external headwinds mask a great growth story, page-17

"I might have to have a look at this SDI mob."

It took me some time to get comfortable that it was a viable business.

Because one thing you need to get your head around is the fact that these guys capitalise a decent slug (between one-half to two-thirds) of their R&D expenditure.

When I first started following the company in the mid-2000s, the rate at which R&D was being capitalised was running at almost 8% of Revenue, and essentially all of the company's EBIT was due to capitalised R&D.

But these, days, now that the business has reached to point of decent scale, capitalised R&D runs at relatively modest, and far more palatable, levels of 1% to 2% of Revenue and 9% of Pre-Tax Profits.

At one stage (in the mid-2000's), the carrying value of R&D on the balance sheet was growing a lot faster than Revenue, which is obviously not a sustainable trend, but for the past 5 or so years the ratio of Revenue to the carrying value of Capitalised R&D has been relatively constant, at a little over 3.0 times, which tells me that the company's accountants and auditors have got it about right, and that there is no accounting alchemy at play (contrary to my initial suspicions some years back):

REVENUE/CARRYING VALUE OF CAPITALISED R&D [RATIO]

2002: Revenue = $35.4m / Capitalised R&D = $5.8m [Ratio = 6.1]
2003: R= 36.9m / Cap'd R&D = $5.9m [Ratio = 6.3]
2004: R = 42.5m / Cap'd R&D = $6.1m [Ratio = 5.0]
2005: R= 45.9m / Cap'd R&D = $11.5m [Ratio = 4.0]
2006: R= 45.2m / Cap'd R&D = $11.5m [Ratio = 3.9]
2007: R = 48.6m / Cap'd R&D = $14.6m [Ratio = 3.3]
2008: R= 49.0m / Cap'd R&D = $16.6m [Ratio = 3.0]
2009: R= 56.4m / Cap'd R&D = $16.7m [Ratio = 3.4]
2010: R= 53.1m / Cap'd R&D = $16.5m [Ratio = 3.2]
2011: R= 54.8m / Cap'd R&D = $17.0m [Ratio = 3.2]
2012: R= 56.4m / Cap'd R&D = $18.6m [Ratio = 3.0]
2013: R= 56.6m / Cap'd R&D = $19.4m [Ratio = 2.9]
2014: R= 65.3m / Cap'd R&D = $20.3m [Ratio = 3.2]
2015: R= 68.7m / Cap'd R&D = $21.0m [Ratio = 3.3]
2016: R= 74.1m / Cap'd R&D = $21.5m [Ratio = 3.4]


In R&D-dependent businesses such as SDI, evidence of organically growing Revenue, combined with a commensurate growth in R&D investment, says that the company's shareholders are getting a good bang for their R&D investing buck.

[I wouldn't read too much into the rising trend in recent years: I think it is likely to be a function of the declining A$ post the commodity boom inflating the Revenue component (to the extent that it has non-A$ elements to it), while the R&D on the balance sheet is purely A$ denominated]

That, there, is the essence of the investment in SDI.

And, in terms of providing an insight into SDI's Intellectual Property being one of the key drivers behind the company's structural growth story, I find those to be an instructive and highly appealing set of numbers.