Sometimes one gets things right, but for slightly wrong reasons.
In the case of SDI, and its most recent result, the standout features to me were, on the one hand, the HUGE jump in Gross Profit Margins, which exceeded my expectations, and on the other hand that the Brazilian business is still bleeding at a rate worse than I had expected.
So I made some compensating errors. It often happens.
However, for me the positive takeaway is that the quality of my errors is good...if latest reported GP Margin is sustainable – and I sense it will be to a large extent – then it means that the company’s prospective financial is still pregnant with the opportunity of the cost-out of the Brazilian business.
Earlier this week I wrote to the company, seeking clarity on a few points arising from the latest result.
(The MD is away at a dental conference in Cologne...I suspect the CFO might come back to me by phone in coming days. I will relay his feedback.)
The points I raised include the following:
1. Determinants and assumptions behind management’s full-year FY13 guidance.
I am aware that the business has become far less seasonal that it was say, 5 or 6 years ago, but for me to get to the mid-point of management’s full-year guidance (namely NPAT of $4.5m) requires some really unlikely outcomes, namely:
• Flat revenue growth on previous corresponding period [unlikely]
• Gross Profit Margin of around 58%, (which basically sees a complete reversal of what we saw in the DH12 [see point 2 below]) [unlikely given silver price and A$ movements in recent months, as well as what I have heard about favourable product mix], and
• No further improvement in the losses in the Brazilian business [unlikely...some clear focus is clearly being brought to bear on that business by management, and we’ve seen the first benefits of this in this latest result)
I have to try very hard in terms of modelling assumptions to get to full-year FY13 NPAT of $5.0m, which is at the upper end of management’s guidance.
By my (perfectly reasonable, I think) modelling, that incorporates some 2.0% Sales growth and a 61% GP Margin (refer below for context), I come up with full-year NPAT closer to $5.50m.
2. Gross profit margin sustainability (the GP margin in the recent result is a full 700 basis points higher than the previous corresponding period, and is at a level last seen in the mid-2000s)
DH03: 72.9% (Average Silver price and A$:US$ exchange rate = $5.0/oz and 68.8c, respectively) JH04: 70.0% ($7.20/oz and 78.0c) DH04: 58.6% ($6.50/oz and 73.4c) JH05: 65.8% ($7.10/oz and 77.3c) DH05: 66.7% ($7.60/oz and 75.2c) JH06: 68.7% ($9.00/oz and 74.3c) DH06: 66.6% ($11.90/oz and 76.4c) JH07: 66.7% ($13.20/oz and 80.9) DH07: 62.3% ($13.70/oz and 86.9c) JH08: 59.9% ($17.80/oz and 95.2c) DH08: 62.7% ($12.20/oz and 78.3c) [GFC hits] JH09: 61.5% ($13.30/oz and 71.3c) DH09: 67.5% ($16.10/oz and 87.3c) JH10: 64.1% ($17.40/oz and 78.0c) [Commodity markets and A$ start recovering on the back of QE1] DH10: 61.6% ($23.30/oz and 94.7c) JH11: 57.9% ($35.30/oz, [spiking at almost $50/oz in April 2011], and 103.4c) DH11: 57.6% ($34.10/oz and 103.2c) JH12: 57.2% ($32.60/oz and 103.3c) DH12: 64.6% (!!) ($31.60/oz and 103.0c)
3. Cost-of-Doing-Business margin sustainability (the company is almost peerless in its impeccable management of fixed costs, which have been held remarkably constant over time, even as the Revenue line has expanded.)
Cost of Doing Business Margin (defined as Selling and Admin Expenses PLUS Research and Development Expenses PLUS “Other” Expenses, all divided by Sales Revenue): DH03: 51.4% JH04: 37.9% DH04: 51.8% JH05: 51.2% DH05: 57.6% JH06: 45.3% DH06: 52.9% JH07: 47.5% DH07: 61.0% JH08: 49.3% DH08: 54.4% JH09: 53.2% DH09: 56.7% JH10: 51.5% DH10: 54.1% JH11: 50.1% DH11: 50.6% JH12: 45.3% DH12: 46.9%
4. The dynamics of the Brazilian business and management expectations and/or objectives for its future performance.
While the losses in the Brazilian business were reduced to $0.68m (which is still a significant 22% of Pre-tax Profit), from $0.99m in the pcp, I am not 100% sure what they are doing there, operationally and tactically. I know they are definitely doing something, but I am just not sure what exactly it is, and what its turnaround trajectory might look like.
5. The scope for the unwinding of the working capital bloat as at the 31 December 2012 balance date, and in particular in relation to operating developments taking play in the Brazilian business.
Note how WC-to-Sales has fallen over time, and also
I suspect some of the lift in Working Capital-to-Sales @ 30 December is a mere reversal of the very low level of working capital as at the 30 June 2012 balance date, but things are happening in the Brazilian business that involve a significant investment in inventory, which will have an impact on future financial performance and I’m really interested to learn what that might be.
6. R&D expenditure (including Acquisition of Intangibles from the Cash Flow Statement) have historically run at an average rate of 7% of Sales (Pre-GFC) and 4% of Sales (Post-GFC), but in the last two half-year results that level around 1.5% of Sales. I sense there has been some change in the philosophy relating to R&D investment I’d like to better understand the extent that the current low levels are at odds with product innovation.
7. Scope and/or prospect for reinstatement of interim dividends, given debt metrics are now back at levels last seen in the early to mid-2000’s, when interim dividends were declared as a matter of routine.
Because on even conservative cash flow modelling, it appears these metrics will reach near-unprecedented levels in coming reporting periods (represented by my forecasts(f) in the listings below, absent any major capital projects and/or acquisitions.
8. Confirmation of the future growth strategy being purely organic in nature. (My experience is that very few corporate acquisitions create value for shareholders and my hope is that the SDI board and management share this view - which they appear to do judging by the apparent lack of acquisition appetite over the past decade).
In closing, I am very happy with this latest result. It was very clean and reinforced my thesis that SDI’s pricing power is playing catch up with the adverse effects of the silver price and the exchange rate of recent years.
The company is now in the sweet spot where those cost inputs are easing, yet product price rises are being harvested (in effect, we are at the opposite ends of the cycle which prevailed in 2010 and 2011).
I certainly don’t believe the upgrade cycle is over for the company.
In a world where undervaluation is increasingly harder to find, SDI – at 6.4x EV/EBITDA, 10.0x P/E and 8.8% FCF yield...and being cum-upgrade – still looks fine to me despite its strong run over the past 6 moonths.
Cam
SDI Price at posting:
49.0¢ Sentiment: Buy Disclosure: Held
(20min delay)
