The AGM recording is available: Stealth Group Holdings AGM 2024 - Webcast Recording on Vimeo

After market there are 35 buyers seeking 1.2m shares from 1 seller of 50k shares… gives you a feel for investor opinion on the results and AGM.

Mike focused on the FY25 to FY28 outlook and plan in his presentation, have a look. 

My takeaway is the focus on efficiency and growth that improves margins and profitability is the story, the same one as when I initially invested 3 years ago. The $60m sell through is still in the plan, starting in next 90 days under a new business “United Supply Company”.

Disc: I own RL+SM

Mike Arnold sold 500k shares of his 10 mil (5%ish) for 200k ‘for tax purposes’

Unconcerned. Small amount of shares and Mike remains a very significant holder of ~10%

Taking stock of the release of Stealth Group results over the past 72hrs I sat back and listed why I bought a slice of this company.

This was over two years and the underlying basis / reason was VALUE.

Stealth was trading cheap across all metrics including share price. I found the Free cash Flow yield (FCF) over the past 2years as the most interesting. At 28mill market capitalisation and with FCF 4.7m yield is 16.7%. This presents itself at 3-5x higher than other retailers.

Stealth Group wasn't performing or delivering results with ROE of 20% + two years ago. The results were more like mid single digits ROE but on the pathway to be profitable and grow its margins and customer base.

Without needing to do much right, consensus (which is always scary) saw more upside than downside. A value play indeed. These factors still present themself in 2024 even though we have good appreciation in market capitalisation and share price.

Stealth Group continues to craft its niche to be an alternative to the majors and in doing so there will be questionable acquisitions and moments in its trading results to but what was attractive over 2 years continues to hold true in 2024 in terms of of a value play.

WHY?

Time enables us to watch and assess the credibility and quality of the CEO and management group and although we have seen slips in the revenue forecasts what i ascertain is that this has been done with the profitability lens (see below in the Individual Business Highlights). This has and is more critical for stealth being in a low margin highly competitive market.

Comparing with other retailers for FY24 we have seen revenue fall for HVN (8.9%), ADH (4.3%) but NPAT fall significantly higher HVN (34.7%) ADH (17.8%). This has not been the case for Stealth infact we have seen rise in revnue but significantly higher rise in profitability and EPS.

Its fair to say that the environment is tough in retail.This is not only reflected in Stealth commentary but was also a feature in Wesfarmers results re Bunnings and Blackwoods last week . CEO Rob Scott and divisional lead for Bunnings were put under much pressure on the conference call last Thursday re Bunnings flat growth and outlook.

I find Mike's approach refreshing especially in delivering shareholder value (self interest plays a major role)

There were question marks over two years ago and there are question marks today which i look forward to the upcoming conference call on Thursday 5th September to have them answered.

What must be recognised is the improved business results over the past 2 years . This in turn has seen share price appreciation well over any index and most small cap stocks.

This does not gaurantee success going forward but as we all recognise past behaviour is a good predictor for the future.

Taking a detail look into Stealth Results i would rate 7/10.

The areas of watch :

• Force acquisition and outlook in terms of revenue and profitability
• Revenue growth especially organic 2025 - 2028
• 60mil plus in revenue flagged in new organic at AGM in 2023

Metric focused organisation - Highlight and strength and hard to fault . Keen to see the next two years in terms of these trends evolving especially in light of the Target 300m in revenue and 8% EBITDA margin call out by 2028.

Impressive is the 28.1 % growth in EBITDA in light of 19.4% revenue growth. Highlights focus on profitable customers.

Also important to call out the improvement made in inventory as a % of sales which has fallen from 16.1% to 13% or 19.25%.

Mike and the team clearly understand the importance adjusting as conditions change and improved inventory management.

Ability to pivot - In H2 when revenue fell away its clear Mike and team pulled back accordingly on costs reflected in personnel costs as a % of revenue falling from 18.2% in H1 to 17.4% in H2. This resulted in total expenses as a % of revenue falling from 24.5% in H1 to 24.1% in H2.

As sales with Force acquisition kick in this will be a key watch in terms of maintaining this downward trend for costs.

