Fellow SKE followers,It has always struck me as curious how...

Fellow SKE followers,

It has always struck me as curious how analyst and investors tend to focus on profit results in isolation, without placing them into any meaningful context.

On the contrary, I think that, when looking at results, it is crucially important not to just look at them in isolation (i.e., “did the company beat consensus expectations, or not?”), but in historical context.

SKE is a classic case in point.

I bought my first SKE share in March 2010, after I read the DH09 result presentation. That particular result, which represented the period right smack bang in the middle of the GFC, had seen EBITDA fall to around $30m, from $57m in the previous corresponding period. At the bottom-line NPAT was crunched even more, down to $4.5m, from $21.5m in the pcp. The DH09 balance revealed Net Interest Bearing Debt of $181m. Needless to say, no dividend was declared for the six months ending 31 Dec 2010 (pcp = 9cps).

What attracted me to the stock was its cash generation capacity. For, even in the midst of one of the most dramatic financial periods in history, namely the GFC, this company was still generating positive Operating Cash Flows, after averaging around $60m pa in the period preceding the GFC, and that included an interest bill of circa $27m pa. It occurred to me that, should the company’s board be able to get its debt under control, the leverage at the OCF line would be significant.

In late 2009 the company had undertaken an equity placement, bringing in $93m to partly repair the balance sheet (SKE exited the 2009 financial year, with a whopping $260m in net debt).

While this equity raising was somewhat smaller than I had expected, it had the effect of reducing NIBD/EBITDA from over 4.5x for the 6 months to June 2009, to a little under 3x for the 6 months to Dec 2010.

In the FY2010 year, SKE’s OCF was $29m. But that was after $26m of Interest paid to the banks!

Importantly, during the course of 2010, the overhaul of the board and the resignation of the CEO occurred. This was a very important milestone for me, because the pre-2010 board and the preceding CEO had presided over significant destruction of shareholder value, due to an aggressive and reckless acquisition spree (which is what got the company’s debt metrics into their stressed state).

It is instructive to study what happened to the business’s interest burden – and therefore its cash generation – over the subsequent few years:

NET INTEREST PAID:
FY2009: $31m
FY2010: $26m
FY2011: $22m
FY2012: $8m
FY2013: $4m

OPERATING CASH FLOW:
FY2009: $100m
FY2010: $29m
FY2011: $76m
FY2012: $102m
FY2013: $62m

Needless to say, the solvency metrics have also improved dramatically:

NIBD to EBITDA
June 2009: 4.5x
June 2010: 2.9x
June 2011: 2.3x
June 2012: 0.8x
June 2013: 0.5x

As has the profitability of the business, with EBITDA having grown from $68m in 2010, to $95m in 2013.
The lower interest burden means that the NPAT line has surged, from $27m in 2010, to $56m in 2013.
Even with the subsequent $69m equity issuance in 2011, EPS has virtually doubled, from 13.1cps in 2010, to 25cps in 2013.

I guess what I am trying to say that, as an investor, I tend to adopt a “business owner” mentality, preferring to look at the changes in a company over time, and to make educated (modelled) projections on what the company’s financials will look like in the future, and to invest (or not) on that basis.

I far prefer to do this rather than trying to react to a squiggle in the share price (up or down) on the day of the result. (Or to try to second guess who is buying the stock or who is selling it on any given day, or why it is up a few % on any given day or, for that matter, what the “bots” are doing.) My sense is that far too many individual investors spend too much time and energy doing this sort of “tick-watching”, making it like a job that needs to be done.

Me, I prefer not to work for my stocks...I prefer them to work for me.

I am convinced that all the noise and activity around result announcement day – specifically whether a company has “beaten” or “missed” analyst forecasts – is a construct of the stock broking profession trying to get their clients to transact one way or another.

Since my ownership of SKE (and other stocks like it), I have seen more analyst reports than I care to recall over the past 3 years, which have told me to sell the stock whenever some incremental little bit of bad news has come to their authors’ attention.

And yet, despite this company finding itself in very tough business conditions in the past 18 months to two years, it has still delivered the impressive kind of financial outcomes as described above.

With SKE – and companies like it - I have luxury of not looking at the stock market for months on end, sleeping securely in the knowledge that the business continues to go forward.

While I don’t think that SKE will double in share price again in the next two or three years, I do see it as a low-risk, medium-return investment proposition.

And at valuation multiples of circa 12x P/E, 7.5x EV//EBITDA, and 6% Dividend Yield, I believe the scope for permanent capital destruction, from an investment in SKE today, is negligible.


Cam