"You may have elucidated your thinking on this earlier (if you have, I am happy to be directed to those posts); I would be keen to know why you have invested (and stay invested) in SDI to begin with."
@thunderhead1,
I only today saw your post now so apologies for reverting belatedly.
Why I first bought shares in SDI was that - with the share price being at a 25% discount to NTA at the time - the market was fundamentally undervaluing the business.
It was in 2012 that I first became a shareholder, after having followed the company for several (5 or 6, maybe) years prior to that.
In an economic world where change seems to happen at an accelerating rate, my curiosity is always piqued when I come across a company that has been conducting the same line of business for an extended period of time (several decades, in SDI's case).
Because, given technological changes, variability in business cycles, structural changes in the global economic landscape, significant changes in political and regulatory circumstances, and the ever-changing competitive environment and customer preferences.... any company that is able to operate and prosper through all that change must be doing something right.
Not many companies have a life expectancy spanning 45 years, which is the case with SDI.
Why, even most large companies barely look the same as they did a decade ago.
So, having tracked the company for some years, in 2007 the share price started falling in response to the rising A$ (which was being carried towards parity with the US$ as a result of the commodity boom... at the time SDI exported ~75% of its sales, so the rising A$ was bad for profitability).
In the mid-2000s the stock was fundamentally overvalued, I thought, with it trading at Price-to-NTA (P/NTA) multiples of around 7 and 8 times.
As the company's operating earnings fell from around $7.5m in 2006 to $2.0m by 20011, due to the surging A$ (and the silver price - then a key raw material for SDI - trebled, as well) , SDI's share price fell from over $1.00 to under $0.15.
The P/NTA had gone from almost double digits, to a meaningful discount, as follows:
SDI's P/NTA:
2004: 8.5
2005: 7.0
2006: 4.1
2007: 3.8
2008: 1.6
2009: 1.0
2010: 1.0
2011: 0.9
2012: 0.7
So the market was basically pricing the company like it was going to make losses, or even go out of business, when it was profitable all the time.
So that's essentially what prompted me to buy SDI shares in the first instance.
Onto your second question, namely why I continue to be a shareholder:
For such a small little company, SDI is quite complex to analyse and it takes some effort to understand the drivers of the business.
First there's the currency issue, which most people talk about to varying degrees.
Here is SDI's reported Revenue line over time, in A$m (growth on pcp in brackets):
FY2000: 22.0 (13%)
FY2001: 26.9 (22%)
FY2002: 34.2 (27%)
FY2003: 36.7 (7%)
FY2004: 42.5 (16%)
FY2005: 45.9 (8%)
FY2006: 45.2 (-2%)
FY2007: 48.6 (8%)
FY2008: 49.0 (1%)
FY2009: 56.4 (15%)
FY2010: 53.1 (-6%)
FY2011: 54.8 (3%)
FY2012: 56.4 (3%)
FY2013: 56.6 (0%)
FY2014: 65.3 (15%)
FY2015: 68.7 (5%)
FY2016: 74.1 (8%)
FY2017: 73.0 (-1%) [Forecast]
And here is the Revenue picture in US$ terms, which is the "purer" way to view the sales performance of the business, given it is dominated by export sales:
FY2000: 13.7 (12%)
FY2001: 14.3 (4%)
FY2002: 18.0 (25%)
FY2003: 21.6 (20%)
FY2004: 30.4 (41%)
FY2005: 34.7 (14%)
FY2006: 33.7 (-3%)
FY2007: 38.5 (14%)
FY2008: 44.3 (15%)
FY2009: 42.0 (-5%)
FY2010: 46.8 (12%)
FY2011: 54.9 (17%)
FY2012: 58.3 (6%)
FY2013: 57.8 (-1%)
FY2014: 59.7 (3%)
FY2015: 56.8 (-5%)
FY2016: 53.9 (-5%)
FY2017: 55.0 (2%) [Forecast]
As can be seen, in terms of growth, this is a period of two contrasting sub-intervals:
1. The rapid-growing period, from 2000 to 2012, where SDI's revenues, measured in US$ terms, grew at an annual average compound rate of an incredible 13%pa (and remember, this company had not acquired any other businesses over that period, so the growth was exclusively organic in nature).
2. The lackluster period subsequent to 2012, where US$ revenues for SDI have, in fact, gone
backwards (but which has been masked in the company's reported A$ figures due to the falling A$ since the unravelling of the commodity boom).
The important question for any investment in SDI - existing or prospective - is why this rapid slowing in revenue is happening (actually, there's been a 6%
contraction (!) in revenue in US$ terms since 2012 and now).
