the gift that keeps on giving

Every financial reporting season I maintain a ranking in my mind of the quality of the results that are reported. So far this year the ranking (in order of preference) is:
1. SLM
2. ARP
3. DTL
4. EMB
5. MCP (did not own the stock going into this result, have since acquired)
6. WOW (do not own)
7. BRG (do not own)
8. SGN
9. CIX
10. SDI

What makes the SALMAT result the most impressive to my way of thinking is the excellent margin performance against the backdrop of a challenging macro environment for the company.

Over the past few years the focus on improving the business performance has created significant shareholder value from improving margins:
DH07: 9.6%
JH08: 10.4%
DH08: 11.3%
JH09: 11.8%
DH09: 12.7%
JH10: 13.6%

This margin, uplift, combined with around 5% pa revenue growth over the past 2 years, has driven EBITDA to its current level of $115m, from $81m in 2008, an increase of some 20%pa.

When margins started to improve in 2008 some might have argued that this was simply a function of the removal of duplicated overheads following the HPAL acquisition made in 2007, and that the benefits were one-off in nature. But it clearly didn't stop there because the margin uplift momentum is still continuing today, 3 years later.

And its not just confined to one or two isolated pockets of the business either. Margins are being driven up over all segments of the group:
* Business Process Outsourcing:
DH07: 9.2%
JH08: 10.3%
DH08: 10.8%
JH09: 11.5%
DH09: 12.4%
JH10: 13.4%
* Targeted Media:
DH07: 11.8%
JH08: 10.1%
DH08: 12.4%
JH09: 12.6%
DH09: 17.4%
JH10: 17.5%
* Customer Contact:
DH07: 5.5%
JH08: 6.6%
DH08: 7.3%
JH09: 7.5%
DH09: 7.3%
JH10: 7.8%

Note the favourable trends in the elements of the cost base:
Materials Used (~10% of operating costs)- down 15% in FY1o depsite relatively flat revenue
Equipment Expenses (also ~10% of opex)- down 20% in FY10
Freight and Distribution Expenses (~15% of opex)- down 1% when most industrial companies are reporting experiences of mid- to high single digit inflation in distribution costs over the past 6 months.

Another striking feature of this company's financial performance is the strength and resilience of the cash flows. Despite SLM having increased dividends by 12.7% pa, on average right through the financial crisis, paying out a total of $82m in the process, the company has still been able to halve Net Interest Bearing Debt, from $260m in Dec, 2007, to $134m today. Highly commendable. Working Capital (WC) management continues to be exemplary, with WC-to-Sales falling from 12.9% in Dec 2006 to just 3.2% in the latest result:
DH06: 12.9%
JH07: 8.8%
DH07: 9.2%
JH08: 4.5%
DH08: 4.4%
JH09: 3.5%
DH09: 3.6%
JH10: 3.2%

One gets an unambiguously clear sense with this company and its management of an unrelenting focus and drive to do things better, more efficiently and to constantly seek to eliminate waste and redundancy.

The conservatism with which the accounts are struck is also a pleasing feature of SALMAT financial results. For example in this latest result, $1.7m of gain on a property sale is broken out as a non-recurring item, yet $3.0m of expenses for relocating the HK operations are expensed directly with little more than an obsecure note tucked away in the accounts. So really, while SALMAT beat analyst EBITA expectations by around $1.0m to 2.0m (6%-7%) at the headline level, adding back the additional $3m makes the underlying result closer to 10% ahead of expectations.

Even after today's share price jump, valuation-wise, SALMAT is still undervalued, in my opinion.

Valuation metrics are as follows (on my modelled FY11 forecasts):
EV/EBITDA = 6.1x
P/E = 11.4x
DY = 6.2%
FCF Yield (on Mket Cap) = 11.5%
FCF Yield (on EV) = 9.7%

I came to be ashareholder of SALMAT when the company acquired HPAL (stock code = HPX) in 2007. (HPAL was in itself a good business and I was a happy shareholder in that company for serveral years). Once my HPX shares were acquired for SALMAT scrip I thought the prospects were high for the SALMAT management team to extract synergies and drive up returns, but they have exceeded even my own lofty expectations.

As I said, it's the gift that just keeps on giving.
SALMAT is one of my highest conviction investments right now. (And I haven't even touched on the special dividend, something of a rarity after the fallout of the GFC.).

Prudent Investing

Cameron