Amy, Author at TAMIM Asset Management

Trump vs Hillary – Immunising the Portfolio

by Amy | Oct 16, 2016 | Stock Insight

In the lead up to Brexit Robert Swift, head of the TAMIM Global Equity High Conviction Individually Managed Account (IMA), took the view that one could effectively immunise a portfolio from the effects of potentially massive global economic events like Brexit or the upcoming US Election. Having successfully taken precautions to hold stocks that rode out Brexit admirably he now turns his attention to the US in an attempt to immunise the global equity portfolio against any shocks following the US election. The themes presented here should present strong investment opportunities whatever the outcome of the election may be. Robert also provides us with a list of stocks he is watching with this in mind.

Trump vs Hillary – Immunising the Portfolio
Robert Swift – Head of Global Equity

On November 8th America votes for the next President. The USA electoral system is not the same as in Australia. If you want to understand more fully how it works please check this out.
https://en.wikipedia.org/wiki/Electoral_College_(United_States)

We don’t know who is going to win. It looks a close race. Typically voters who prefer the ‘unpopular’ or ‘unfashionable’ candidate will tend to be reticent about volunteering that information.

The vote for Brexit was a recent case in point. Voting ‘out’ was so unfashionable that respondents lied about their intentions causing the polls to falsely predict a ‘Remain’ victory. Consequently Donald Trump is probably closer to Hillary than the media that we watch and read, would suggest. At a recent conference we attended, a USA based Professor of Economic History suggested that Donald Trump could get 60% of the popular vote – not 60% of the electoral college but 60% of the turnout.

It could easily be irrelevant who wins. The President can’t always get much done if Congress isn’t ‘on side’ and either candidate could find they don’t get the support of the two houses in Congress – the Senate and the Representatives. Conceivably Clinton and Trump could each find themselves stymied by an obstructionist Congress and there will be no major economic or foreign policy shift.

As investors watching this event unfold we have some choices to make if we think that market will react differently. These can broadly be classified as:

Invest for a Hillary win
Invest for a Donald win
Go to cash since we don’t know who will win and don’t find anything attractive
Invest in a way that is a ‘win win’ regardless – this includes the stymied result.

1 and 2 are risky in that we might be wrong. We think that Hillary will stand for “more of the same” for USA foreign policy but will ‘punish’ big Pharmaceuticals and (sort of) punish Wall St.

Avoid pharmaceutical companies and maybe be wary of companies that play egregiously unfair games with their tax rates – they look unpopular everywhere?

We don’t really know what Donald would do but it will probably involve much posturing about radical change and would result in quite a volatile ride for global capital markets.

Companies with large cash balances may bring money back to the USA if there is a tax amnesty. We should favour Google, Apple which might have a harder time under Hillary?

If we decide we know nothing we could hold cash. Occasionally that has been a good decision.

If we opt for 1, 2, or 3 and pick stocks we think will benefit, or hold lots of cash, but are wrong, it would be an unnecessary and sub optimal decision. We have thought about it and have decided we can do in USA stock selection what we did with UK stocks before Brexit. Namely we can invest in US stocks that we think are attractive which will be immune from the downside of a win by either side. Before the Brexit vote we decided that large multi-national companies which happened to be listed on the UK Stock exchange were cheap. Glaxo Smithkline, the pharmaceutical company, and HSBC the UK and Chinese bank, were likely to benefit regardless of who won the UK referendum. Both had global products, a global presence, good products, good balance sheets, attractive valuations and a compelling catalyst.

Glaxo and HSBC are both up over 15% since the June 23rd Brexit vote.

Here’s how we think we can do the same again in the USA. We believe 3 trends will continue regardless of outcomes 1, or 2, above. If we can pick the right stocks our investors should do ok and certainly better than by holding cash yielding virtually nothing.1 – The USA yield curve will start to steepenThis means that longer term interest rates will rise relative to shorter term rates. Note we are not claiming that short term rates will be raised (although we wish they would). This steepening typically happens when an economic recovery is being discounted and investors expect more demand for, and a higher cost of, longer term money.

