This article is Mephisto's explanation (he doesn''t believe in brief ones, apparently) of his stock pick in the Stock Challenge.

Dutech supplies more than 50% of Wincor Nixdorf's safes that the latter uses to assemble ATMs.
Photo: Company

DUTECH IS a company that few investors are paying attention to. Listed in August 2007 at 33 cents a share, the company manufactures ATM safes and commercial safes as well as semiconductor equipment.

Sounds boring? Spend some time examining the company and you will see the value beneath its business.

ATM safes undergo stringent checks before being approved by insurance companies and granted UL certification. If the safes are not up to standard, insurance companies would not approve the insurance policies taken against burglary. 

Where is the technology barrier in this case? Making safes for ATMs is high-tech science. The founder, chairman and CEO of Dutech, Dr Johnny Liu Jiayan, 45, has a strong engineering background, especially in brazing processes involving the joining of dissimilar metals.

Dutech is the only SGX-listed China-based manufacturer of ATM safes.
Photo: IPO prospectus

Dutech employs engineers with doctorates and master degrees who experiment with various methods on how to break into an ATM safe (reverse engineering).

Dutech innovates to defend against potential criminals. That is why, for instance, the current commercial safes cannot be broken open by an electronic drill. Steel ball bearings located within the walls of the safe would break the drill bit as drilling gets underway.     

Industry Dynamics

The ATM industry is dominated by three major players - Wincor Nixdorf AG, Diebold Inc, and NCR Corporation. Dutech is the major supplier to Wincor, accounting for more than 50% of its total supply. The other supplier to Wincor is located in Germany (which means having to contend with higher costs of manufacturing).

As for Diebold and NCR, the manufacturing is done in-house.  Dutech enjoys a monopolistic position as the only Asian UL-certificated manufacturer. Compared to its US and European competitors, Dutech has a competitive advantage with its low cost production base in Nantong, PRC.

With the current slowdown in the U.S economy, it is likely that safe makers could be eyeing to outsource the manufacturing operations to more cost-efficient locations. Along with the growth story of ATMs in the world, especially PRC, Dutech is clearly in a sweet spot.

According to an OCBC Securities report, the number of ATMs worldwide is estimated to have grown by 35% between 2001 and 2007. This figure has not taken into consideration the rate of replacement. ATM safes have to be replaced on a regular basis.  

Dutech supplies more than half of Wincor's safes.
Photo: IPO prospectus

Bargaining power against supplier

Dutech sources its key raw material – high tensile steel - from Bao Steel, which accounted for 55.3%, 54.2%, 59.7% and 60% of Dutech’s cost of goods sold (COGS) in FY04, FY05, FY06 and FY07, respectively.

Dutech secures the supply at the start of the year by placing huge pre-payments/deposits (usually 30%). This in itself is a high barrier to entry for newcomers. Who would place a huge order for high tensile steel unless one has the orders for safes?

But the customers would not promise the orders unless one has the necessary raw materials to confirm the supply. Chicken-and-egg situation, right?

Financials

Recently, in announcing its Q1 results, Dutech proposed a RMB 10.05 cents dividend per share (S$0.02). This translates into a dividend yield of 8.7% based on the recent market price of 23 cents.

This represents a dividend payout ratio of almost 50% of its FY2007 net profit. I doubt that such a generous payout would be repeated in the future. But at this juncture, the company’s operating cash flow is sufficient to fund its expansion capex. 

Catalysts

1) The Group has a decent capacity expansion program: 

The increase in production capacity is likely to bring along higher sales given that the outsourcing demand outstrips supply.  

2) Obtaining CEN certification: Dutech is in the mist of applying for CEN certification. The Company expects CEN-certified products to command higher margins than UL-certified products.  

I liken this business to the goose that lays the golden eggs. Boring as it seems, this is a business I am prepared to invest patiently in until the broader market recognizes its value.

Mephisto is a 30-something investor.