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3 Risks Associated With Samurai 2K Aerosol Ltd’s Business

Samurai 2K Aerosol Ltd (SGX: 1C3) is an aerosol coating specialist with a focus on the automotive refinishing and refurbishing industry. Some of its brands include Samurai 2K, Samurai, and Kurobushi.

Recently, I wrote an article about why I like the company, which can be found here. As it is with every company, there will be risks associated with it, and Samurai 2K Aerosol is no different. In this article, let’s look at three risks that I think investors should know about the company.

Supplier concentration risk

According to its initial public offering (IPO) prospectus, Samurai 2K Aerosol relies on a small number of suppliers for its direct materials. These materials include aerosol cans, propellants, solvents, pigments, and packaging materials.

In FY2014 (financial year ended 31 March 2014), FY2015, and FY2016, Samurai 2K Aerosol’s eight major suppliers accounted for 63.6%, 68.6%, and 67.3% of its total purchases, respectively. For the first quarter of FY2017, the self-same figure was at 64.6%. Even though this percentage had declined from 68.6% in FY2015, it is still high.

Due to the supplier concentration risk, Samurai 2K Aerosol could be at the mercy of its suppliers, and the company might have to put up with any significant increase in prices in the direct materials it needs. This would, in turn, negatively affect the company’s gross profit margin.

Moreover, Samurai 2K Aerosol does not have long-term contracts with its suppliers. Any stoppage in the supply of direct materials may affect the company’s ability to sell its products in sufficient quantities to meet the demand of its customers.

Customer concentration risk

Another risk listed in Samurai 2K Aerosol’s IPO prospectus is that a significant portion of its revenue is derived from a limited number of customers. The company’s largest customer, Bun Seng Hardware Sdn Bhd, accounted for 20.3%, 19.6%, 16.7%, and 12.7% of its total revenue in FY2014, FY2015, FY2016, and the first quarter of FY2017, respectively.

According to Samurai 2K Aerosol’s FY2017 annual report, one customer (whose identity was not mentioned) contributed to 13.5% of the company’s total revenue of RM39.4 million in that year.

With Samurai 2K Aerosol depending on just one customer for a significant portion of its revenue, the customer could have the bargaining chip to pressure the company to lower the prices of its products. Also, if this customer should walk away for whatever reason, it could have a big impact on Samurai 2K Aerosol’s business.

Huge jump in trade receivables

Last month, Samurai 2K Aerosol announced its financial results for FY2018. During the year, the company’s revenue surged impressively by 128.8% to RM90.0 million.

However, what jumped out more for me was the fact that Samurai 2K Aerosol’s trade receivables climbed by nearly 800% to RM25.2 million in FY2018. The rate of growth in the company’s trade receivables is significantly higher than that of its revenue. In general, trade receivables that increase at a much faster rate than revenue is a potential red flag.

For perspective, in FY2017, Samurai 2K Aerosol’s revenue climbed by 28.5% to RM39.4 million, but its trade receivables fell by 45.6% to RM2.9 million.

Going forward, investors should keep an eye on the company’s trade receivables.

Bonus risk (valuation)

As noted in my previous article that discussed the merits of Samurai 2K Aerosol, the company’s high valuation is something to be wary of. On Monday, the company’s shares closed at S$1.68 each, giving rise to a price-to-earnings ratio of 44. Any blunder in the company’s growth in the future could cause a sharp decline in its share price.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.