This steepening invariably helps lending banks since they tend to borrow short and lend long where the lending rate resets upwards quite frequently. In short it boosts bank margins on their loan book. Many USA banks are cheap relative to their expected muted but stable, dividend and profit growth. They are also ‘safe’ to the extent that they have raised over $700b of common equity since the first stress tests in 2009. USA banks are a lot safer than they were before the 2008 GFC and while they are a lot less ‘exciting’ now, we think it’s ok to invest in utility type companies which have a tailwind of higher margins. Additionally, the European banks are not well capitalised; the European yield curve is unlikely to steepen; European stress tests by the ECB are a fantasy which gives investors no comfort about their veracity; and they are exiting businesses, leaving it to the Americans.

We could be wrong. Wells Fargo is under fire for unethical business practices but any fine is unlikely to mortally wound the company. European banks are trading on ostensibly much cheaper ratios and so they could outperform if the landscape changes. Given the intransigence of the German government in refusing to use taxpayers money to bail out Deutsche Bank, or the Italian banks, we think “muddle through and uncertainty” prevails in Europe. If Deutsche had to pay the proposed fine of $14bn then it would be a mortal blow – at least to existing shareholders. 2 – Infrastructure spending in the USA has to go upWe have been saying this for a while – especially when I lived there! The decrepit state of the roads, railways, bridges, and schools has to be seen to be believed. It is 60 years since the Eisenhower administration built the national highway system and over 25 years since there was a new international airport opened – Denver. Infrastructure spending is running today at about half the average level of the last 100 years, as a % of GDP. 2.6% vs 5%. This is equivalent to a lot of new $ to be invested. If Trump wins maybe contracts go to USA companies only? If Hillary wins, maybe it goes out to global tender? There is the money and the knowhow! If you have been to a sports stadium in the USA you will see evidence of civic pride and evidence of the will to find the money. We have been to college bowls which hold 80,000 spectators. We think that pride and skill will now be turned to general infrastructure and both candidates are talking about it – a lot. Hillary has promised $275bn of federal spending over 5 years and $500bn in total and Donald twice that, provided by a national infrastructure fund. Hillary’s proposals seem a little more soundly costed but Australians will know all about the debate surrounding that issue!

Check out this website (www.infrastructureusa.org) to get a sense of news and views on North American infrastructure and the political stance of both opponents on the issue.

Which stocks benefit? Construction companies, manufacturers of heavy trucks, Steel companies, Concrete companies, Technology companies and Capital goods stocks. Pretty much everyone and even those pariahs, the banks. It makes so much economic sense and, thankfully, if enacted will allow the era of Zero interest rates to come to an end since the economy will get a boost.

We are invested in Daimler for heavy trucks, Vinci for construction skills and Honeywell for capital goods. We also expect technology stocks to benefit since much of the infrastructure will be wired up.3 – New inventions and innovation, especially in Technology, continuesTechnology is already everywhere and in everything but we can’t see that trend stopping. Mobile phones today contain more computing power than did Apollo 11 for its moon landing.

Neither Hillary nor Donald is going to do anything to prevent the USA develop further. Arguably it will even be given a boost by the new President because Chinese patent applications are now running ahead of those in the USA. It has a geopolitical dimension.

In the digital economy we think there are 3 certainties:-

Products and platforms will converge meaning standardization – Betamax vs VHS all over again!? Or not?
R&D rises but shelf life falls so winners win bigger; losers completely fail; and it happens fast. Miss a product generation and you will be toast. Valuation may matter less than (product) momentum. Blackberry and Nokia vs Apple and Google phone?
The cost will be in the form of loss of privacy and security. Integrity of, and trust in, which platform you keep your data is essential. Yahoo and its Verizon deal now in jeopardy?

Pretty much everything we own has technology in it and increasing amounts of it. Glaxo SmithKline is now working with Alphabet (Google) to develop bioelectronic medicine. Toray was a manufacturer of seatbelts for Japanese cars but is now also a global leader in membrane technology and designing carbon fibre shells for aircraft. Western Union from the USA uses sophisticated software to transmit electronic payments of over $150bn via 500,000 agent locations in 200+ countries. Anyone remember travellers’ checks?