Clear in guidance - Mike and the leadership team haven't hesitated to put on the table the aspirations in seeking to gain share of the fragmented industry of industrial maintenance, repairs and operations and now with Force consumer technologies products and services. Albeit having to adjust as conditions alter Stealth North Star of 300million and 8% EBITDA by 2028 is set and clear.

Taking the outlook and guidance numbers provided above the range of the results may evolve to be

Rev - $159m

GP - $46m-55.65m

NPAT - $2.38m - 5.565m

EPS 2c- 4.78c

Div - 1.2c - 2.86c (60% payout ratio assumed).

Held

Stealth just issued another slide deck, as part of a presentation to ShareCafe.

I'll highlight what i see as the new information in a minute, but boy, this really hasn't been a smooth process.. As others have noted, you have weird (nonsensical?) performance calculations & inaccurate charts, and less than 24 hours after your own investor briefing, you do another with a 3rd party that includes new information..!

Probably a reflection of a small team, and maybe it's a good thing they aren't engaging some IR firm to manage things (and exaggerate them). But still.. it's a bit amateurish!

Anyway, here's the latest presentation -- Stealth-Investor-Webinar-Presentation2.PDF

The key differences to yesterday's presentation i saw were:

1. The most important difference is Slide 18 which provides specific financial guidance for FY24, including expected year-on-year growth ranges for sales, gross profit, EBITDA, EPS, and capex. This forward-looking information may have been discussed verbally yesterday? But I don't believe so.
2. Slide 10 provides updated "Key Numbers" after the acquisition, such as the $159.0m pro forma FY24f revenue, 250 team members, and over 3,310 retail reseller stores. The first presentation had slightly different figures.

So if NPAT is 25% higher, that gives us a FY24 value of $1.125m (last year was $0.9m)

Of course, post acquisition there will be an extra 14.4m shares on issue, or let's call it ~115m in total. So that's an EPS of 0.98cps. Last year they did 0.91cps, so that's growth of 7.7%.

SGI is right that EPS growth will be 25% if you exclude the Force acquisition (about 3 weeks contribution and extra shares). Maybe it's too late on a Friday, but I'm struggling to work out what the EPS will be in FY25 based on what has been said.

Here's my thought process (someone please correct me if needed!):

• FY24 NPAT (ex-Force) = 0.9m x 1.25 = 1.125 million
• On a per share basis, accounting for dilution, that's 0.98c
• FY25 EPS including the accretive impact of Force (expected to be ~26%) = 0.98 * 1.26 = 1.23 cents (this is before any new revenue contribution)
• So that puts SGI on a forward PE (using FY25 forecast as FY24 is essentially over) of 22.5c (current market price) / 1.23c = ~18.3x
• 
  

I'm just not sure if i'm interpreting what they are saying correctly...? Still, that's a higher PE than I was expecting, but if I'm understanding things right that doesn't include any organic growth from the legacy business or the new one. And you'd like to think we get some of that!

As has been noted, Mike suggested $300m in revenue by FY28. Let's assume a EBITDA margin of 6% by then (it should be 5.7% this year, compared to 4.7% last year, and they have suggested previously 8% is reasonable at more scale). That'd be a FY28 EBITDA of $18m, which is almost 3x what they should do this year.

Let's thumb suck a net margin of 3% to get a FY28 NPAT of $9m, or 7.8cps

That's certainly a lot of growth, and even if you do use a forward PE of 18, that'd be more than justified if true. But it comes down to a lot of revenue growth (around 20%pa, and continued margin expansion).

It seems possible, but the expected sales growth for FY24 isnt huge (and why is there such a range given there's only 3 weeks left in the financial year)..

Anyway, too much thinking out loud for me. I need to ponder this a lot more..

Thanks for your updates and insights @mikebrisy, @Tom73 and @wtsimis. Sounds like a strong meeting with quite a detailed trading update from Mike. Some AGMs are dry. Mike’s openness perhaps reflects his confidence in progress and comfort in share price increase.

