Given SDI’s export focus, and given what has happened in exchange rates in recent months, it seems prudent to undertake a bit of a mark-to-market exercise on what FH2016 might look like for SDI’s financial performance.
To do so, a bit of context is useful, specifically the current geographical splits for SDI’s Revenue and Earnings:
GEOGRAPHICAL SOURCES OF REVENUE:
Australia: 35%
USA: 30%
Europe: 27%
Brazil: 9%
As can be seen, a significant element of SDI’s Revenue is generated in non-A$ terms, most notably in US dollars and Euro. (Note that the 35% Revenue derived from Australia includes direct export sales to other regions of the world.)
This means that about 90% of SDI’s Revenues are derived from export markets.
With the A$ falling a further 5% since the start of the current financial year against the US dollar (making the current exchange rate 11% lower than 31 December 2014 and almost 25% lower than it was at the start of the last financial year), this alone will provide a healthy boost to FY2016 Revenues.
And yet with the A$’s fall against the US$ well-documented, some might have overlooked that recent fall in the A$ against the Euro as well (from above 0.72 in the first half of this year, to 0.66 today).
So exchange rates are clearly providing a tailwind to SDI’s top line at the moment.
For further context since, it warrants monitoring what SDI Revenues are doing on a constant currency basis (i.e., comparing Revenue growth in global regions on a constant currency, like-for-like basis, with growth in SDI's Total Group Revenues, recorded in A$ terms):
CONSTANT CURRENCY REVENUE GROWTH IN REGIONS vs SDI GROUP A$ GROWTH
DH2012:
North America = +3.0%
Europe = +5.4%
Brazil = -4.6%
Australia = +2.9% (incl. direct export sales)
Change in A$:US$ exchange rate = +1.0%
[SDI GROUP (in A$ terms) = -0.6%]
JH2013:
North America = +3.6%
Europe = +8.6%
Brazil = -4.0%
Australia = -8.3% (incl. direct export sales)
Change in A$:US$ exchange rate = +0.2%
[SDI GROUP (in A$ terms) = 1.3%]
DH2013:
North America = -5.6% (dealer customer over-stocking in prior period)
Europe = -2.4%
Brazil = +24.4% (introduction of lower cost product from offshore packaging operations)
Australia = +9.8% (incl. direct export sales)
Change in A$:US$ exchange rate = -9.6%
[SDI GROUP (in A$ terms) = 12.4%]
JH2014:
North America = 0%
Europe = +2.2%
Brazil = +17.0%
Australia = -4.4% (incl. direct export sales)
Change in A$:US$ exchange rate = -10.7%
[SDI GROUP (in A$ terms) = 18.1%]
DH2014:
North America = +1.2%
Europe = +7.3%
Brazil = +4.6%
Australia = +6.5% (incl. direct export sales)
Change in A$:US$ exchange rate = -5.3%
[SDI GROUP (in A$ terms) = 5.2%]
As can be seen, even when constant currency growth has been a bit patchy across various regions, the thing that matters most is the A$:S$ exchange rate.
Note that in JH2015, the A$ fell by a further 15% on the pcp, but Revenue growth for the half will be around 3%, according to the guidance provided by the company on 9 June (which was for 4% growth for the full-year). So this period is at odds with the historical relationship between the A$:US$ rate and growth in SDI’s total group revenue.
The reason for this, according to the company, is because of the weakness in the Euro and the Brazilian Real during the half.
As a check, let’s deal with each of these individually, starting with the Euro: in JH2014 the A$:Euro averaged about 0.67, and in JH15 around 0.71, so that’s a 6% headwind in A$ terms on 27% of Revenues.
And the Real fell by 2.10 to 2.35 against the A$ over those respective periods, so that’s a 12% hit in A$ terms on 9% of SDI’s Revenues.
So it seems to make sense that the A$’s fall against the US$ was neutralised by the impacts of A$ relative strength against the Euro and the Real.
Now let’s mark-to-market for how we are travelling so far in FY2016 to get a sense of what Revenue growth might be in the current half (and in doing we need to compare with the prevailing exchange rates in the previous corresponding period, i.e., DH2014):
Since the start of the current financial year, the Real has depreciated a further 19% against DH14’s average rate (to 2.51), but the Euro has strengthened to 0.66 against the A$ (5% up on DH2014’s average rate), and the A$ is down 20% against the US$, compared to DH2014.
So, while persistent Real weakness is providing an ongoing headwind to A$ translated earnings, remember that this affects less than 10% of Revenue for the group. The Euro has turned into a tailwind, and the biggest determinant of Revenue growth, the A$:US$ rate, will prove to be highly favourable if it remains at current levels.
So if I punch current spot exchange rates into an Excel financial model, I get Revenue growth of some 12% just from currency movements alone.
If one then adds to this an element of growth in Revenue on a constant currency basis (and the momentum in this regard reads very promising given traction from products launched in 2014, some of the evidence of this being already evident in the DH2014 results), then the current half will see Revenue increase by 15% to 17% on pcp.
Now onto Margins, starting with Gross Profit Margins:
It is not just SDI’s Revenues that benefit from A$ depreciation. There’s a double-whammy benefit on the company’s financial performance.
Because SDI’s manufacturing base is domiciled in Australia, its Cost of Goods Sold (CoGS) is serviced in A$ terms, so when SDI’s A$ Revenues rise due to currency movements, the associated cost base remains the same, meaning GP Margins rise, as well.
As case in point, when the A$ was last around current levels (in 2003/4/5 before the commodity boom took the A$ up with it), SDI’s GP Margin averaged 68% and at times hit more than 70%. That compares to the current GP Margin of 64%.