If we can invest in companies that develop or implement, technology at a good price then we are happy. We don’t invest in start-ups, nor in smaller companies with single products but find plenty of opportunity globally but especially in the USA. We don’t see that changing post November 8th.Stocks on these themes:Below are some stocks which are attractive on our ‘multi factor’ stock selection model. This ranks stocks based on their relative attributes with regards to Valuation, Quality of earnings and balance sheet, and earnings and price Momentum. We call it VMQ. Typically stocks with higher scores outperform those with lower scores but we only invest after verification by performing fundamental analysis on a company’s future prospects, paying careful attention to accounting, strategic and governance shortcomings. Note that we don’t own many of these because our strategy has to be responsible. We don’t put all the eggs in one basket and so select from amongst a range of industries and regions to get the best stocks which, together, provide diversification and a good risk adjusted return.US yield curve steepening – USA listed financial stocks we like:AFLAC (AFL.NYSE) – VMQ Score = 98
A provider of supplemental insurance against income and asset loss with medical especially popular. Dominant in USA and Japan.

JP Morgan (JPM.NYSE) – VMQ Score = 86.6
A global multi segment bank with investment banking, asset management and consumer banking. It has been through many stress tests and raised a lot of capital. Well placed to benefit from the withdrawal of European banks from the global scene.

Bank of Montreal (BMO.TSE) – VMQ Score = 95
More of a retail bank than JP Morgan this is strong in Canada and the USA mid-West. The build out in asset management and infrastructure financing is attractive.

Principal Financial Group of Iowa (PFG.NYSE) – VMQ Score = 99
An asset management and insurance company with a focus on retirement products.

BB&T Corp (BBT.NYSE) – VMQ Score = 81.7
A retail bank offering personal loans and mortgages. The stabilisation of house prices and the need to replace aging cars will be a driver of interest margins and loan growth.Infrastructure Spend – Infrastructure, Materials, and Capital Goods stocks we like:Vinci (DG.EPA) – VMQ Score = 85.8
A French listed but global construction company with significant exposure to stable revenue from operating infrastructure such as airports and toll roads.

Eaton Corp (ETN.NYSE) – VMQ Score = 79
A power management company – electrical, hydraulic, mechanical. All aspects of major construction and capital goods investment and replacement covered.

Parker Hannifin (PH.NYSE) – VMQ Score = 68
A manufacturer of components to regulate air, water, and motion. Will be a late cycle beneficiary but share price likely to discount before news flow gets better.

Dow Chemical (DOW.NYSE) – VMQ Score = 93.5
Supplies the raw materials that go into pretty much everything that is made globally.

Cummins (CMI.NYSE) – VMQ Score = 93
Makes diesel engines for trucks and power generators.

Siemens (SIE.ETR) – VMQ Score = 89
A German based but global conglomerate operating in power, transport, healthcare and factory equipment. Evidence it is becoming more focussed should help profits and rating.Technology and Innovation stocks we like:Apple (AAPL.NASDAQ) – VMQ Score = 90.6
A very large cash pile which needs to be deployed makes this hard to gauge but net of cash it is trading cheaply as a dominant mobile phone designer.

Intel (INTC.NASDAQ) – VMQ Score = 95.6
Moving from relying on microprocessors to a general provider of hardware and software platforms for the digital age.

NetApp (NTAP.NASDAQ) – VMQ Score = 92.7
Software to manage customer data.

Cisco (CSCO.NASDAQ) – VMQ Score = 97
Switching and routing gear for the internet and moving into software.

Xerox (XRX.NYSE) – VMQ Score = 91.5
Imaging and business process and printing services. An iconic name which will come under increasing shareholder activist pressure without an improvement in results.
Consequently we won’t be holding a lot of cash ahead of this election. We will continue to invest in mis-priced companies with identifiable competitive advantages and a solid strategic position. If we are right about these 3 trends we expect to come through November as safely and profitably as we navigated Brexit.

Happy Investing,

The team at TAMIM

September Small Cap Stock Review

by Amy | Oct 13, 2016 | Stock Insight

This week the team at DMX review some of their portfolio holdings and the meetings they have had with the Small Cap companies they are invested in. Identifying these types of businesses is both the passion and the bread and butter of the manager of the TAMIM Australian Equity Small Cap IMA. We continue to believe that the addition of a small cap portfolio to your overall investment strategy adds a strong return and diversification benefit.