Stealth has now more than doubled in value for me. I built to a large position and I’m now pondering my outsized holding. I’m also contemplating @Strawman’s frequent reflection that some of his bigger regrets are decreasing holding too early. Stealth is now around the fair value that I’ve posted on Strawman for the last couple of years. That fair value was based on a discount rate of 20% that I used because of razor thin profit and illiquidity.

I’ll continue to hold. My 20% discount rate implies a forecast 20% return at current share price. The assumptions behind my valuation are starting to seem conservative with the continued positive and open updates from Mike. I’ll resist the fear, trust in the process, and continue to stay the course!

Another reflection and lesson for me with Stealth … In an odd way I’ve been lucky that Stealth has taken so long to see a significant share price increase. I started accumulating 3 years ago. I presented my stock pitch for Stealth on Strawman a couple of years ago soon after I joined in late 2021. My conviction just continued to grow with the support of all of you in the Strawman community who have debated the pros and cons of Stealth. Up until about a year ago I continued to build my holding until it was my largest holding and I wasn’t comfortable putting more in. All up it was about 3 years between first investment and significant increase in share price. Our natural desire is for price to increase as soon as we start to invest, that provides immediate validation of how smart we are. But quick price increase deprives the opportunity to steadily dollar cost average into a large holding.

So, note to future self; be content when the share price DOESN’T increase soon after you spot an opportunity, it’s better to be slowly right than quickly right.

Further to @Tom73's straw, here are the notes I took at the AGM today.

I won't summarise Chairman Chris Warton's address, which you can read here.

Mike gave up an update presentation which had some usefuly information. I'll focus on two elements:

1. FY24 Trading Update
2. Update on Strategic Initiatives

Overall, he was his usual matter-of-fact delivery style, although at the start he indicated his delight at the recent share price progression, and clearly sounded more upbeat that the progress they are making is getting recognised.

1. FY24 Trading Update

The Trading Update gave information on the 1^st four months of 2024.

The chart below shows how the segmental split of sales has evolved, with two views presented: product segment and customer segment. The shares of workplace, safety and automotive segments have all increased slightly at the expense of industrial. On the right of the chart, Mike noted that declining share of Retail and Trade and Other (“small end of town”) customer segements is consistent with the overall trend they are seeing in other businesses.

In the next slide below from Mike’s presentation, it is titled “Highlights - year in review” but it has some relevant current year insights, which I will explain below.

Mike noted that on sales revenue in 1H FY24 vs FY23, they achieved 15% EBITDA “received on additional sales” – this is a key metric Mike has referred to in the FY23 results and, also, I think in his Strawman meeting. Given their statutory EBITDA Margin in FY23 was 4.8%, this would indicate that operating leverage is coming through as Mike has indicated it would. Should this trend continue, it will drive ongoing margin expansion over time. And Mike discussed this in terms of their target to achieve 8% in FY25, and also its significance in terms of their target range of achieving 10%-15% EBITDA margin on all incremental sales into the future. Good to see the evidence showing through.

On scale benefits, Mike described how the centralised purchasing office is achieving scale benefits. This is achieving a 2% to 4% uplift in margin, equating to $1.3m NET, with most of the benefits starting to flow in January / February.

Of the 8 new contracts signed last year with customers, 2 will start in March and 1 in May, with pre-determined order values with purchase orders supplied. One is for $6m for a supply over a two-year period. Mike said “We’re getting invited for big tenders, we’re winning those big tenders. And the investment we’ve made in technology has allowed us to onboard large customers now that we have an EDI linkage … which means that every order they supply to us comes automated instead of via email or via phone and then we manually have to key that in.” So, he said this is driving the people efficiency metrics, which I’ll show below, 2 slides down.

The trading update is shown in the next slide.

Against the 1H revenue target range of $55-$59m, they are at $39.0m after 4 months.

So, by my maths that's 68.4% of the mid-range with 67% of the time elapsed. (But I have no idea what the seasonality is towards the year end, so I can't read anything into that.)

Looking back at the same time last year, their 4 month result of $36.0m ended up being 68.7% of their 1H FY23 result of $52.4m. So they are pretty consistent.

The $39.0m represents +8.3% over the PCP.

