Shanghai STEP Electric Corporation: Is the Age of Robotics Upon Us?

Shanghai STEP Electric Corp. (STEP) was established in 1995 and has been listed on the Shenzhen Stock Exchange since 2010. Its shares are mainly traded on the small- and mid-scale board of the Shenzhen Stock Exchange and less traded on the large-scale board of the Shenzhen stock exchange. The company’s registered capital is 200 million yuan and its A-share are listed under the stock short: STEP (“STEP”, stock code: 300221).

STEP’s leading business portfolio is in industrial robots and elevators with additional products in the segment of AC drives and servo motors. With its high technology, advanced manufacturing facilities, and complete production lines, STEP has become one of China’s most competitive robot manufacturers. Several of STEP’s products also occupy leading positions in the international robotics industry.

Source: STEP Robots YouTube

The firm has been identified as a famous Shanghai trademark. With the support of the State Ministry of Science and Technology for its robot technologies, STEP has applied for more than 200 invention patents to date [5].

Management

Source: craft.co

Corporate History

Source: stepelectric.com

Business model

How does STEP create and capture value?

STEP creates and captures value through its top-notch (1) key account management strategy, (2) customizable solutions and services to existing clients and (3) leveraging its successful past experience and advantages in the automotive industry.

(1) STEP’s key account management strategy constantly creates new demand for its clients, which develops long-term and mutually beneficial business relationships that in turn helps STEP in building its growing customer base whilst streamlining specific subdivisions and improving marketing capabilities. Its key account management strategy captures value by transacting in an increasing number of products with long-term trusted partners.

(2) STEP provides customizable solutions and services to existing clients using cloud infrastructure, which adds value to its clients by closely monitoring the products’ life cycle. STEP captures value by providing a variety of products in real-time with minimal delay, which strengthens its customer stickiness with the clients.

(3) Moreover, STEP creates value by utilizing successful past experience and advantages in the automotive industry for future projects. The firm is now penetrating into the general industrial segment, thereby enhancing its brand influence and gaining a leading edge in the industry. This, in turn helps STEP to diversify its industrial exposure whilst increasing its total market share.

How does STEP differentiate itself?

STEP is a Shanghai Intellectual Property demonstration enterprise, Shanghai patent model enterprise, national innovative enterprise and has a nominated Technology Center and a national post-doctoral research station.

STEP has a strong drive and control technology R&D advantages through many years’ accumulation. It has passed the German TÜV ISO9001 certification, ISO14001 certification; STEP products have passed the European CE, EN-81, North American CSA and other international certifications. The company has the ability to produce whole robot systems and customize them according to the client’s demand. STEP robots and components are utilized in elevators, machining, food, printing and packaging, automotive parts, electronics, ceramics and other industries. The firm is able to complement its core products with robotics R&D and industrial control sensors.

This is the section where the rubber meets the road, often as the starting point to making an informed investment decision in the stock market. Qualitative analysis is an important stepping stone into understanding the business, how it operates, and how the company makes money and deals with risk.

Market Analysis

STEP’s Government Ties

STEP benefits from strong ties with the Chinese Government, as it is classified as a “High-Tech” company and part of the 10 priority sectors of “Advanced numerical control machine tools and robotics” in the “Made in China 2025” strategic plan to reduce China’s dependence on foreign technology and promote Chinese technological manufacturers in the global marketplace [6]. Being part of “Made in China 2025” helps STEP to receive a reduction in corporate tax at 15% (initially 25%). The state also incentivizes companies from the 10 priority sectors to merge or even acquire foreign technology companies to obtain the required technology the fastest way and direct state funding of R&D as part of the state’s commitment of 23.1 billion USD for both the Advanced Manufacturing Fund and National Integrated Circuit Fund [7].

STEP’s Industrial robot project has received financial support under Shanghai government special funds. The firm has participated in and revised 12 national technical standards; has applied for 194 patents (including 100 invention patents); obtained 100 patents (including 27 invention patents). STEP finished 7 tech achievement transformation projects, 2 national key new products, and won the Shanghai and Hebei Science and Technology Award [8] [9].

