Shades of 2012..., page-4

"To be devil's advocate however, and the the caveat here, is that rather than demonstrating a likely undervaluation, what you are really demonstrating is the acute sensitivity of SDI's bottom line to currency swings. Now that, as you know, is something that can cut just as dramatically in the other direction."

Yes, indeed.

Your post gives me opportunity to re-emphasise that I am not trying to forecast the direction of currencies.

My view is that the best forecast of an exchange rate is probably whatever its level happens to be at the time.

All I was trying to demonstrate is the high degree of variability of both financial performance and valuation for SDI, with respect to changes in the relative strength of the A$.

And that - to the extent that the market expectation has been, and still is, for an Australian dollar stronger than it is today (which, given the sharp fall in the A$ in recent months, is probably the case) - it means that the stock is cum-upgrade.

Put another way: sure, something could happen in the world tomorrow which could make the A$ do an about-turn, and start to rise. Or, it could continue declining. Or remain where it currently is for a period of time. Who can possibly know?

But, given the precedent for the market often being tardy in these sorts of dynamic situations, it stands to reason that it is highly unlikely that latter two scenarios are factored into SDI's share price, while the price of the stock still largely reflects the first possibility (i.e, a sudden strengthening of the A$).

Besides, with SDI its not just a pure cyclical play: yes, the earnings follow a cycle (driven largely by currencies), but over the course of each cycle it is growing its earnings organically (eg. SDI's EBIT is currently running at around $8m; the last time exchange rates were at similar levels to today's, SDI's EBIT was $5.6m (FY2009), and the time before that when the A$ was also at roughly today's levels, EBIT was $3.7m (FY2005))

SDI is really a growth company.
As the chart below shows, the issue for the company has never been the ability to grow its Revenues (even despite the flat A$ Revenue outcomes in the 3 years to 2019, Revenues have grown by around 6.5%pa over time).






The challenge for the market, when it comes to valuing SDI, has been the fluctuations operating margins which, given the nature of the business, are always at the mercy of exchange rate vagaries.

And, sure, sometimes exchange rates will be a tailwind (like they were between 2013 and 2016, when EBIT almost quadrupled) and some times they will provide a headwind (like they have just been over the past two years, when EBIT will have fallen by some 40%).

But as long as the top line keeps growing in constant currency terms, that is the important thing for investors; because that's the thing that will drive long-term earnings and increase the value of the business through each earnings cycle.

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