So, overall, they appear on track for revenue to be within the 1H guidance range.

On costs, Mike spoke about some of the wage inflation challenges and said “our costs have increased roughly 7.4% since 1^st July.” The are clawing this back in the "pricing reset program", mentioned at the FY23 results, however they are only 17% of the way through this, so there is still margin “uptake” still to come. Mike said “we are receiving more gross profit per order and that will obviously benefit us as well when our results come out.”

Mike noted that 1H represents about 42% to 45% of the FY result so, from his perspective, he considers that they are “sitting ahead of plan, which is encouraging.”

Mike then showed the comparable per day metrics over the 1^st 4 months FY24 compared with FY23, slide shown below.

I note the daily sales are higher than I calculated in the pcp comparison in my analysis above. Overall, these metrics are encouraging.

I haven’t tried to calculate the potential EPS – slightly tricky with the FY23 result coming off a small base. But they should be making decent progress off these operating metrics.

Encouragingly, the overall business progress appears to be holding consistent with the “non-discretionary” banner that both the Chairman and MD tout.

2. Update on Strategic Initiatives

Mike called several strategic initiatives:

Loyalty Rewards Club, which gets rolled out in March. They hired a couple of people with experience doing this elsewhere, and expect it to drive both revenue and profit.

Launch of a Superstore format, coming first with a redesign of the Brisbane facility, and then will be replicated elsewhere. They are getting support in merchandising and fitouts from suppliers, so not having to bear the full cost. Four other locations have been identified for refurbishment and fit out.

Consolidating Skipper Transport into Heatleys to create a new category format of “Safety, Industrial, Automotive”, something Mike says he saw in the US, and where he perceives there to be a gap in the Australian market. By December the two current ERPs will be integrated onto one system – “quite a significant investment that we’ve made”.

Launch of a Hire Business operation, already operating in Queensland, but to be rolled out across the network focused on the “smaller end of town”. It covers tool, equipment, and lighting, and has alongside it the sale of all the consumables, PPE etc. that are needs for any hired equipment operation. Mike spoke about the attractive metrics, with payback on investment in the first 13 weeks, whereafter revenue drops straight to 100% gross profit, and then items are sold after a further period to recover value.

My Overall Takeaways

Good progress showing through on a range of metrics and very consistent where Mike indicated the business would be heading at FY results and at the SM meeting.

I have only a small position, which I am minded to increase, but will wait to see if there are opportunities to do better than today's SP.

Disc. Held in RL and SM

As mentioned yesterday, @Strawman's and @DrPete's enthusiasm for $SGI spurred me into a deep dive into the numbers of the business. In this straw I outline the potential earnings and cash flow leverage the business has to modest organic growth and margin improvement. It’s not a valuation, as such, but more like a sensitivity analysis that indicates the very material upside potential of the business.

 After reviewing the SM meeting recordings and recent company presentations, some key facts stand out:

• Revenue has grown steadily at a c. 15% CAGR over the last 4 years through a mix of organic and inorganic growth;
• Consistently profitable at Statutory NPAT level;
• Broadly cash neutral over 2019-2022, with 2023 a breakout with FCF of >$5m (although partly due to a higher than normal level of payables);
• Lean IT-system investments enabling adoption of best practice inventory management and (in future) dynamic price management; and
• Capital light model as majority of stores are partner-owned-and-operated.

However, what stood out most of all (and in fact really piqued my attention) was CEO Mike Arnold's assertion that their existing partners purchase some $60m of sales from the top 5 current $SGI suppliers but currently outside of the $SGI umbrella.

In valuing any business, I try to understand the quality of the organic revenue engine - particularly that which is accessible without significant new investments. So, I present below a set of scenarios out to 2027, to estimate the 2027 earnings, calculate value/share based on p/e ratios of 8, 12 and 16, and then discount these at 11%p.a. back to today to get some sense of the current value.