Competitive Landscape Around STEP

Local Competition in the Industrial Robots Segment

Local Competition in the Elevator Segment

STEP shows high profitability and high returns on capital and performs strongly compared to its peers in similar geographic regions [10]. STEP has established a competitive advantage in the local Chinese market by owning numerous technology- and manufacturing centers, R&D- and post-doctoral scientific research workstations whilst holding a whopping number of 415 industrial patents.

International Competition in the Industrial Robots Segment

International Competition in the Elevator Segment

STEP is still a minor player on the multinational playing field and shows meager statistics compared to international industry leaders. STEP thrives on establishing a competitive advantage in the global market by leveraging advantages from its home market and supporting its export business through international subsidiaries that include host market research hubs. It also tries to make use of its multitude of patents across borders to secure a comparative cost advantage.

Corporate Analysis

STEP has five product categories in its portfolio

Industrial Robotics: Welding robots, handling robots, desktop robots, universal robots, SCARA series robots Control Systems: Variable frequency drives, frequency converters, energy-savings inverter Controllers & Sensor Chips: Motion controls, servos, linkages and dispensing Elevator: Elevator controls, wires and cables, elevator & escalator system boards, indicator boards, pushbuttons Automation and AI:  Internet of Things peripheral products, multiparty IoT terminals, analytics products & Adtech

BCG Matrix:

STEP’s two most important business lines are its Industrial Robotics business line and its elevator business line. STEP’s Robot’s revenue has been 390 million USD. According to Bloomberg, the product line covered 2.64% of the global 14.76 billion USD market in 2019 [11]. The elevator business is the second most important business line of STEP but only covers 0.01% of the global 82,3 billion elevator market and 0.04% of the Chinese 26.25 USD billion elevator market. The most potential lies in STEP automation and AI product segment. STEP has the chance to cross-sell software that complements its “cash cow” business lines and create robustness in the advanced analytics space.

Source:indiamart.com Source: superexpo.com

Looking at STEP’s revenue of product lines in the BCG matrix, we can observe that the firm is riding on the recent success of its Industrial Robots segment, with 64% of its total revenue coming from this product line. As for its Elevator Drives and Elevator Control System segment still holds a significant share of STEP’s revenue at 23%, with better overall margins than its industrial robotics business. However, it is worth noting that both of these segments are very insignificant compared to the global market share and not very promising in terms of future growth prospects; hence both are placed under the “Dog” section. Lastly, STEP’s Controllers, Sensor Chips and Automation segment present an enormous potential to drive the company’s future prospects in the new era of industrial 4.0 in China. Being categorized under “Others” in the annual report, it now sits at a revenue share of 13% and a healthy growth rate at 28%, beating the other 3 segments aforementioned easily. While there are still uncertainties whether STEP is able to utilize this opportunity with this segment of their business (which is also why it is placed under “?” in the BCG matrix), nonetheless STEP is in an excellent position to continue its steady growth as the generational high-tech industrial company in China.

Strategic Analysis

The 5 Elements of STEP’s Strategy indicate that the company is a multinational player that thrives in its home market through imported knowledge. STEP’s international business operations are export focussed and it grows its host market presence organically.

Following STEP’s globalization strategy, the firm has established R&D and manufacturing centers in China and Germany and a global selling and service network of coverage over 65 countries worldwide. Shanghai STEP Electric Corporation (STEP Group) consists of the following owned subsidiaries, namely Shanghai STEP Robotics Co., Ltd., Shanghai Sigriner STEP Electric Co., Ltd., Shanghai STEP Cable Technology Co., Ltd., Shenzhen ADTECH Technology Co., Ltd., Shanghai STEP Automotive Equipment Co., Ltd., Shanghai Huitong Automation Technology Development Co., Ltd., Yixin (Shanghai) International Trade Co., Ltd. in China; STEP Sigriner Elektronik GmbH in Germany, Hong Kong STEP International Holdings Co., Ltd, SIGRINER Automation (Mfg) Sdn. Bhd. in Malaysia, STEP-Sigriner DO BRASIL in Brazil.

