I spent a few minutes this morning reviewing my financial model...

I spent a few minutes this morning reviewing my financial model for this company with a view to distilling expectations for the upcoming result.

It wasn't a very conclusive exercise, I'm afraid, with a wide splay of possible outcomes due the business's current elevated forecast risks.

There are always parts that move around to drive SDI's financial performance , viz., sales mix, exchange rates, R&D spend and the degree to which it is expensed vs capitalised, Marketing spend, Gross Margin.

Usually these P&L determinants aren't overly volatile, which mostly makes it possible to make a stab at what SDI's earnings composition is going to look like.

But this is not one of those times, because extraneous factors, such as logistics costs and investments in re-launches of marketing initiatives post-Covid, are impacting the GP Margin and Cost of Doing Business far more than is usually the case.

So, in calibrating expectations for the upcoming result I've been forced to look at the range of possibly outcomes, i.e., a Basecase scenario, with Low and High scenarios around it.


Starting with the top line:

At the time of the AGM, Sales in constant currency terms were running at 11.6%.

While the A$ was meaningfully weaker than the US$ in DH2022 vs DY2021, it was stronger by a similar magnitude against the pound and the Euro.  Given that the European sales are the similar scale as US sales, this means the relative exchange rate movements are a bit of a wash in the half.

So, A$ sales growth will have largely tracked constant currency sales growth, i.e, around 11.5%, which is what I've applied in my Basecase scenario (with 11.0% and 12.0% growth respectively representing the Low and High scenarios).


Next, Gross Profit Margins:

Again, a YTD update was provided at the AGM, namely for 55%.  This is clearly out of kilter with longer-term history (noting that December half GP Margins are seasonally a touch softer than June halves), due partly to product mix, but with higher freight and warehousing costs being the dominant influence.




It is unclear to what extent the sales mix finished the remainder of the half, but given the anecdotal evidence of a trend of easier logistics costs in the December quarter, I've used the FYTD GP Margin of 55% as the Low scenario, with 55.5% for the Basecase and 56.0% for the High scenario.


Finally, Cost of Doing Business:

Variances here have historically mostly reflected fluctuations in international business development investment and sales and marketing initiatives; however in recent times, general cost inflation has also become meaningful.

For context, CoDB in JH2022 was $20.7m, up 15% on DH2021's $18.0m, and the Low, Basecase and High scenarios assume  further 6%, 5% and 4% increases, respectively, in DH2022 vs JH2022.

Of course, this means that DH2022's CoDB is assumed to be >20% higher than DH2021, which might sound excessive, but there are a few things to bear in mind when comparing with DH2021 in pcp terms:


1.)  DH2021 is not at all a meaningful reference point, reflecting a suspension of many non-essential business activities during the heart of Covid. As can be seen, CoDB -to-Sales in DH2021 was just 39% an all-time December half-year low.



2.)  Over the years, SDI has invested increasingly in headcount abroad; mostly in Sales & Marketing. These costs are non-A$ denominated, meaning that a while a weakening A$ is supportive of GP Margins, it tends to negate some of this benefit by pushing up the CoDB to Business margin.  

(As an asides, taken to it's logical conclusion, this means that, whereas SDI's earnings were historically highly leveraged to the movements in the A$ vs other currencies, with the growing offshore fixed cost base, the P&L is building in some natural exchange rate hedges. This implies less volatile earnings over time, i.e., better quality earnings. And we know that better quality earnings warrant higher valuation multiples ...but that's a debate for another time.)

As can be seen from the blue column in chart above, in this exercise I've used CoDB of 42% in the BaseCase (reflecting CoDB of $21.75m.)  In the Low and High Scenarios, CoDB of $22.0m (42.8% of Sales) and $21.5m  (41.5% of Sales) are the inputs.


Throwing all of the above into the spreadsheet, yields the following outputs (and focusing on Pre-Tax Profit (PBT) as the salient financial metric because that will be the easiest one to audit when the result is announced in a few weeks' time):




The Basecase has PBT at $4.2m, which would be a 16% improvement on DH2021.
(Note that there are likely to be a few hundred thousands of dollars of finance charges - interest and/or loan establishment fees i.r.t. the property purchase - in this result that were absent in the pcp, so the operating profit result (EBIT) would be 21% higher in this case.  

The Low scenario yields a result that is similar to DH2021 (PBT of $3.6m), while the High scenario would be almost than 35% up on pcp.

As said at the outset, that's a wide splay of possible results; so wide as to almost be not very useful at all, one could say.

However, where it will be of use to me as a long-term shareholder is that - irrespective of where this particular result lands - I have a range around a central expectation which will inform me about the likely trajectory SDI will follow in coming years as it emerges from the disruptions of Covid and the dislocation in its supply chains.

In that light, a PBT result anywhere between $4.2m and $4.8m I would consider to be a decent outcome.

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