While about it, I consider a larger set of scenarios as follows, with further comments below on why I have chosen these:

• Annual revenue growth of 8%, 10% and 12% FY23 out to FY27
• %GM at 30% in F24 increasing progressively to 31% by 2027 (and 31.5% in the 12% revenue growth scenario)
• % Cost of Doing Business starting at 24% and falling progressively to 23% in FY27 (22% in the 12% revenue growth scenario)

Comments on values selected:

• Revenue: even in the highest 12% p.a. growth, this only takes 2027 revenue to $175m, so the lion's share of revenue growth could potentially be achieved by progressively capturing more of the potential partner volume from existing top 5 suppliers. This is an organic scenario and doesn't assume any network expansion.
• Gross Margin: with increasing volumes, better deals will be struck with suppliers. In addition, Mike has said they are going to add higher margin (albeit lower value) white label lines. Finally, the benefit of recent price increases initiated part way during FY23 are yet to show through, albeit they will be eroded by price and cost increases. So, the %GM margins are modest, and might even be improved upon. The table below shows the %GM in FY24 ("%GMi") and this improves incrementally and linearly to achieve with "%GMf" in FY27.
• Cost of Doing Business (CoDB): this assumes good cost control and it picks up on Mike's target that they can get from 24% to 19% over time, and that now incremental volumes are attracting a <10% incremenal CoDB. So, again, the range of scenarios is modest. The table below shows CoDB/Revenue(%) starting at "CoDBi" in FY24 (which is 24%) and reducing progressively and linearly each year to reach "CoDBf" in FY27. I assume there is greater leverage potential in the high revenue growth assumption.

I assume receivables, payables and inventory all scale with revenue (actually they should scale more slowly for a given network), and that other P&L, cashflow and balance sheet items scale with increasing Cost of Doing Business. However, I do assume a significant ongoing investment in systems, with FY24 (PPE+Intangibles) of $6.2m and scaling annually with CoDB. Mike will need to continue to make prudent systems investments to maintain an efficient, scalable operation.

With long term debt falling to zero, I assume the financing continues to be a revolving facility to fund progressively increasing inventory - the major balance sheet item. Interest rate of 7% is charged on Leases and Short-Term Financing.

I don't model any accumulation of free cash, so as far as the model is concerned all free cash is paid out and does not earn interest, but I have not tested this against the potential payout goal to achieve 5% yield, although the FY27 FCF looks pretty healthy and is lower than you might expect because I have a fair chunk going into Intangibles (IT Systems).

In essence, therefore, the modelling indicates the earnings and free-cashflow leverage over the next 4 years as $SGI passes through its inflection point.

Model inputs and results are presented in Table 1. I've then plotted the calculated $/share in three curves in Figure 1. Each curve lists the 9 scenario results for each P/E ratio. Assuming each scenario has an equal likelihood, results are plotted as an implied probability function.

TABLE 1: Scenario Inputs and Summary Results

To get your eye in on the graph below, the three results, 1.1, 2.1, and 3.1, show the effect of revenue growth and P/E expansion only, without any margin improvements.

FIGURE 1: Modelled Valuations for Each Scenario at a Range of Assumed P/Es

(Note: labels on blue line relate to scenario number; labels read across horizontally for orange and grey P/E curves)

Discussion of Results

First, I am not pretending to have properly modelled the value of $SGI. For sure, I have no doubt that Mike will continue to pursue both organic and inorganic growth, with the prospect that over the next 4 years revenue growth will be higher than I have considered. After all, the current target is to get to $200m revenue by FY25! (Good luck) Because of that, I don't think margins and cost of doing business will advance in the smooth way that I have assumed. If $SGI try to acquire their way to their targets, CoDB will likely go backwards before it improves.

However, I still believe the analysis is instructive because it confirms the following:

1. Material growth in value does not rely on driving revenue to achieve the FY25 "target"
2. There is a lot of leverage to modest improvements in margins and control of costs
3. Investments in technology to continue to support business scalability can yield significat returns, particularly if $SGI can continue to achieve a lean off-the-shelf approach to adoption of systems
4. The existing partner volumes that currently lie outside the $SGI supply chain are a very valuable prize.