September Small Cap Stock Review

Elanor Investors Group (ASX:ENN)

Elanor Investors Group (ASX:ENN) is busy securing assets for its two new funds (a $250m ASX listed retail property REIT and an unlisted commercial property fund) to be launched towards the end of 2016

Management have advised that they have a strong pipeline of potential asset acquisition opportunities across the hotel, commercial and retail property space.

ENN’s Hospitality and Accommodation Fund ( http://www.elanorinvestors.com/hospaccomfund.php ) is performing well, with ENN focused on implementing initiatives to continue to improve the operating performance of the underlying hotel assets. We expect at some point ENN to list this fund on the ASX, which would make it one of the few ASX hotel exposures, and, as such, would be likely to be well received.

ENN’s two operating businesses (Featherdale Wildlife Park and John Cootes Furniture) continue to have good growth outlooks. The challenge for ENN is to continue to identify and acquire attractive assets at good prices in order to continue their FUM expansion.

Konekt Limited (ASX:KKT)

Konekt Limited (ASX:KKT) reported a strong FY16 result, driven by strong organic and acquisition growth.As has been widely reported in the financial press, there has been a number of recent corporate transactions in the injury management sector as private equity and other corporate players look to build their presence.

Acquisition multiples and vendor expectations are likely to have risen as a result of this activity, which may impact the acquisition activity of the likes of KKT in the short term.

KKT’s management have a strong track record of generating organic growth. Management have a number of initiatives in place in order to continue to grow the business organically, including rolling out nationally their corporate mental health offerings, the opening of new offices to provide KKT with further scale; and targeting the provision of pre-employment services to corporates that attract high workers compensation premiums such as construction firms and aged care services.

KKT see themselves as an important provider of corporate health initiatives, servicing numerous large Australian corporates.

Pioneer Credit Limited (ASX:PNC)

Pioneer Credit Limited (ASX:PNC) reported a strong FY16 result, although it was masked somewhat by PNC’s investment in new products and overhead support.

When we met with PNC they reiterated the difference in their business model versus others in the sector – PNC is focused on acquiring debts with ‘long dated’ collection profiles (primarily personal loans and credit cards) to enable PNC to develop deeper relationships with their customers over a longer period of time (this is in contrast to telecommunication and utility debts which are often one off in nature and don’t provide an opportunity to build a relationship with the customer). The other advantage of having a longer collection cycle is that it provides PNC with a lower turnover portfolio, meaning that PNC is not under pressure to constantly replace/purchase more ‘short dated’ utility type debts.

Over the medium term, PNC is focused on using these customer relationships to offer a wide range of financial services. PNC expect these financial services products (including personal loans and credit cards) to contribute meaningfully to its profit over time.

We also spent some time discussing with the MD and CFO PNC’s valuation approach for PNC’s purchased debt portfolio, and the discount rates they have adopted. We are comfortable with the valuation approach.

SDI Limited (ASX:SDI)

SDI Limited’s (ASX:SDI) Management team conducted a national roadshow following its annual results.SDI is focused on positioning itself in its markets as an innovative dental supply company with a strong technology focus (as opposed to the traditional amalgam supplier that many in the industry still see it). This corporate re-positioning is expected to be complete by the end of the calendar year.

To further its innovation, Management expect to invest approximately 5% of sales on research and development initiatives as they look to continue to develop high quality dental products to sell to their customer base in over 100 countries. As an example of their innovation and unique product offering, SDI note that a major multi-national competitor continues to purchase a high end glass product from SDI that is not available elsewhere.

SDI’s product portfolio will be enhanced during FY17 with the release of two new products that Management are positive about – a new LED curing light and a new Riva Glass Ionomer product.

SDI’s

share price continues to perform well on the back of its FY16 result, a positive outlook, improved investor relations and wider market recognition.