For reference purposes, correlation between A$:US$ exchange rate and GP Margin is as follows:
FY2004: A$:US$ = 73.4, GPM = 71.4%
FY2005: A$:US$ = 75.4, GPM = 67.4%
FY2006: A$:US$ = 74.8, GPM = 67.9%
FY2007: A$:US$ = 78.7, GPM = 66.7%
FY2008: A$:US$ = 89.7, GPM = 61.0%
FY2009: A$:US$ = 74.8, GPM = 62.1%
FY2010: A$:US$ = 88.4, GPM = 64.7%
FY2011: A$:US$ = 99.0, GPM = 59.8%
FY2012: A$:US$ = 105.2, GPM = 57.4%
FY2013: A$:US$ = 103.5, GPM = 59.9%
FY2014: A$:US$ = 93.2, GPM = 62.9%
FY2015 (e): A$:US$ = 83.5, GPM = 64.2% [DH14 was 63.9%]
FY2016 (f): A$:US$ = 73.0, GPM = 65%
Note that GPM margins are already improving, as the A$ started falling around 24 months ago.
Note also that – in the interests of conservativeness – I am not assuming just a modest increase in GPM margins in FY2016, despite the materially lower A$ (For context, for every 100bp of GP Margin move, NPAT in turn moves by around 7%, all other things being equal).
Next, let’s take a look at Cost of Doing Businesses (i.e., Selling and Admin Expenses, and R&D Expenses).
Over time, given that the company’s head office is Australia-based, CoDB as a % of Revenue should be higher when the A$:US$ rate is strong and lower as the A$ falls, which has indeed be the case (see below).
But increasingly as the company invests more in marketing and administration capability in offshore geographies, this variability should reduce and, assuming the business model is scale-able then, all else being equal, CoDB as a % of Revenue should actually start to fall as Revenue continues to grow.
A$:US$ EXCHANGE RATE vs COST OF DOING BUSINESS/REVENUE
FY2004: A$:US$ = 73.4, CoDB margin = 42.3%
FY2005: A$:US$ = 75.4, CoDB margin = 41.8%
FY2006: A$:US$ = 74.8, CoDB margin = 47.4%
FY2007: A$:US$ = 78.7, CoDB margin = 45.8%
FY2008: A$:US$ = 89.7, CoDB margin = 49.8%
FY2009: A$:US$ = 74.8, CoDB margin = 49.8%
FY2010: A$:US$ = 88.4, CoDB margin = 48.8%
FY2011: A$:US$ = 99.0, CoDB margin = 43.7%
FY2012: A$:US$ = 105.2, CoDB margin = 43.1%
FY2013: A$:US$ = 103.5, CoDB margin = 42.3%
FY2014: A$:US$ = 93.2, CoDB margin = 44.3%
FY2015 (e): A$:US$ = 83.5, CoDB margin = 45.3% [DH14 was 46.3%] [*]
FY2016 (f): A$:US$ = 73.0, CoDB margin = 44.0%
I recognise that I am assuming a fall in CODB/Revenue going forward, but we know that Marketing and Admin expenses for the past 12 months have been particularly elevated due to the company accelerating its push into offshore markets, especially Europe and Brazil, where additional supply chain infrastructure has been established, and by increasing resources in North America. The bulk of these associated set-up costs should be non-recurrent.
I think what risks being missed by many investors is the scope for a widening of Revenue-Cost jaws in coming financial results.
The dynamic has already started (refer margin trends below), and my experience is that when these trends take hold they usually develop a life of their own.
EBITDA MARGINS:
FY2005 = 13%
FY2006: 19.6%
FY2007: 17.1%
FY2008: 9.5%
FY2009: 13.8%
FY2010: 13.5%
FY2011: 7.9%
FY2012: 10.1%
FY2013: 16.3%
FY2014: 16.5%
FY2015 (e): 18.1% [note that 1H14 EBITDA margin was 220bp higher than pcp]
FY2016 (f): 19.9%
WHAT DOES THIS MEAN FOR FY2016?
After that exhaustive and painful discussion on the input assumptions for forecasting purposes, here’s what I reckon FY2016 financials look like (with growth on pcp figures in parenthis):
Revenue = $76m [up 11% on pcp]
EBITDA = $15.1m [up 22% on pcp]
EBIT = $12.1m [up 28% on pcp]
NPAT, EPS = $8.6m, 7.24cps [up 30% on pcp]
[Incidentally, that would be a record NPAT and EPS for the company, eclipsing FY2014’s figure of $$8.3m (6.9cps). (FY2015 was the second-highest reported profit in the history of the company, and FY2014 the third-highest, so there is definitely a healthy trend established.)]
And an important point that warrants mention is that during FY2004, the previous period when profits and EPS were of a similar order of magnitude to today’s current level, the company’s share price averaged over $1.50, and peaked above $2.00.
Just saying, is all….
VALUATION
Based on my forecasts for FY2016 (for what they are worth, and recognising fully I am not a great believer in my ability to get forecasts definitively right, maybe directionally right, at best) SDI is trading on the following valuation multiples:
P/E = 7.3x
EV/EBITDA = 4.2x
FCF yield = 8.0%
Yes, I know it’s a micro-cap and yes, I know it is not very liquid, so will never have institutional interest, but at those multiples, with bottom-line growth in the high-20% levels (admittedly currency assisted), I have been buying the stock on the basis of a re-rating taking place sometime before the company reports its DH2015 interim result which, on my analysis, will be a cracker assuming nothing too dramatically changes in SDI’s business environment.
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