external headwinds mask a great growth story, page-3

It's not often that a microcap warrants much online debate, but in SDI's case it is becoming increasingly justified.

The latest trading update made even my unbridled enthusiasm for the company appear woefully over-conservative.

Put simply, the company says 1H NPAT will come in between $1m and $2m, compared to $0.3m for the pcp. That's a disconcertingly wide range, but my modelling wasn't even within the lower limit.

So what does this mean?

Well, recall from an earlier post that SDI has been buffeted (sic) by the dual headwinds of a rampant A$ (which is a big deal when two-thirds of your revenues are non-A$ denominated), and a key inputs into SDI’s alloy products, namely silver, has seen its price rise almost exponentially, from sub-$5/oz in the early 2000s, to over $40/oz this time last year.

Recall, too, the conclusion of the pricing power that the company has, and that it required only for the A$ and the silver price to stabilise, even at elevated levels, and the company would be able to adjust its price list to drive the sorts of impressive double-digit organic EBITDA growth rates that it displayed some years ago before the A% and the silver price jointly conspired to cause the company untold grief...which it managed to navigate without needing to go cap in hand to shareholders for fiscal support. This, I believe, is testimony to the business as well as its conservative and prudent management.

What’s happening, pleasingly, is that the pricing power theory is becoming manifest in practice:

Firstly, the June half is typically the seasonally stronger period for SDI. Yet this update will have the Dec half result roughly in line with the June half of 2012, which worked out to be about $1.6m.

Secondly, given the clear momentum in the business now that the A$ and the silver price have stabilised, albeit at elevated levels, the June half of 2013 will also show strong growth on its previous corresponding period.

I expect that the EBIT and NPAT profiles over the past three half-years, and the next two, will look something like the following:

EBIT trends ($m):
JH11: 1.10
DH11: 1.03
JH12: 1.99
DH12 (f): 2.31...implied by mid-point of latest update
JH13 (f): 2.71

NPAT trends ($m):
JH11: 0.76
DH11: 0.31
JH12: 1.65
DH12: 1.50...mid-point of latest guidance
JH13: 1.89


Valuation-wise, that puts the stock on a P/E multiple of around 8.5x and on an EV/EBITDA multiple of 5.2x, which for a micro-cap, does not look mouth-wateringly cheap.

However, there are few things that warrant bearing in mind when looking at this stock:



Firstly, headline earnings numbers include a massive cancer in the form of the Brazilian Business. In FY12, Brazil reported a $2.5m EBIT loss. The company has almost $5m of capital invested in supporting this loss-making Brazilian business.

In other words, if the company exited the Brazilian business, and assuming – conservatively, I think – that:

1) the company still has to retain a $0.5m corporate overhead that had been allocated to the Brazilian business (i.e, the ensuing EBIT uplift is $2m), and

2) 1.0m of the $5m in invested capital is consumed in executing the exit

Then the valuation metrics become: P/E = 6.0x and EV/EBITDA = 3.6x

The drag on the group’s overall financial performance due to Brazil is therefore highly significant.

BY MY RECKONING THE BRAZILIAN BUSINESS IS CAUSING SDI’S CURRENT EARNINGS TO BE UNDERSTATED BY AROUD 50%!!


Secondly, the state of the balance sheet is the best it has been for many years, with EBITDA exceeding Net Debt for the first time since 2004, and EBITDA-to-Net Interest coverage reaching the teens, once again for the first time in many years.

(If Brazil is exited in the manner described above, then SDI’s solvency metrics will be at all-time record easy levels)

This paves the way for a significant re-installation of the sorts of dividend policy that prevailed in the mid-2000s prior to the rise in the A$ and the silver price, i.e. 70% payout ratios.

In that instance, SDI’s 2014 DPS would be 2.5cps, putting the stock on an 8.9% Dividend Yield (If Brazil was addressed, an extra 1.25cps could be paid, or 3.75cps, equating to a Dividend Yield of over 13%)

The upcoming result will be highly instructive in terms of the board’s thinking about the timing of “normalising” the dividend policy. Since the GFC no interim dividend has been declared...given the dramatic uplift in the company’s profitability over the past 12 months, I think a re-instatement of the DH dividend is virtually assured.

I believe these two factors, namely addressing the haemorrhaging of the Brazilian business and the normalisation of the dividend policy, will come to pass over the course of the next 12 months.

And when they do I think the intrinsic value of the business will begin to be reflected in the share price.

And I believe firmly that the intrinsic value is somewhat higher than the current share price.

At the moment, SDI is primarily a growth story.

Before long, it will present both a growth AND a yield investment attributes.