The answer to this question lies largely in what is happening within SDI's product mix (told you it was a complex little business to model).
For simplicity, SDI manufactures and distributes 2 kinds of products:
1. "Legacy" products (amalgam, the sliver-based dental filling material)
2. "Modern" products (dental composites, aesthetics and whitening compounds)
In 2012,
Amalgam represented almost half (47%) of SDI's Revenue.
Today, that figure is just
30%.
By contrast,
Aesthetic products in 2012 made up 22% of SDI's Revenue.
Today, they represent over
36%.
What's been happening is that Amalgam has been going out of fashion, and is being replaced by dental filling compounds (Aesthetics) whose colour matches the tooth colouring of the patient.
So, by my estimates,
Amalgam sales have been as follows (US$ terms):
2012: 27.4
2013: 26.0 (-5%)
2014: 25.7 (-1%)
2015: 22.2 (-14%)
2016: 17.8 (-20%)
2017: 16.5 (-7%) [Forecast]
... for an average annual compound
contraction of around
10%pa over the past 5 years
And sales of
Aesthetic compounds have been as follows (US$ terms):
2012: 12.8
2013: 14.4 (13%)
2014: 14.9 (3%)
2015: 17.1 (14%)
2016: 17.8 (4%)
2017: 19.8 (11%) [Forecast]
... for an average annual compound
growth of around
9%pa over the past 5 years
In 2012, as a proportion of SDI's revenue, Amalgam constituted more than twice as much as Aesthetics. Today Aesthetics accounts for 20% higher sales revenue than Amalgam.
So, what has been happening over the past 5 years is that something that made up almost half of SDI's business was shrinking in contribution by 10%pa, and this created a significant drag on SDI's overall top line growth, masking what was happening in the other fast-growing parts of the business.
Because when a big proportion behaves in a certain manner, it overrides whatever other smaller portions happen to do.
Of course, mathematically, the Law of Large vs Small Numbers has a finite life, because as the fast growing part becomes proportionally larger, and the shrinking parts become proportionally smaller, at some stage a tipping point is reached when the impact of the positive growth surpasses that of the negative growth.
And given that Aesthetics is now more significant a revenue contributor than Amalgam, that tipping point for SDI has now been passed, and the company will - all things being equal - resume the sort of organic top line growth, going forward, that was seen before 2012, when Amalgam's path to obsolescence accelerated.
[*]
In other words, while SDI's revenue performance since 2012 has been very mediocre, I think this needs to be seen in some sort of context, and that context is this:
For the vast majority of companies, if the market for their largest product declined by a whopping 40% in the space of 5 years (like Amalgam sales have done for SDI), very few of them would be able to produce a Revenue outcome that was a mere 6% lower. Most of them would have their Revenues savaged, many of them would cease to have much of a business left, and a few would even cease to exist.
And that's just putting SDI's Revenue experience into context.
An even better story is told by the company's earnings outcome (albeit a large degree of that wasdue a bit of good old fashion exchange rate luck):
While SDI's Revenue has fallen since 2012, in terms of the company's earnings line, Pre-Tax Profits have risen by a factor of 3.5 times, driven by Gross Margin increasing from ~53% to ~60%.
Of course, it must be conceded that a large part of that Gross Margin uplift was due to the declining A$, it was also in part due to the fact that SDI's proprietary Aesthetics and Whitening Products enjoy higher GP Margins than the more commoditised Amalgam products.
Don't get me wrong; I'm not saying this is a totally bullet proof business. Far from it. It is a little tiddler operating in a global market, coming up against some Godzilla-sized competitors. So it is not without risk. But it is a business that punches well above its weight and which has the ability to reinvent itself - like it is doing now - whenever it encounters major tectonic changes in it world. It has demonstrated this on several occasions during the course of its long history.
At some stage over the foreseeable future, the underlying growth of Aesthetics will become manifest and, if this happens at a time when exchange rates are stable and not a headwind to earnings, the market will come to appreciate the fundamental organic growth in the business.
When that happens, I very much doubt that the share will continue to be ascribed valuation multiples of 11x P/E and 5x EV/EBITDA.
And that is the long-winded answer to your question as to why I remain an owner of SDI.
[*] For simplicity, the above discussion ignored SDI's two other product lines, namely Equipment (~10% of Group Revenue) and Whitening products (25% of Revenue). Suffice to say that, together, these are contributing only modestly to organic growth at a rate of around 2%pa (3%pa for Whitening, while Revenue from equipment sales has been largely flat since 2012).
(20min delay)