STEP owns a national-level Postdoctoral Research Station and STEP high capacity port crane inverter development and application of key technologies, crane safety monitoring and information systems research and industrial development projects have been included in the national science and technology support program.

The industrialization of the STEP inverter project and robot servo project has received financial support under the national key technology innovation fund. The STEP Vector-type inverter and control system has been identified as National Key New Products and honored with Shanghai Science & Technology Invention Award.

A number of STEP’s industrial robots have been incorporated into the Shanghai major technical equipment research projects. Food aseptic carton packaging robotic automation line development and application demonstration projects have been included in Shanghai Science and Technology Achievements Transformation and Application Project [12].

Compared to its competitors, STEP has relatively low margins but achieves cost leadership through lean structures.

Operational Analysis

Core Resources and Dynamic Capabilities

What are STEP’s existing core resources and dynamic capabilities and how do they differ?

STEP succeeded to take advantage of the evolution and growing interest in automated technologies. In the future, the company is expected to take more advantage of its vast database by building up in-house big data capabilities. Core resources are primarily STEP’s physical factories and IoT platforms. The firm has a well-established robot factory in place that uses advanced manufacturing execution systems. The firm used three years to push its robot industrialization forward and has built a new robot industry basement and a robot R&D center. It also has established an enterprise technology center as a platform in cooperation with foreign and domestic universities to develop and manufacture high-level robots. STEP’s factories use a highly automated production line and automated guided handling trolleys. Those resources have been established over time and secure the firm’s positioning within the market.

STEP’s dynamic capabilities differ from its core resources by being more subtle and ingrained into the company culture, vision and mission. The firm’s dynamic capabilities are constantly evolving and enable STEP to consistently work on innovations that lead to synergy and efficiency gains and improve customer satisfaction. Managerial practices on matters of digitization (1), integration and synergization of existing knowledge and experience with new resources (2) and the firm’s sustainable roadmap (3) are the most crucial of STEP’s dynamic capabilities in place. These capabilities are not exportable per se and offer a needed dynamic for a volatile, uncertain, complex and ambiguous future.

STEP digitization dynamic capabilities lie in its ability to drive internal evolution from analogue to digital constantly forward and digitize the front end to cut complexity. STEP has a strong focus on continuous digitalization and a clear vision of how to digitize its front end in the following years [13]. STEP’s capability to embrace opportunities associated with the emergence and adoption of digital technologies and integrate and synergize existing resources such as knowledge and experience enables STEP to continuously adapt to disruptive changes and achieve new resource configurations by integrating, reconfiguring, gaining or releasing resources[14]. STEP’s sustainable business practices are applied right from the start and with purpose, short-term complexity is traded for long-term ingrained sustainable operating structures.

How can STEP use its resources and dynamic capabilities to better achieve its goal of greater societal exposure, growth and sustainability in the future?

STEP believes that digitalization is the key to sustainable development. By integrating its core resources, such as its IoT platform and other digital solutions, the firm can promote digitization of society and help reduce its own and others environmental impact and thus improve societal sustainability in the future. STEP’s IoT platforms help its clients become more sustainable by optimizing production processes and realizing energy savings. In addition to that, STEP’s business lines are difficult to imitate, especially STEP’s patents on its industrial robotics segment. This segment has been growing exponentially since 2015. The firm has developed industry-specific capabilities that can be leveraged to sense, shape, and seize upcoming opportunities in the robotics and automation sectors.

With that in mind, STEP has vouched to make its internal systems and processes more efficient by integrating and streamlining different business functions within the company stated in its Annual Report. The company also emphasizes that it will continue to invest in research and development to make more significant breakthroughs in disruptive technologies, which translate to the competitive advantage of its products and services. STEP also affirms its stance on promoting internal reforms and implementing effective corporate governance to effectively manage the unforeseeable risks while sustaining the healthy development within the company.

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In the quantitative analysis section, we will discuss the financial statements (income statement, balance sheet, cash flow statement) and valuation metrics. The data is obtained from the latest 5-year annual reports from Capital IQ.