Remember, all of this assumes that most of the growth will come from bringing much of the current $60m of purchases by $SGI’s partners from $SGI’s top 5 suppliers that is currently outside $SGI’s scope. Of course just because Mike is targeting this doesn’t mean they’ll get it. For example, perhaps current partners are obtaining these supplies via one of the category-focused market leaders (think workwear and PPE, autoparts etc.). These suppliers may already have a scale that means $SGI cannot offer better value. Time will tell. But this is one reason to consider this analysis a sensitivity analysis and not a valuation or prediction.

Key Takeaway

While my methodology and assumptions are very different to @DrPete's, the conclusion is the same. If $SGI continues to be well-managed driving a balanced approach to revenue growth, returns and operational efficiency, there is a very significant multi-bagger upside.

Risks? Of course there are several. Industrial MRO is a mature market and although $SGI highlight the huge market scale, there are existing players with 10-20x SGI's scale, including category specialists. It is easy to code incremental margin improvements in a spreadsheet, but not so easy to do deliver margin improvements in practice in such a market.

Moves by competitors to grow or defend share or existing partners defecting from the "$SGI consortium" cannot be ruled out. In fact, this potentially becomes more likely as $SGI continues to scale and improve its own margins. In my sensitivity analysis these downsides are not considered. So beware.

As ever, anything but the most modest of acquisitions would also be likely to muddy the waters, even if it expands the network and volumes which will ultimately deliver returns if $SGI continues to execute well.

So What? After All This Analysis!

If pushed, I’d venture that $SGI is fairly worth anywhere between $0.20 and $0.30 today. Over time, however, if it sustains a strong earnings growth trajectory, there is significant further upside if it re-rates to achieve growth stock P/E ratios. (A good comparator case study would be $SNL.)

So, I have voted up @Strawman 's valuation of $0.23 from 4 months ago.

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P.S. This morning, I pushed my order up to $0.155, and it cleared. Now looking a wee bit thin on the sell side!

Here's a recording of the recent results meeting: https://vimeo.com/805827197

Key points:

• It's a very resilient market. Most of what they sell (95%) they class as non-discretionary.
• The addressable market estimate is now over $50b -- and very fragmented. I read that as a lot of acquisition opportunity, and an opportunity to build a scale advantage over other players.
• Strategy is clear and consistent, with a focus on ROI and capital management. There's a long way to go before the vision is fully realised, but I think you can say objectively that the company's growth and execution has been pretty decent to date.
• Higher fuel costs and other cost issues a factor, but have the ability to pass on higher costs. Price rises will help improve margins in the coming quarters. Gross margins were mostly maintained in the reported period
• Getting more invitation to tenders. Not just about cost competitiveness, but range and reach.
• $260m worth of spend across the group -- have set up a procurement division to better leverage this to negotiate for better terms.
• Closed unprofitable sites accounting for $2.4m in annual sales. Only interested in sites that make financial sense, and will be focused on further rationalisation if needed. This should improve margins across the group, even though it will have a revenue impact. It's the right thing to do.
• Brands will likely be consolidated under one banner.
• Proprietary products expected to grow to 15% of total (also leads to better margins)
• Technology expected to help improve efficiency -- overall, very focused on costs and margins.
• Inaugural dividend proposed for FY24 (maybe 30% of FCF).
• Acquisitions remain a core part of the growth strategy, but next 6 months will remain focused on bedding down recent purchases. Have walked away from lots of opportunities. Must make financial sense.

Thesis remains on track.

Held.

I can create a naive valuation of over 50c but this ignores the risks. First the positive:

Revenue is on track for about $120M in FY23. Take 3% NPAT margin and a PE of 20 and I get a $1 SP. Only the revenue number is actually reasonable here.

SGI is a distributor on wafer thin net margins. There actual net margin over the last four half years (for ongoing business) was 0.1%, 1.6%, (0.8%), 1.6% with last FY averaging a tiny 0.5% overall. It doesn't take much to go wrong for target NPAT to be destroyed.

I've worked with and owned computer distribution businesses with a similar gross & net margin and here are a few observations.

