This week, i Capital initiates coverage on ECS ICT Berhad (ECS), an Information & Communications Technology (ICT) products distributor. ECS started its business in 1985 and obtained listing on the Bursa Malaysia on 15 Apr 2010. ECS has successfully established an extensive distribution network throughout Malaysia, having growing its number of resellers from 2,500 in 2010 to more than 5,500 today.
ECS has 2 main business segments consisting of [1]. ICT Distribution, and [2]. Enterprise Systems & ICT Services. The ICT products distributed by ECS include notebooks, personal computers, smartphones, tablets, printers, software, network and communication infrastructure, servers, and enterprise software from more than 40 principals .
ECS is representing 40+ principles in Malaysia. (Source: ECS)
ECS used to rely heavily on a single brand which was HP Malaysia. Aapproximately 74.4% of ECS total purchase in FY2009 were products of HP Malaysia. ECS has since then secured long term relationship with some other international brands such as Apple, Microsoft, and Oppo. In addition, ECS provides its customers with a substantial range of services such as system integration, network and Internet solutions, software support services, hardware repairs and general ICT maintenance services.
The introduction of mobility business such as smartphones and tablets in FY2014 has improved its sales since FY2014 despite a dip in FY2016 largely due to the weakening Ringgit and soft consumer sentiment.
ICT Distribution
The ICT Distribution segment is the main contributor for ECS’s earnings, constituting 77.2% and 57.6% of ECS’s total revenue and gross profit respectively in FY2016. The ICT Distribution segment purchases ICT hardware and software from many international ICT principals and distributes them to its resellers, comprising mainly retailers such as Harvey Norman, SenQ, and Sen Heng. Generally, the end users are SMEs and home-users.
ECS now represents Google for Google Nexus 7 and Xiaomi for MiPad, in addition to representing Dell, Lenovo, ASUS, Huawei, Samsung, BenQ and Microsoft for all their ICT products in the Malaysian market. Prior to appointing ECS, Xiaomi had exclusively sold its products online via its web store. In 2016, ECS entered into the Internet of Things (IoT) and wearable markets with a few key distributorships. ECS was appointed to distribute 4 smartwatches; namely, Apple Watch, Motorola Moto 360, ASUS ZenWatch2 and Huawei Watch. Additionally, ECS was appointed as the first distributor of DJI Phantom and Inspire range of drones and Osmo 4K action camera in Malaysia. ECS also secured the distributorship of the Orion Virtual Reality (VR) goggles in Malaysia.
As the principals would fix a recommended margin and price for the products, the gross profit margin for the ICT Distribution segment is less than 4%. Being a volume-based business, ECS has to continuously broaden its product distribution range by securing new product lines from existing principals and attracting new brands, besides expanding its distribution channels such as B2B e-commerce platform. Resellers can then simplify their procurement process and make all of their required purchases from ECS, rather than using a few vendors.
The IoT products are unlikely to become a major component of the ICT Distribution product range in the near term. The drone manufacturers need to make the drones more affordable. The wearables and VR markets still cannot take off as the applications cannot catch up as fast as the hardware.
Enterprise Systems and ICT Services
The Enterprise Systems segment comprised 20.7% and 35.2% of ECS’s total revenue and gross profit respectively in FY2016. ECS designs, installs and implements ICT infrastructure systems and solutions by offering a comprehensive range of enterprise servers, workgroup servers, operating systems, application software, systems management tools and ICT security products. Approximately 50% of the end users in this segment are the government or the government-linked corporations. ECS represents many of the global ICT principals such as Cisco, IBM, Juniper, VMWare, Sun, Panduit, Red Hat, Lexmark, Google, Blue Coat, Intermac, and EMC.
Under the ICT Services segment, ECS provides value-added services including: [a]. hardware support, maintenance and repair; and [b]. systems integration which involves consultation, designing of networks, installation of hardware and software, implementation and management of ICT systems. The ICT Services segment serves the large corporations and customers from the ICT Distribution and Enterprise Systems segments. Although the ICT Services segment reported an attractive gross profit margin of 17.9%, the segment only constituted 2.1% of ECS total revenue in FY2016.
Both the Enterprise Systems and ICT Services segments are value-based businesses. ECS is investing in the latest technology focusing on Hyper-Converged Infrastructure, cloud services, 3D printing and cyber security products, as well as hiring more certified engineering workers and promoting among enterprises. The Enterprise Systems segment has been challenging for the last 3 years due to slower project implementations from the private and public sectors. ECS hopes that it will benefit from the pent up demand from the private and the public sectors due to upgrading of their systems in FY2017.
Highly competitive business
The ICT distribution industry generally favours large, financially-sound distributors that have broad product portfolios, economies of scale, strong business partner relationships and wide geographic reach. The ICT distribution market in Malaysia is highly competitive, with players like Ingram Micro Malaysia, Servex and JOS Malaysia. Barriers to entry are relatively high as ICT distributors like ECS has to provide comprehensive range of products and fast logistics, as well as competitive credit terms.
On top of that, Avnet Malaysia, a global ICT distributor that offers solutions services is also a strong competitor to ECS in the Enterprise Systems segment. With its global presence, Avnet can better serve the resellers such as systems integrators and corporate dealers which intend to expand their business overseas.
ECS has been able to maintain zero borrowing and strong cash position post listing. Having strong financial resources is important for ECS to purchase products in bulk, offer resellers good credit terms and operate warehouse and logistics services.
Although ECS keeps broadening its reseller base, it also focuses on the quality of the resellers by offering them training and incentives. In order to win distributorships, ECS needs to continuously achieve the sales targets and run effective marketing campaign. As a testimony to ECS’s solid business relationship with leading brands such as Apple, IBM, and HP Malaysia, the distribution agreements with the said brands are automatically renewed every year.
ECS needs to carry a sufficient amount of inventories to meet customers’ rapid delivery requirement. Due to a higher sales level, inventories and trade receivables have also increased. However, ECS was still able to maintain a relatively stable inventory turnover days despite the increasing volume of inventories held. The creditor turnover has improved over the years due to the extension of credit period granted from the suppliers – see figure 1. Debtor turnover surged from 36 days in FY2015 to 52 days during FY2016 due to the higher sales in 4QFY2016 with the launch of iPhone7. Some of the credit period is due in Jan 2017.
Conclusion
At RM1.55, ECS ICT Berhad is capitalised at RM279 mln. For this, what do investors get in return ?
ECS has a proven track record in meeting or exceeding yearly performance targets set by the principals and increasing its reseller base. However, both its profit margin and return on equity have been on a downward trend since listing. Additionally, ECS is exposed to a single market risk despite having an extensive breadth of products and solution offerings.
ECS has to expand and invest in higher margin advanced and specialty solutions and high value services to build its Enterprise Systems and ICT Services segment. Its strong financial position with zero borrowings accords sufficient working capital for future expansion as well as financial stability to withstand headwinds. With Malaysia’s economic growth, in line with the global economy, expected to pick up in the medium-term and stability in the Ringgit, i Capital rates ECS ICT Berhad a Buy below RM1.30 for the medium-term.