"What's the thesis? Take out the Govt Grant and it's still...

"What's the thesis?
Take out the Govt Grant and it's still burning $500kpq. This is why I didn't buy in the placement @ $0.05 but to their credit the directors did.
it's had 2 CF+ quarters out of the 11 I am tracking and both were due to Govt money.
If they could throw together a couple of back to back quarters I'd agree they had turned the corner. "


@Patient,

I think a focus solely on quarterly cash flows in isolation is flawed for companies at SP3's stage of corporate evolution.

Because, when it comes to sub-scale businesses such as SP3, there is a choice between:

1. Positive Cash Flow - achievable by ceasing to incur the sorts of costs that drive revenue growth

or

2. Negative Cash Flow - due to actively investing ahead of the curve in order to grow sales to a point of sufficient scale at which the Revenue-Cost jaws start to widen and the resulting free cash flow generation is meaningfully higher than it would be under Point 1 above.


Of course, there is always a risk that pre-profit businesses keep investing in costs and the Revenue line fails to respond, in which case the investment is a dud.

But there are ways to monitor the extent to which this is a looming problem, and that is to look at what is happening to Gross Profit (i.e., essentially Earnings After Variable Costs, but Before Fixed Costs, or Cost of Doing Business).

If Gross Profit is rising satisfactorily over time, then at some stage the Fixed Cost base will be overtaken by Gross Profits, and the company will turn EBIT-positive (and hence Free Cash Flow positive, to the extent that EBIT is a proxy for Free Cash Flow).

In that light, let's look at what SP3's Gross Profits are doing (figs. in $m):

FY2015: 0.28
FY2016: 0.53 (+93% on pcp)
FY2017: 0.78 (+45%)
Fy2018: 1.23 (+59%)
FY2019: 2.84 (+130%)
FY2020: 3.07 (+8%)

I think that FY2020 number warrants some comment, because to generate GP growth in that year - when the company faced the mother of all storms in the form of the onset of Covid, and a significant change in the revenue model (from unit sale to leasing) - is no mean feat. For context, in DH2019 Gross Profit increased by 30%; in Covid-impacted JH202 it contracted by 9%.

But to be forewarned is to be fore-armed: Beware that Gross Profit pressure is likely to have persisted into DH2019 (due to the reasons listed above, as well as some self-inflicted pain in the form of not being in a position to meet the surprisingly strong demand for the new STA6 product).

So the upcoming financial result is unlikely to be very pretty and there might very well be some sticker-shock hit to the share price when the result is released.

Which is why I have kept some powder dry.

Because, if the stock does sell off on the result (and it is not very liquid so a mere few sellers could whipsaw the share price down a lot), I think that will present the last good buying opportunity.

Because, over the following 12 months, the company will be cycling the highly abnormal JH2020 and DH2020 periods (which corresponded with Covid and significant statewide lockdowns, esp. Victoria, insufficient manufacturing capacity to meet demand, and the most significant hit to short-term financials, the change in revenue model from unit sales to rentals).

The investment thesis here is that this will be a company doing in excess of $10m of sales at some point over the foreseeable future, at a +70% Gross Margin (they are making in excess of 60% GP Margin on the unit sales business model; going to the rental model will see that figure being closer to 80%, I'm sure). So that's $8m pa in Gross Profit.

The cost base of the company is currently around $5m pa.

Meaning EBIT of ~$3m pa, and NPAT in excess of $2m.

When that occurs, what the company will not be, is a $7m Enterprise Value company, as it is today. More like triple that, methinks.

We just need to get past the current painful point of inflexion.

Yes, there is some execution risk, but this is a hugely asymmetrical Upside vs Downside investment opportunity.

.