Happy Investing,The team at TAMIM

Time to Buy the Banks?

by Amy | Sep 29, 2016 | Bank, Stock Insight

This week Vincent Cook, senior analyst with the fund underlying the TAMIM Australian Equity Growth & Income Individually Managed Accounts (IMA), takes time out to discuss the Australian Banks. There is a significant amount of negativity in the Australian press regarding the outlook for our banks however we see some positive signs with indications of consolidation appearing in the sector. Given the worry about Deutsche Bank and banks in general, it is timely to discuss our thoughts on the sector.

This week Vincent Cook, senior analyst with the fund underlying the TAMIM Australian Equity Growth & Income Individually Managed Accounts (IMA), takes time out to discuss the Australian Banks. There is a significant amount of negativity in the Australian press regarding the outlook for our banks however we see some positive signs with indications of consolidation appearing in the sector. Given the worry about Deutsche Bank and banks in general, it is timely to discuss our thoughts on the sector. Read on to find out more.

Time to Buy the Banks?

The major banks are currently trading at the largest PE discount relative to the All Industrials ex Financials since 2001, at 35%, which compares to a 10 year average of 20% (figures from UBS), reflecting fears including capital requirements and bad debts.

A case can be made that some of these concerns may be overplayed and we believe the sector is now discounting the fall in margins and ROE, a tightening in lending requirements to the property sector and Basel III changes. While it is too early to suggest we are back into an uptrend especially given the concerns around the European banking sector, it is certainly worth highlighting some positives on the Australian Banks.

Capital Adequacy:In terms of capital, the Financial System Inquiry recommended that our banks be unquestionably strong, with the benchmark being top quartile capital ratios relative to international peers. The banks have already achieved this, as illustrated by the below chart from CBA’s FY16 result presentation.

Revisions to the Basel III capital measurement framework are expected from the Basel Committee towards the end of this calendar year, which may push this benchmark somewhat higher. However, governments and central banks, particularly in Europe and the UK, have begun to push back against ever increasing capital requirements, which may mean that the new requirements are not too onerous. The oversight body of the Basel Committee said in a statement in September 2016 that they had “discussed the Basel Committee’s ongoing cumulative impact assessment and reaffirmed that, as a result of this assessment, the committee should focus on not significantly increasing overall capital requirements”. APRA’s Wayne Bayres also said in January 2016 that the changes in the pipeline will likely be “well within the capacity of the banking sector to absorb in an orderly fashion over the next few years”.

A key difference between the prospective changes and the situation in 2015 is that APRA is talking about a multi-year time frame, whereas the 2015 raisings were driven by a change to mortgage risk weights on only a 1 year horizon. A multi-year time frame gives banks the opportunity to accrete the additional capital organically, from retained earnings. A worst case scenario is probably capital raisings of a similar magnitude to those in 2015, which diluted shares on issue by around 5%, while organic capital generation combined with dividend reinvestment plan dilution of 1-2% may be a more likely outcome.

Bad Debts:

In terms of bad debt risk, the back drop to the current situation is that interest rates are at record lows and business and personal credit growth, historically the key drivers of impairments, have averaged 2.0% and 1.0% respectively since the GFC i.e. we have not had a systemic buildup of credit risks. There are pockets of weakness, such as the mining sector and a potential oversupply of residential apartment developments, however these represent a relatively small share of bank lending, at sub 2% each, with residential development lending also generally well secured. The banks were burnt by commercial property lending in the GFC and subsequently tightened up their risk standards. Hence the fallout from an oversupply of apartments may hurt the profits of some developers of lower quality stock, but have only a limited impact on the banks. Sector impaired assets as a percentage of loans have declined materially in recent years and remain at low levels, as shown in the chart below from CBA’s FY16 result presentation.

EPS and DPS growth is expected to be non-existent (or slightly negative) for the banks sector in FY16, driven by the capital raisings undertaken in 2015 and a modest increase in bad debt charges from record lows. However, system credit growth is continuing at a reasonable clip of 6.2% for the year to June 2016 and the banks are targeting costs. For example, WBC is aiming for cost growth of 2-3%. Assuming the banks concede 1-2% per annum of the revenue growth from increased loans to competitive pressure on margins, these drivers could deliver reasonable, mid-single digit EPS and DPS growth over the medium to long term.