• Growth sucks up working capital. If you double in size you need roughly double the stock in the warehouse and have roughly double the debtors to fund.
• Credit quality is a key issue. You can reduce margin by taking debtor insurance but the insurer will set the credit limits for you. In the current climate the building industry is struggling which is a key credit risk. SGI don't disclose bad debts.
• For high-tech, stock obsolescence is a major cost. Not so much for SGI but holding the wrong stock / old stock is still a risk.
• Inflation will also cause margin pressure as wages rise. Personnel soaked up 63% of gross profit in FY22, 67% in H2.

Margins will be volatile and unlikely to ever hit management's target of 5%. Profit will be used to fund working capital and pay the increasing finance charges. Last 4 half years finance cost has grown as follows: $k 171, 223, 313, 413. It only takes one bad period and they will be going to the market for more capital.

Nevertheless, as others have pointed out, the business is growing and and on an undemanding multiple. Transaction costs have been a major drag on profit and simply focussing on organic growth would improve net margins by about 1%. And with debtor insurance, they should be able to fund their receivables, so a cap raise is not inevitable unless they keep acquiring.

Here's my revised valuation after researching Stealth's FY22 financials, watching the CEO Mike Arnold's recent investor webinar, and some personal Q&A directly with Mike.

Summary: Share valuation of $0.22, using a very conservative discount rate of 20%. At current share price of $0.12, I forecast an ROI of 35% pa.

For the long version . . .

For details about Stealth's FY22 financials, see other recent straws on Stealth by @wtsimis and me for details. But here are the big themes that feed into my valuation:

1. Mike's communication about future growth has become more restrained. Instead of past communications saying 25% pa growth encompassing organic and acquisitions, he's now saying 10% organic growth plus acquisition. The difference may be the constraint on future acquisitions he is facing because of Stealth's current low share price and high net debt. So I've pulled back my assumptions about growth. My base case takes the conservative approach of assuming only 10% CAGR over next 5 years.

2. In addition to the 8%+ EBITDA goal for FY25 that Mike has communicated frequently (I suspect this will be "underlying" by the time we get there), he communicated to me that NPAT of 3-4% (again, I'll assume "underlying") for FY25 was quite possible. My base case valuation takes a more conservative assumption of achieving statutory NPAT of 3% in FY27.

3. Mike has been clear about his drive for solid cash generation, starting 2H23, and his intention to use the cash for acquisitions and/or reduce debt, and start paying dividends around 2025. My base case valuation assumes a dividend payout ratio of 20% in FY27.

4. Mike's recent investor webinar raised the spectre of future capital raising and dilution. To-date Mike and Stealth have shown strong capital management. But he has continued to talk about future acquisitions and explained that if debt was a constraint he would consider "inside and outside investment" to fund acquisitions, by which I assume this means either institutional or public capital raising. This feels like he is opening the door a little more to capital raising even if the share price is low. However, given the very low share price, even a small $3m raise would be a 20% dilution for current shareholders. So I'm factoring in 20% dilution over the next 5 years into my base case valuation. 

5. Finally, if you noted my previous valuation, it might seem like my current share price valuation is a big drop. But it's mainly because I'm now applying a much more conservative discount rate. I'd previously used 10%, but as an investor in Stealth I'm going to apply a conservative 20% discount rate to compensate for risks associated with liquidity, debt, dilution and not yet having growing or healthy free cash flow. 

Scenarios

For my valuation, I compiled and assigned probabilities to 5 scenarios (blue sky, bull, base, bear and bust). I also looked at a "backwards" valuation, fleshing out what the market seems to assume will happen based on current share price. I've detailed my base and backwards valuations below, and you can have a look at the attached pdf for the full set of valuations.

Stealth SGI Scenarios 220917.pdf

Base: 30% probability, FY27 financials: 10% 5-yr CAGR, 20% dilution of shares, rev of $161m, NPAT of 3% = $5m with 20% payout ratio, PE of 12, market cap of $58m, 5-yr ROI 32% pa.

Backwards: FY27 financials: 5% 5-yr CAGR, 30% dilution of shares, rev of $128m, NPAT of 2% = $3m with 0% payout ratio, PE of 10, market cap of $21m, 5-yr ROI 10% pa.

