New Holding; Scientific Digital Imaging funded by sale/cutting of Superdry

Scientific Digital Imaging (SDI.L AIM All Share, Market Cap ÂŁ35m, 39p, 1.5% of JIC Portfolio and 0.0% of JIC Top 10)

I have introduced a new holding to the Portfolio this morning. I have been looking at SDI for some time and on Friday I lunched with the Chairman, Ken Ford and CEO, Mike Creedon.

Conclusion: To buy SDI one is buying into a buy and build strategy being managed by a first-rate team, with ambitions to grow the company into a £100m + market capitalisation business. I think that it has done enough so far to demonstrate its strategy and its ability to add shareholder value. It looks good value at current valuation and Finncap’s target price of 51p does not look out of order. However, I am buying this as I expect the share price to do much better than that over the next three years or so.  It is not without risk; it is a small company and a poor acquisition could have a material effect on results, the company’s valuation and its ability to do future deals. It is also quite illiquid and one where one should be wary of chasing the share price. A sudden spike up, often leads to profit takers emerging and the share price drifting back. It pays to be patient! I have bought a 1.5% position to start with but intend to increase it to 3.0% in due course. 

Time to grasp the nettle. Last week when I wrote up Serica Energy, I asked, “would I buy it now if I didn’t already hold it?” In that case the answer was a resounding yes. I have gone through the Portfolio and one where I really can’t give that answer is Superdry. It has been a huge mistake and I have several misgivings: the current management team might not be doing the right thing to get the brand back on track; the brand might have seen its day, (in the same way as French Connection had its time); it is the most shorted stock of all my positions. Quite often the “shorters” get it right! There is a compelling value story but for the share price to recover it needs to start to beat expectations and for a recovery to reflected in improving financial results. In a year’s time there is a risk that I will look silly, (i.e.to have sold it near the bottom) but I think I will have done a lot better out of Scientific Digital Imaging. Time will tell. 

Superdry is my third largest loss by monetary value since inception of the JIC Portfolio in January 2012. In terms of performance it has knocked 1.5% of the performance of the JIC Portfolio since buying last year. 

What does it do?

From its website: “Scientific Digital Imaging plc (SDI) designs and manufactures scientific and technology products for use by the life science, healthcare, astronomy, consumer manufacturing and art conservation markets through the Synoptics brands (Syngene, Synbiosis and Synoptics Health), the Atik Cameras brand, Quantum Scientific Imaging, the Opus Instruments brand (Osiris), Sentek, Astles Control Systems, Applied Thermal Control as well as the recently acquired, Fistreem International.

SDI continues to grow through its own technology advancements, as well as through pursuing strategic, complementary acquisitions.”

Why am I investing:

Ultimately, I am backing the management and its ability to add shareholder value through sensibly priced acquisitions. I am also backing them to increase the value of the acquired companies through investment and more focused management. By more focused, I mean on growing turnover and more importantly profits and cash flow.

I have known Ken Ford for many years and trust him implicitly and have absolute confidence in his ability to steer the company in the right direction. As a former corporate financer in the City he has great experience in the mergers and acquisition world. In short, he knows how to make money.

I was also impressed with Mike Creedon, CEO and I think the two of them make a good team. Mike struck me as being 100% on top of his brief in terms of the everyday management of the group as well as being involved in assessing potential acquisitions.

On the acquisition front, it likes companies where it sees growth prospects, the ability to generate cash, usually a niche player with barriers to competition, a direct relationship with customers, (no middle men taking their cut) leading to high gross margins. It aims to pay between 4.0x and 6.0x profit before interest and tax.

Last week’s acquisition of Graticules is a good example. It paid £3.4m free of cash or debt. That represents c. 1.8x 2108 sales and 5.1x 2018 EBITDA, (earnings before interest, tax, depreciation and amortisation). It funded the purchase from cash resources and some of the proceeds from a £2.5m share placing at 34p. FinnCap expect the acquisition to be 1.0% accretive to earnings per share in Fiscal Year 2019 and 6.0% in FY 2020.

Graticules is based in Tonbridge and applies chemical etchings and micro patterns to glass, film and metal foil, serving the microscopy, metrology, education, scientific and defence markets.

Group track record as at the first half ended 31stOctober 2018: Since 2014, when the current management team took control, it has made eight acquisitions, four of which were stand-alone operating units and the other four were combined with existing units. Sales grew by a compound annual growth rate of 27% between 2015 and 2018, with pre-tax profits growing 82.0% per annum. The share price has appreciated by 147% since January 2014. Importantly to me, cash generated from operations has exceeded adjusted profit before tax in each of the last four years.

Stockopedia: it has a StockRank of 84, with Quality of 94, Value of 36 and Momentum of 73. Price to free cash flow is just 15.5x. It does not yet pay a dividend, and there is an argument for them not; if it can generate a higher return through re-investing cash in acquisitions, it makes sense to do so. The alternative argument is that some will not invest in companies that do not pay dividends and therefore paying a small but growing dividend might lead to a higher rating for the shares. That would be helpful when issuing shares for acquisitions, (it would need to issue fewer shares and therefore the acquisition would be more accretive to share holder value). I made that point to them and it will be interesting to see what they do.

For what it’s worth, Finncap have increased their share price target to 51p. At the current share price, the company is valued at 15.4x April 2019 earnings forecast and 12.4x April 2020. That does seem cheap to me for growth of 24% growth.

I got 507p for my Superdry and paid 38.88p for SDI

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