Conclusion:

We are now less then 45 days out from the ex dividend dates of the major banks. Traditionally bank share prices will run into the dividends as income conscious investors buy the banks to comply with the 45 day rule. Assuming the European banks do not melt down this could be an opportune time to pick up some Australian bank exposure yielding 8 to 9%.

Happy Investing,

The team at TAMIM

Stock Picking – Auckland International Airport (AIA.AX)

by Amy | Sep 8, 2016 | Stock Insight

This week Michael Newbold, senior analyst with the fund underlying the TAMIM Australian Equity Growth & Income Individually Managed Account (IMA), takes time out to discuss Auckland International Airport (AIA.AX) – a solid defensive yield stock. AIA has been a strong performer for our growth & income portfolios in recent years. However, with a changing risk-reward profile we have begun to trim the position. Read on to find out why.

This week Michael Newbold, senior analyst with the fund underlying the TAMIM Australian Equity Growth & Income Individually Managed Account (IMA), takes time out to discuss Auckland International Airport (AIA.AX) – a solid defensive yield stock. AIA has been a strong performer for our growth & income portfolios in recent years. However, with a changing risk-reward profile we have begun to trim the position. Read on to find out why.

Stock Picking – Auckland International Airport Ltd (AIA.AX)

Auckland International Airport Ltd (AIA.AX) remains a solid defensive yield stock that is performing very strongly with traffic growth at multi year highs, helping to drive other areas of the business. Industry dynamics continue to be very positive for airports with the real cost of travel declining while disposable income and propensity to travel continue to increase, particularly in emerging economies.

Management seems very confident in the outlook for the business with traffic growth strong, the Auckland property market in an upswing, retail benefitting from the new duty free operators and revenue to step up over coming periods from the delivery of additional retail space and areas like car parking also seeing solid growth. Risks still exist around the pricing reset in 18 months’ time but management still seems comfortable that they have levers to pull to maintain an inflation level increase in aero-charges.

Our valuation (based on a blend of discounted cash flows (DCF) and multiples) and target price increases to NZ$7.03 (from NZ$5.92) reflecting a roll forward of the valuation and updated growth assumptions. This trails the current share price of NZ$7.68 and implies a -6% total shareholder return (TSR). Average 12 month forward broker valuation is NZ$6.12 (range from NZ$5.00-7.95). The street generally can’t get its head around the currently priced valuation on AIA and we are struggling too.

Trading on 22.8x FY17F EV/EBITDA (vs an historical average 14.5x, 18.8x 2-year average) and a 2.6% yield (vs 3.6%, 3.2%), AIA looks fully valued at current levels.

Auckland Airport is a quality asset that is well held internationally and is an important part of the NZ index. Given the quality of the business and solid outlook, we don’t see a significant catalyst for a derating in the short term (aero pricing outcome is the biggest issue) and we expect it to continue to trade at elevated multiples (especially with the NZ Reserve in a rate cut cycle). We also note that Sydney Airport Holdings Ltd (SYD.AX) is trading well ahead of historical multiples. However, interest rates are closer to the bottom and we are arguably starting to see a cyclical shift as the US moves to increase rates and further interest rate cuts are being seen as being more detrimental than beneficial.

We reduced our position after the last result and may look to reduce again from our current holding. While management is executing well, it is hard to argue that the largest portion of the +60% TSR over the 12 months to 2 September reflects the 21% earnings growth and 20% dividend per share (DPS) growth. The return is more reflective of global bond rate movements and these will normalise over time with the next US lift likely by the end of December. The Australian share market is heavily exposed to the yield trade and when it turns it is likely to be relatively rapid. Those investors blindly holding stocks for their ongoing yields will be hurt. Finally, those stocks that have rerated most through the cycle are at most risk of derating and AIA is a leading candidate in this regard. In this scenario, AIA could trade down to NZ$6.06-6.25 some 19-21% below current levels. If it were to rerate to long term multiples (unlikely) the downside is 28-44%.

