SDI Ltd (SDI) is an Australian-based dental products manufacturer, which exports 90% of sales through a distribution network to more than 100 countries.
A combination of supportive external drivers, new products and other internal efficiency initiatives has placed the company on a path for further growth with a recent profit upgrade.
In 1972 Jeffery Cheetham started the company with his wife, initially just manufacturing the grey and inexpensive amalgam fillings. Prior to starting the company Cheetham worked for a US-based company that imported dental products to Australia. It was there that he identified a gap in the market with no local manufacturers.
In 1985 the company publicly listed as Southern Dental Industries Ltd. Today Cheetham is executive chairman, his daughter Samantha is transitioning to become the managing director, and he has three other sons all working in the business.
Demand for the grey amalgam fillings has steadily declined over the years as they are replaced by tooth coloured composite based fillings. Although amalgam remains popular in third-world countries, SDI can benefit from the expected shift towards higher-value restorative products in developed nations. Over the years a huge amount of intellectual property has been developed, with three new products released last year and expectations of more to follow.
The high-value range of new restorative products is a growing global market. An example of the benefits from the company research and development program can be seen from the Glass Ionomer restorative range of products. These now comprise approximately 15% of sales, with the proportion likely to increase further over the next few years. The competitive positioning in this market is strong, with only four manufacturers globally.
With Jeffery Cheetham 70 years of age and owning approximately 47% of the company there is certainly a high degree of key man risk. However, his daughter has been earning her stripes for more than 20 years and at age 42 appears well placed to take over. Jeffery Cheetham will remain chairman, and is likely to pursue his keen interest in working with the scientists and chemists to develop new products.
Silver is the company’s largest input cost for the amalgam fillings, with the stabilised silver price and lower Australian dollar to provide more supportive operating conditions than recent years. In 2011 the silver price hit a peak of $50 per ounce, compared to approximately $20 today.
The company’s manufacturing facility in Bayswater, Victoria is technologically advanced. The high degree of automation has reduced the manufacturing staff headcount, and increased earnings margins. Whilst the major manufacturing process remains in Australia, packaging has been outsourced to various lower-cost overseas locations including the Philippines.
The improved profitability in FY13 and again this year has also enabled the capability to review the management structure, and increase the sales and marketing spend globally. The appointment of senior managers in both Europe and the US has improved the company’s marketing reach, and also reduced the sales task for Samantha Cheetham.
With the recent profit upgrade to $65 million sales, and $6 million net profit after tax, it places the stock on a price earnings ratio of approximately 10, with expectations of continued growth. In earlier years before the GFC, the stock had periods of trading at very high P/Es. For example, in 2003 when the Australian dollar averaged US65 cents, and demand for tooth whitening initially increased, it traded on a P/E of up to 50.
Tooth whitening remains an important category for the company. Colgate dominates the over-the-counter market, however SDI is a leader in many regions for sales direct to the dentist. This is a premium $500-$1,000 product. In Australia and UK they lead this segment and are number two in the US. Tooth whitening is now a $2 billion global market, with $500 million relevant to SDI.
With the head-office in Australia, SDI has another five subsidiary companies in Germany, North America (Chicago), Brazil, Ireland and New Zealand.
A large sales and marketing focus is placed on the unique dynamics of each market. For example, the mix in demand for high value versus low value dental products. In Australia and the US there is an increasingly cosmetically focused population who embrace innovative products.
The relative advantage of currency moves also drives the priority in marketing focus for each location. At times hedging is used for both currency and the silver price.
Although the silver price has stabilised in recent times, a key risk for the company would be a sharp sustained increase.
Generally speaking, the competitive structure of the industry appears supportive. There are two large competitors in 3M and Colgate, and then many smaller competitors who generally service the one location. An ongoing competitive risk is that other companies come out with new innovative patents and products before SDI.
The dynamics of the family-run business is a risk that can be tough to assess from the outside. The management team does have some quality non-family members as well, including the two man finance team of John Slaviero and Larry Squillace and the head technical director Ray Cahill.
The family members have been largely spread out in separate divisions, possibly to minimise the potential for conflict. Samantha Cheetham is in charge of sales and marketing, Joshua the R&D director, and Nicholas who is operations and IT director. Another of the Cheetham brothers works under Samantha in the sales team.
With the 47% Cheetham family ownership and two other 5% shareholders, there is a lack of free float which presents a stock liquidity risk for shareholders.
We view any management ownership above 30% as a risk due to a potential conflict of interest in trying to maintain control of the company.
Valuation and Recommendation
The company believes it has the manufacturing and marketing capacity for $100 million of sales with minimal additional costs. Therefore, with FY14 revenue at around $65 million any increase towards $100 million revenue would produce a large increase in margins due to a larger percentage of sales falling to the bottom line.
Management is focused on further reducing debt, although it is down to a comfortable 10% of equity.
Assuming no major currency or silver price moves, we are forecasting an annual growth rate of 10-20% for the next three years.
We have a Buy recommendation and $0.75 discounted cash flow valuation and target price.
To view SDI’s Forecasts and Financial Summary, click here.