specifically, we project that the company’s key growth drivers in the next quarters are:

1) According to McKinsey, the oldest and largest of the “Big Three” management consulting firms by revenue, the global semiconductor industry is poised for a decade of growth and is projected to become a trillion-dollar industry by 2030.

McKinsey analysis based on a range of macroeconomic assumptions states that the industry’s CAGR could average from 6 to 8 percent a year up to 2030. McKinsey also states that about 70 percent of growth is predicted to be driven by just three industries: automotive, computation and data storage, and wireless, which bodes well for TRT’s future.

2) In December 2021, TRT entered into a joint venture agreement to establish a new facility in China to supply testing and burn-in services for a number of various semiconductor components with applications in computing and automotive electronics. The facility is only a few miles from the company’s current China operations with TRT holding a majority equity ownership position in the new joint venture company, as quoted below:

On December 1, 2021, the Company’s wholly owned subsidiary Trio-Tech (SIP) Co., Ltd. (:TTSZ”) entered into a joint venture agreement with Suzhou Anchuang Technology Management LLP (“SATM”), both parties are governed under the laws of the People’s Republic of China. The Agreement provides for the establishment of a joint venture for the provision of sub-contract services in the semiconductor and/or other related services in the electronics industry, mainly in Suzhou, China. Subsequent to the quarter ended December 31, 2021, the Company had incorporated Trio-Tech (Jiangsu) Co. Ltd. (“TTJS”), located in Suzhou, China together with SATM. TTSZ owns 51% of TTJS and 49% is owned by SATM. Based on our current visibility, revenue attributable to this joint-venture is not expected to be material this fiscal year, as the joint venture company is in the development stage at this time.”

On that front, TRT recently installed the first burn-in system and expects to commence production in Q4 FY 2022, as quoted below:

We have successfully established our joint-venture company and installed the first burn-in system at the new facilities of Trio-Tech (Jiangsu) Co., Ltd. They are now ready for qualification and we anticipate commencing volume production in the coming fourth quarter of fiscal 2022.”

Valuation

Based on the outlook and growth initiatives above, we estimate that revenue and adjusted EBITDA in FY 2022 will be about $40 million and $5.5 million, respectively.

Meanwhile, with interest-bearing debt of $2.5 million (including finance leases) and $12.5 million in cash & cash equivalents & short-term deposits, TRT’s Enterprise Value currently is about $16 million.

Therefore, EV-to-FY 2022 Revenue and EV-to-FY 2022 adj. EBITDA are about 0.4 times and 3 times, respectively, at the current price of $6.50 per share.

Obviously, in our view TRT currently is cheap despite the fact that its stock has doubled over the last twelve months. Therefore, we believe that it still has upside potential from today’s price levels for investors with an investment horizon of 2-5 years.

Insider Ownership

Insider ownership is high, which is a big positive. Specifically, insiders own 46.17%, so their interests are aligned with shareholders’, as illustrated below:

Name	Amount of Shares Owned Beneficially			Percent of Class
S. W. Yong		659,068			16.3	%
A. Charles Wilson		555,500			13.6	%
Richard M. Horowitz		474,364			11.8	%
Jason T. Adelman		109,188			2.7	%
Victor H. M. Ting		161,757			4.1	%
Hwee Poh Lim		84,483			2.2	%
Siew Kuan Soon		21,850			0.6	%
All Directors and Executive Officers as a group (7 persons)		2,066,210			46.17	%

However, based on the most recent proxy statement linked above, institutional ownership is low at just 6.5%, as illustrated below:

Name	Amount of Shares Owned Beneficially			Percent of Class
Renaissance Technologies LLC		253,980			6.5	%
Peter J. Abrahamson		290,994			7.4	%

Therefore, we believe that the CEO needs to present the company to funds and institutions in the next months in order to spread the word about TRT and attract institutional money. Although many funds specialize in small-cap stocks, it seems that they have missed TRT so far.