Income Statement

Income Statement Analysis (Revenue Growth, COGS Growth, Gross Profit Growth)

Despite the pandemic and the Sino-US Trade War, Shanghai STEP still witnessed a positive revenue growth at 12% compared to 2019. However, this growth is outpaced by the COGS growth at 13.5%, which resulted in negative gross profit growth. Fortunately, gross profit growth for Shanghai STEP is still strong at 18.4%. Based on these observations, Shanghai STEP had an excellent performance and with the ‘Made in China 2025’ plan part of the Chinese Government’s comprehensive agenda to make China a high-end producer of industrial manufacturing goods, ​Shanghai STEP is on the right track to grow exponentially for the coming years [15].

Income and Revenue (Net Income, YoY Revenue Growth, Sales Volume, Price of Goods)

Shanghai STEP reported a net income of 13.4 million USD in 2020. This is an improvement of a whopping 53.19% due to an increase in sales volume by 32.4% (3.3 million pcs in 2020 vs 2.5 million pcs in 2019), especially in the Industrial Robots and Controllers & Sensor Chips segment, a decrease in net interest expenses and inclusion of other unusual items in the Financial Year End 2020.

Cost of Goods Sold

Between 2019 and 2020, a cost of goods sold (COGS) growth of 13.5% was observed. It is essential for us to analyze whether any COGS growth was expected and to do this we must compare COGS growth to revenue growth. Revenue increased by 12% in 2020; however, COGS grew more at 13.5%. This is still a fair indicator as Shanghai STEP COGS growth is still in line or marginally more than revenue growth (as observed from 2018 to 2020). Most of Shanghai STEP’s products (including Elevators, Industrial Robots and Controllers & Sensor Chips) have very high raw material costs (> 80% of the total costs) compared to other costs, including labour costs and manufacturing costs; this indicates that Shanghai STEP is very reliant on the price of its products’ raw materials to control its costs while balancing it with its manufacturing output with increasing demand anticipated for the coming years.

Revenue and Profit

Comparing revenue to gross income, gross income growth is at 5.9%, which is less than revenue growth. This can be observed that Shanghai STEP’s COGS holds a significant influence on how much is left for the company to pay for other expenses and taxes for the year. Comparing it with the pre-tax income, we can see it far exceeds both revenue and gross income growth at 45.9% over the same period. This resulted from including other unusual items aforementioned earlier which had a significant positive effect on pre-tax income.

Interest and Expenses

A low proportion of interest expense represents a good income statement for a company. In 2020, Shanghai STEP recorded 23.83% of its interest expense over EBIT (operating income), lower than the recorded percentage in 2019, at 25.5%. The company is paying less to its debtors in 2020 than in previous years and has scaled down more than 10.86% of its total liabilities compared to 2019; this is likely due to the decrease in short term borrowings as Shanghai STEP are more prudence in borrowing short term loans and instead reduce its financial leverage.

In the non-operating section, some significant changes between 2019 – 2020 were none other than other expenses and management expenses increasing by 9.54% and 15.03% respectively and a decrease in interest expense by 18.07%.

Balance Sheet

Looking at the Income Statement and Balance Sheet together, the company’s strength can be evaluated by three key areas: liquidity, financial strengths and how well the business is being managed.

Liquidity

We need to look at how well the company can pay from existing assets for ongoing expenses, including payroll, inventory and investments in capital equipment. The first ratios we are going to look at are called the working capital ratio and the quick ratio.

The working capital ratio measures a company’s ability to pay obligations within a year.

The working capital ratio for STEP has improved over the last five years from 1.5 in 2016 to 1.6 in 2017, to 1.7 in 2018, to 1.8 in 2019 and to 2.0 in 2020. A working capital ratio of 2.0 or higher indicates the company has sufficient liquidity and is a sign of good health.

STEP quick ratio is 1.368x, it has also been increasing over the last five years from 1.0 in 2016, to 1.1 in 2017, to 1.3 in 2018, to 1.4 in 2019 and to 1.5 in 2020.

