It always fascinates me which sort of posters you encounter in the same place.
After SNL's FY16 result, I started to research the company deeper and to build a financial model.
Soon after that I came to this thread, only to find some of HotCopper's most insightful posters already in deep debate about the thing that happens to matter most to me, namely Free Cash Flow.
So your discussion and analysis about SNL's FCF growth not matching growth in the P&L was most instructive.
There is just one caveat that I think warrants adding; for a little company like this, I think that 3 years is an insufficient period of time to really get a grip of what is happening in the business.
Especially a business that increases its Sales Revenue by 60% (corresponding to a CAGR of 17%pa) - and by purely organic means - over that relatively short time frame.
I suspect that sometimes we, who analyse business performance, can easily forget that there is a world of difference between modelling some numbers in an Excel spreadsheet, and actually living out those numbers in the real world.
In a practical sense, being in a business situation where you are supplying your customers at a rate that is 17% higher than it was last year is not easy. But having to do it for 4 years on the trot is crazy (between FY2009 and FY2014, SNL's Sales Revenue doubled).
And remember, that occurred largely using the same asset base, facilities and infrastructure, because over the 8 years leading up to FY2014, the company spent a mere $4.0m (net $1.3m, netting off cumulative depreciation over that period) on PP&E, and despite that paltry investment, between FY2009 and FY2014, it delivered $40m in incremental Revenue and $6.2m in incremental EBIT.
As a result, EBIT/Assets ballooned from under 12% to 22%.
Clearly, that sort of trend has limited sustainability before something has to give.
And of course, as the economists say, there's no such thing as a free lunch and this super-normal growth had to be paid for somehow, and the way this payment occurred was not out of an investment in fixed capital (as has been shown), but out of an investment in working capital.
Which is what the nub of your earlier discussion in 2015 so aptly deal with.
So, with respect, what I think your analysis overlooks - because it is confined to just one extraordinary (and relatively short) period of time - is some of the practical realities of what would have been happening inside the company, its warehouses, branches, logistical infrastructure, and its human resources.
As I said, delivering 17%pa growth in business activity, in the type of tactile goods business that is SNL's, is on its own enough of a feat; but to do it year after years is something I am convinced that we armchair critics don't appreciate.
Over the course of my career, I didn't spend much time in the real world of commerce and industry but I do recall, as a young graduate, how much stress and strain there arose in the organisation where I worked even when we had some of our customers calling for 10% or 15% increase in service levels over relatively short periods of time.
At the risk of labouring the point, when a business is undergoing the sort of rapid pace of growth for an extended period of time, as SNL had been, then that business is sure to come under some sorts of pressure and certain inefficiencies are certain to emerge.
Reading between the lines of management commentary during 2013 and 2014 one gets a clear sense of a business operating at more than full capacity and bursting at the seams, but being too busy to do anything meaningful about it... the classic circularity of, "we are so busy that we aren't able to do something to help us deal with how busy we are."
So, I think that, under those sorts of business circumstances, some sloppy inventory control - to which your analysis at the time rightly pointed - is not at all surprising, I don't believe. In fact, in some ways, I'm surprised it wasn't a lot worse.
But if you look at the longer-term trend in your Sales-to-Inventory metric, you will see that what was supposed to be happening with scale benefits as the company grew - namely increasing the Sales-to-Inventory metric - was indeed happening in earlier years, until the growing pains started to be felt in Fy2013 and FY2014 (which was the culminating point of your exercise).
(Note: To smooth out any lumpiness, I have used average inventory, as opposed to period-end inventory figures.)
This pattern is confirmed when studying the more inclusive measure of total Working Capital-to-Sales, which - while still high - was trending in the right direction until the company started to run out of wiggle room in FY2014.
And, I am sure, the deterioration in these working capital intensity metrics over the course of 2013 and 2014 is manifestation of the organisational congestion that prompted the bringing forward of the 3-year strategy review.
The result of this strategic review was the wholesale re-configuration of the company's supply chain in NSW (effectively an entire relocation of its national distribution center from one city to another... no small project), as well as major operational changes and expansion in its operations in WA, QLD and New Zealand (again, no mean feat considering the need to maintain service levels in a rapidly-growing business).
There can be no mistaking it, SNL's offices, warehouses and branches have been very busy places for an extended period of time, and I suspect the company's management and staff have earned ever cent of their somewhat modest remuneration over the past 6 or 7 years.
SNL's financial history suggests to me that this was a business that grew very fast, so much so that it caught its own managers a bit by surprise.
I think that, as casual observers of SNL, cutting and slicing the numbers, as we do, we don't really have any real insights into what has been happening in this business for the past 6 or 7 years, namely the phenomenal growth in Sales Revenue since the GFC and 2014, at which point dis-economies of scale started to appear, and then management's response (belated, possibly) to doing something about it by investing in capacity to cater for the growth over the next decade or so.
And that's where we are today... emerging from the point where much-needed capacity has been created (at modest capital cost, incidentally... a mere $5.0 of capex over the past 3 years) for future, long-term growth.
Last week's trading update, which indicated for 10% Revenue growth and 27% EBIT growth in DH2016, certainly seemed to provide the first evidence of it.
Having seen many companies undergoing growing pains such as those experienced by SNL, and then responding like SNL has, tells me that the company is at the start of another 3 or 4 year period of above-average growth (maybe not at the same pace as the 2010/11/12/13/14 period) but still at a healthy enough pace to materially impact the bottom line.
Specifically, I suspect the company will - barring the sky falling on our collective economic heads - generate around 7%pa to 8%pa growth in Revenue over the foreseeable future.
Meaning that in 3 years' time the company should be generating Revenue of $120m, at an EBIT margin of around 10%, so $12m EBIT (cf. $8.5m this year).
Assuming the balance sheet remains as prudently and conservatively geared as it has always been (essentially, free of net debt) then NPAT will be around $8.5m.
Applying a not-unreasonable exit P/E multiple between 13 and 14.0 times to that NPAT figure yields a theoretical market capitalisation value for SNL somewhere between $110m to $120m, or $2.70 to $2.80 per share by 2020.
That translates into capital appreciation of around 10%pa to 11%pa which, adding 5%pa in dividends, offers a total investment return of around 15%pa.
While this is not the most sexy investment outcome one can possibly envisage, given my sense of the low risks involved in achieving it, it is one that certainly has appeal to me.
Which is why I have been buying shares in SNL over past months (at least, trying to buy...the stock is notoriously illiquid)
SNL Price at posting:
$2.07 Sentiment: Hold Disclosure: Held
(20min delay)