Risks

We believe that the key risks for the potential buyers and existing shareholders are:

1) Growth in the semiconductor industry is not linear. In other words, sector growth isn’t a straight line in one direction, but there are often some steps backwards or sideways before moving forward again, as quoted from the company’s annual report:

The semiconductor industry has experienced periods of rapid growth, but has also experienced downturns, often in connection with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions. To reduce our risks associated with sole industry focus and customer concentration, the Company continues to put effort into expanding its line of businesses. The Real Estate segment contributed only 0.1% and 0.2% to the total revenue for fiscal 2021 and 2020 respectively and has been an insignificant business operation since the property market in China has slowed down due to control measures in China to cool surging property prices.”

2) Competition in the semiconductor industry is going to remain fierce, as quoted from the company’s annual report below (emphasis added):

Our ability to compete depends on our ability to develop, introduce and sell new products or enhanced versions of existing products on a timely basis and at competitive prices, while reducing our costs.

There are numerous testing laboratories in the areas where we operate that perform a range of testing services similar to those, we offer. However, due to severe competition in the Asia testing and burn-in services industry there has been a reduction in the total number of competitors. The existence of competing laboratories and the purchase of testing equipment by semiconductor manufacturers and users are potential threats to our future testing services revenue and earnings. Although these laboratories and new competitors may challenge us at any time, we believe that other factors, including reputation, long service history and strong customer relationships, are instrumental in determining our position in the market.

The distribution segment sells a wide range of equipment to be used for testing products. As the semiconductor equipment industry is highly competitive, we offer a one-stop service alternative to customers by complementing our products with design consultancy and other value-added services.

The principal competitive factors in the manufacturing industry include product performance, reliability, service and technical support, product improvements, price, established relationships with customers and product familiarity. We make every effort to compete favorably with respect to each of these factors. Although we have competitors for our various products, we believe that our products compete favorably with respect to each of the above factors. We have been in business for more than 60 years and have operation facilities mostly located in Asia. Those factors combined have helped us to establish and nurture long-term relationships with customers and will allow us to continue doing business with our existing customers upon their relocation to other regions where we have a local presence or are able to reach.”

3) TRT has high concentration of customers. Specifically, the company had two major customer that accounted for the following revenue and trade account receivables in FY 2021 and the first half of FY 2022, as quoted below:

	For the Year Ended June 30,
	2021	2020
Revenue
Customer A	37.7%	38.4%
Customer B	9.7%	17.6%
Trade Account Receivables
Customer A	34.7%	40.6%
Customer B	11.8%	6.3%

and:

		For the Period Ended Dec 31,
		2021				2020
Revenue
– Customer A			42.8	%			37.1	%
– Customer B			15.6	%			7.5	%
Trade Account Receivables
– Customer A			40.1	%			48.5	%
– Customer B			16.7	%			7.2	%

As a result, losing a customer will weigh on revenue, profit, and cash flow. Therefore, TRT needs to diversify its portfolio and lower its customer concentration to decrease its revenue risk and increase the predictability of its future revenue, profits and cash flows.

4) A couple of weeks ago, Shanghai imposed lockdowns as COVID-19 soars. However, Shanghai is not alone and several other Chinese towns have mandated lockdowns since early 2022 including Tianjin, where TRT’s facility is located, as quoted below:

Subsequent to the quarter ended December 31, 2021, the Company was required to close its facility in Tianjin, China in compliance with the Tianjin city government’s imposed lockdown measures for mandatory testing of Tianjin city’s residents and China’s ZERO-COVID policy. The Company then resumed 100% operating capacity in Tianjin, China operation by January 21, 2022. The Company is actively working on production output to catch up with backlog.”

Although TRT reopened its facility a few weeks ago, we can’t know in advance whether the Tianjin’s city government will impose another lockdown again in the next months, which will impact negatively the company’s operations.

5) TRT is a microcap stock with low float and low daily volume, so the volatility will remain high. In other words, TRT isn’t for day traders, momentum traders or short-term traders. The potential buyers need to have a 12-month investment horizon (at least).

Takeaway

We advised the subscribers to our research to buy TRT at $3 per share in July 2020, and TRT has risen almost 120% since our buy recommendation currently standing at about $6.50 per share. In other words, TRT is one of those undiscovered value names that span a variety of sectors and have outperformed over the last twelve months.

Despite this outperformance, TRT is cheap with high insider ownership, strong fundamentals and positive outlook. This is a promising mix and we project that, barring unforeseen events, its stock still has upside potential based on an investment horizon of 2-5 years.