The quick ratio excludes some of the current assets that cannot easily be turned into cash, such as inventory and represents liquidity that is immediate. A ratio of 1.0 or higher indicates adequate liquidity to operate.

Financial Strengths

Secondly, we evaluate the company’s financial strength through 3 parts. We analyze (1) debt-to-equity ratios, (2) interest coverage, (3) return of equity/return on assets.

(1) When evaluating company strength using debt to equity ratios, the smaller the ratio, the better, as a company is financially more robust, the less debt it has than equity.

The smaller the ratio, the better; long-term debt to equity is 0.3, which is excellent. However, when we look at total debt to equity, it is 1.029 and it is significantly higher. As the ratio is > 1.0, it indicates that more than 50% of its assets have been funded by debt. If this ratio grows larger every year, the company is becoming more highly leveraged by debt.

(2) It is crucial in evaluating financial health to look at its current operating profit versus the amount of interest it has to pay its debt holders.

We want the ratio to be above 1 to indicate that operating profit is more than interest expense, and usually, something at 5 to 7 is considered very healthy. STEP has relatively high-interest expenses at 12.7 million in relation to its operating profit, but its interest coverage ratio is still acceptable at 2.197.

(3) Return on total equity and return on assets measure the company’s earnings on the equity that the shareholders have invested and the profit on all capital invested in the business, which was used to acquire assets, respectively.

The return on equity is poor at 3.2%. In today’s market with low inflation and high risk, investors are not fond of that 3.2% return, especially in volatile markets. The return on assets ratio eliminates the impact of the source of financing, regardless if it is debt or equity and measures management efficiency. 1.4% is an average return for unleveraged investments.

Business Management

Thirdly, we evaluate how well the business is being managed through 2 parts. We analyze (1) inventory turnover and (2) accounts receivable days outstanding & accounts payable days outstanding.

(1) Inventory turnover shows how well STEP is managing its inventory. We look at the number of days that something is in inventory. We divide 365 days by costs of goods sold over ending inventory and receive 91 days. It takes STEP an average of 91 days to sell all inventory from their inventory turnover; this is a relatively low inventory turnover compared to the industry competitor (Estun Automation Co Ltd) of 140 days and indicates that the company is working with a considerable amount of inventory stock.

(2) Account Receivables days outstanding measures how well management turns sales into cash and represents how long it takes to collect on sales. We take the Accounts Receivable balance at the end of the period, divide it by sales for the past year and multiply it by 365 days.

STEP takes an average of 117 days to collect on its sales. It takes pretty long for the company to collect its bills. Still, the late bill collection practices are not an outlier in the industry as its competitors (Siasun Robot Automation Co Ltd & Estun Automation Co Ltd) take around 160 days to collect their bills and therefore does not create a significant issue.

Accounts Payable Days Outstanding is an indication of how fast the company pays its bills. To calculate it, we take the accounts payable balance and divide it by the cost of goods sold and then multiply that by 365 days.

It shows that STEP payables outstanding were 78 days. This is relatively low for a days payable outstanding compared to its competitors (Siasun Robot Automation Co Ltd & Estun Automation Co Ltd) at 211 days and 115 days respectively. Generally, having a high days payable outstanding is advantageous because it means that the company has extra cash on hand that could be used for short-term investments.

STEP pays its creditors later, but it is still 1 month faster than them collecting timely payments; as these 2 metrics balance out to a certain degree, we should closely watch the accounts receivable ratio close to >120 days.

Cash Flow

Cash Flow Analysis

The net operating cash flow has been positive over the last five years and therefore, the company has been consistently making money. Its total Cash Flow from operations is in the safe range of 40 million starting from 2019, a 600% increase compared to 2018 due to the rise in other operating activities and account receivables, indicating that STEP’s core business and other revenue streams have increased for the last 2 years. On the one hand, we can see that STEP has been investing 21.7 million USD back in its own business, more than its net income of 13.4 million. This indicates STEP’s strong commitment to reinvesting back into its core business lines to gain more competitive advantage and stay ahead of the competition.