Fighting against the risk of investors' optimism, I believe I've taken several conservative assumptions in my valuations. My base case uses revenue and profitability figures lower than communicated by Mike. It assumes a large 20% dilution of shares even though no dilution has been confirmed by Mike. And I've used a terminal PE well below historical averages and much lower than would be typical for the growth and profitability figures I have used. And with my probabilities I've weighed the bear and bust cases slightly higher than the bull and blue sky cases.

Despite all that, the risk adjusted valuation aggregating across all scenarios suggests an ROI of 35% pa over the next 5 years.

Coming from the opposite end, the current share price suggests a scenario of only 5% 5-yr CAGR (super conservative given there is already strong evidence that FY23 will see 15-20% growth), 30% dilution of shares, NPAT only getting to 2% in 5 years' time, no dividends and a PE of only 10. That's a pretty bleak scenario, one that I think is highly unlikely. But if even all of that happened investors would still get 10% annual return.

Risks

1. Statutory margins. Like too many companies, Stealth has a habit of focusing on "underlying" margins which are often a long way from what ends up benefitting shareholders. Stealth has perhaps had more reason to do so given the large number of recent acquisitions. But other expenses such as investment in IT and store refurbishments have been excluded from reported underlying margins which I believe should more honestly be accepted as normal business expenses. Stealth's statutory NPAT is only marginally positive and was unchanged from FY21 to FY22. Stealth will always have thin margins, so expense management during volatile trading conditions is critical. It is understandable that investors do not yet have strong confidence in future sustainable profitability.

2. Debt. Stealth's net debt of $10m is very high for a company with market cap of $12m, but is a lot more reasonable when Stealth is viewed as a company of $100m revenue and $6m EBITDA. Still, given Mike has said the company continues to look for acquisitions, there is a risk that the company draws further debt at a time of increasing interest rates. To date, however, Mike has shown sensible use of debt given it has been cheap and has stated that he will not exceed a ratio of net debt to EBITDA of 3x.

3. Dilution. Similar to my debt concerns, Stealth may resort to funding acquisitions through capital raising. Given the very low share price, even a small capital raising in the near future will substantially dilute existing shareholders. To date, Mike has avoided capital raising, explicitly saying that with the low share price he didn't want to punish early shareholders. But for the first time, in the recent investor webinar he explicitly mentioned the possibility of "inside or outside investment" to fund future acquisitions. Time will tell if Stealth maintains its discipline of selecting and funding acquisitions only in clearly value-adding ways.

4. Liquidity. There are days when no Stealth shares are traded, and other days when $500 of trading shifts the share price by 10%. The low analyst coverage of Stealth is a double-edged sword. It means there is potentially amazing value to be found, but it also means that investors need to wade in very slowly (or meaningfully drive up the price), and at this stage can't get out quickly (unless you sell at heavy discount). Investing in Stealth requires patience, comfort with seeing the share price jump around by large amounts on small trades, and acceptance it is a multi-year adventure. Think of Stealth as a 3-5 year term deposit that you need to drip feed into, but which is, I believe, likely to deliver a 30%+ pa return. Once some consistent healthy profitability has been delivered over the next couple of years, liquidity should improve.

Summary

I continue to be high conviction bullish with Stealth. So long as you're patient, I can't see much downside, the current share price assumes a pretty bleak future that I believe is very unlikely, and if just a few things go right Stealth could be a 5 or 10 bagger in 5 years.

Here are the milestones my valuation assumes, and against which I'll test my thesis over the next 12 months:

1. FY23 revenue of $115m, which will be 15% growth over FY22.

2. FY23 statutory NPAT of $1.5m (excluding any acquisition costs if acquisitions occur in FY23), which will be a $0.9m (or 150%) improvement on the $0.6m in FY21 and FY22. Mike has guided that 1H23 will be focused on acquisition consolidation whereas 2H23 will be focused on cash generation. Hence, much or all of this NPAT will be delivered in 2H23.

3. Mike keeps to his stated limit of net debt to EBITDA of 3x.

4. Mike does not raise capital with share price below $0.20 (or it needs to be an exceptional value acquisition to justify a capital raise).