Happy Investing,

The team at TAMIM

Stock Picking – SDI Limited (SDI.AX)

by Amy | Sep 1, 2016 | Stock Insight

The Australian smaller companies universe is home to a number of companies which are building global leadership positions in their respective niche markets, and yet somewhat surprisingly remain largely unrecognised in the local investment community. Identifying these types of businesses is both the passion and the bread and butter of the manager of the TAMIM Australian Equity Small Cap IMA. We are pleased to provide a profile of our investment in SDI Limited (SDI.AX).

The Australian smaller companies universe is home to a number of companies which are building global leadership positions in their respective niche markets, and yet somewhat surprisingly remain largely unrecognised in the local investment community. Identifying these types of businesses is both the passion and the bread and butter of the manager of the TAMIM Australian Equity Small Cap IMA. We are pleased to provide a profile of our investment in SDI Limited (SDI.AX).

Stock Picking – SDI Limited (SDI.AX)

SDI Limited (SDI.AX), a Melbourne based manufacturer and exporter of dental products. Established in 1972 by Jeffrey Cheetham, a trained metallurgist, SDI operates in the global dental equipment and consumables market, which is estimated to be in excess of $25 billion. SDI exports around 90% of its products to over 120 countries.

SDI commenced operations in Jeffrey Cheetham’s garage, producing amalgam fillings and selling the products direct to dentists. By 1975, the company had operations in New Zealand, United States and Greece. Following a decade of national and international success, the company listed on the ASX in 1985. A strong focus on research and development has seen SDI develop an extensive portfolio of innovative restorative and cosmetic dental products including fillings, cements, tooth whitening products and associated dental equipment, with market leading positions in various geographies.

SDI has offices and warehouses in Chicago, USA; Cologne, Germany; Dublin, Ireland and a recently commissioned packing facility in Sao Paulo, Brazil, and turns over in excess of $70m annually.

WHY IS SDI TRADING UNDER THE RADAR?

SDI is a relatively small family-controlled and family-run Australian company which competes against some large multinationals. The company has had an operationally challenging past few years with its performance subject to foreign exchange and commodity price fluctuations, and as a result, trades very much under the radar.

SDI has built its reputation as a supplier of high quality amalgam (silver and mercury based) dental products. However, as consumer preferences have shifted towards more visually appealing dental products, there has been a move away from SDI’s original core amalgam products. As a result, SDI has struggled to generate significant sales growth momentum in recent years.

Fortunately SDI’s more recent research and development initiatives have been focused on non-amalgam products, which is where the industry growth is. The company has been developing a more complex glass ionomer product range, as well as composite and whitening products. Given SDI’s historic reliance on amalgam products, the transition from amalgam to non-amalgam product sales has taken some time.

However, with amalgam sales now representing only 36% of total sales, SDI has successfully managed this product mix transition.

All of SDI’s sales growth in recent years has come from non-amalgam products as shown below:

While amalgam sales have essentially been flat since 2012, non-amalgam sales have increased by over 30%, and have shown consistently strong year on year growth. The more complex non-amalgam products attract a higher gross margin, which, together with the company’s increased scale, has helped to drive SDI’s net profit from $2m in FY12 to around $7.5m in FY16.

COMPELLING VALUATION

Based on its recent guidance, SDI is trading on a FY16 p/e of around 11x, and on an Enterprise value / EBITDA multiple of 7x. It should be noted that SDI capitalise, rather than expense the majority of their research and development costs, which potentially overstates their reported net profit. However, these valuation metrics suggest to us that SDI is under-valued for a business with a strong global sales reach and solid growth prospects.

OUR VIEW

SDI is a great example of a small Australian company developing unique intellectual property and achieving global success in its chosen niche market. We believe the stock deserves its position in our emerging global leaders list.

A sell-down by one of SDI’s larger, long term institutional investors has recently provided some liquidity in this somewhat illiquid stock, and has enabled new institutions and shareholders to enter the register. Whilst SDI is very much perceived as being a family run company, there is the opportunity for a stronger non-family aligned shareholder base to now help change this perception.

For many years the company has demonstrated its ability to consistently bring innovative new products to market. With a strong culture of research and development SDI has excellent potential to continue to grow its sales by expanding its product portfolio and its customer reach, and to become a more robust and larger company. We are happy long term shareholders.