In 2020, net cash provided by operating activities was higher than the sum of the net cash used for investing activities and the net cash used for financing activities, we are left with a 2020 net positive change in the cash position of the company. In 2019, in contrast, we had a negative change in the cash position of the company. This can be attributed to the low net financing cash flow in 2020 and the circumstances of the pandemic. It is good to invest in companies that are increasing their cash position as it makes the firms more resilient towards change and crisis. Still, we do not have to consider this a red flag as the company has left operating cash flow throughout 2020 in a positive trend, which is a good sign for investors.

Overall, we can say that STEP’s statement of cash flows gives positive signals, having a positive net income over the last 4 out of the 5 years whilst remaining resilient and helped STEP to bounce back despite the negative impacts of the pandemic in 2020.

Discounted Cash Flow Analysis

DCF: Shanghai STEP Electric Corp DCF.xlsx

Risk Matrix

The most severe business risks for STEP are of external and uncontrollable nature. STEP is very prone to external risk as it relies on exporting and operating in an international environment.

Most of the firm’s clients are export-driven and thus, are directly affected by import taxes. STEP risks losing government tax breaks/ subsidies in the future, but this risk is low in the near term as the government’s 5-year plan is focused on supporting high-tech companies.

STEP’s recent acquisitions from 2020 are currently being integrated and can cause significant operational disruptions and impairment of goodwill in case of integration shortcomings or cultural clashes. But the risk has a low likelihood of occurrence since STEP has done thorough due diligence beforehand.

In addition to that, STEP operates in a very fast-paced market environment and is subject to various competitive threats. More and more sustainability-oriented or technology-driven robotics manufacturing firms are responding to the increasing demand for more sustainability. This is a big disadvantage for STEP, since innovation is very costly and associated with a high degree of upfront investment.

New entrants do not pose a significant risk for STEP since the entry costs are relatively high in the robotics industry, incumbents will be able to counter the threat of new market players with price reductions or improved product placement. Nevertheless, it has to be taken into consideration that STEP does not have a monopoly in its market segment and has to introduce capacity and price increases with careful planning and caution. Many investors may also be concerned with the recent fiasco of Evergrande, the Chinese real estate business that had suffered a significant blow and in turn, impacted complementary industries such as the elevator manufacturing industry. Fortunately, STEP does not have any business transactions with Evergrande. Its elevator business branch is not negatively affected by recent developments.

All considered STEP is well-prepared for the increasing market demand for robots and the shift in demand for increasingly automated productions.

STEP has a strong drive and has controlled technology R&D advantages through many years’ accumulation. Today STEP is well integrated into the whole robot system R&D and customization. The firm used three years to push its robot R&D and robot industrialization forward and has built a new robot industry basement and a robot R&D center. It also established an enterprise technology center as a platform in cooperation with foreign and domestic universities to develop and manufacture high-level robots.

Ironically, China is likely to rely mainly on its relatively cheap workforce instead of fully automated factory floors in the next couple of years. The adoption of robotics and the growth of the local industrial robotics industry will take longer within the Chinese sector compared to other sectors because the business case for full automation is relatively hard to make for the densely populated country in the next couple of years.

Nevertheless, the local Chinese market and Asian smart robotics demand are growing in many consumer-facing and back-end areas and STEP is well-positioned to capitalize on the growth in most of Asia. Investors have to consider that it will be challenging for STEP to compete with its international competitors in the European, Japanese and American markets on high-end quality because companies such as ABB are more established in western markets and are more accustomed to high-end product demand.

STEP fully utilized its existing clientele base to capture additional market share, which consequently strengthens the infrastructure of the company’s solution capabilities. The company will also benefit from government subsidies in the future, has a strong pipeline and is committed to continuous research and development investment [16]. According to our quantitative analysis, the firm has comparably strong key ratios and is undervalued at the current stock price. The company’s economic moat is robust and it will be tough for its competitors to have a technological edge over STEP. We recommend a “BUY” for Shanghai STEP Electric Corporation.