Stealth Global Holdings (SGI.AX)

Investment Thesis

This was originally a thesis I wrote for Micro-cap club months ago and thought I might as well post it here, I know the share prices ect aren’t up to date. I haven’t changed them given it was the price I originally wrote up the piece and bought shares in the company.

Stealth Global Holdings (ASX: SGI)

Market cap: ~ AUD$12.12m

Shares outstanding: 100.95m

Share price as of writing: $0.12

All currency figures are in AUD ($)

Stealth Global Holdings is an Australian industrial distributor based out of Perth, Western Australia

Highlights:

-        2023 Revenue of $111m with profit before tax (PBT) of $1.3m up 86% (margin of just 1.17%)

-        Trades at 11.65x 2023 PBT, with substantial increases in margins expected going forward to between 2-4%

-        Large debt balance from acquisitions rolling off in the next 12 months which has been masking the underlying growth of the business

-        Since its IPO in 2018 Stealth has grown revenues from $24m to $100m organically and inorganically with a long runway for growth

-        Founder-owned and operated

About Stealth Global Holdings

Stealth has 3 operating divisions: distribution (84.4% of revenue B2B), wholesale (9% B2B), and retail (6.6% B2C) which all sell industrial products such as tools, PPE, workwear, vehicle parts, first aid gear, scaffolding and much more, anything you might need on a blue-collar worksite. Stealth’s end markets are highly diversified with resources accounting for 32.9% of sales, trade and retail 25.5%, infrastructure and construction 18.5% transport 13.4% and so on.

Stealth is well positioned to benefit from the strong industrial tailwinds, with increasing demand for mining CapEx projects, housing, infrastructure, defence and more which is all a consequence of a large immigration policy, high resource prices, housing shortages, geopolitical tension and shortages of skilled tradespeople ensuring a resilient and robust end market.

Stealth was founded in 2014 by Mike Arnold who still remains the CEO and largest shareholder owning 11% of the business, with total inside ownership of 16%. Mike has an extensive history in industrial distribution and logistics, following the business for a while and being a shareholder, Mike has always been consistent and clear in his strategy for the business and has executed very well on his strategy.

Acquisitions

You can see above Stealth’s acquisitions and divestment history. Stealth’s current business consists of 5 brands listed below (brackets show purchase price and financials as of purchase date):

·       Heatley’s- listed in 2018 as Heatley’s group with revenue of $43m & PBT of $1.4m

• C & L tools- Acquired for $3.83m through cash and debt (revenue of $14.3m & EBITDA of $1.26m)

• Skipper Transport- Acquired for $4.2m through cash and debt ($18m revenue & $1.1m EBITDA)

• United Tools- Acquired for $1.25m through cash and debt (Net asset value) – (revenue of $8m EBITDA $0.3m)

• United Tools Albany- Acquired for $0.46m through cash and debt (revenue of $1.4m & EBITDA of $0.3m)

• ISG- industrial supply group- Acquired for $1m from cash (revenue of $2m & EBIT of $0.3m)

Distribution businesses are faced with many structural challenges with large capital requirements, extensive working capital needs, narrow profit margins, and extreme difficulty in maintaining a sustainable competitive advantage. While this isn’t ideal for Stealth it also isn’t ideal for competitors, and generally, the biggest moat in low-margin business is scale. Stealth has identified a nice niche in the Australian market, and now Stealth is the only industrial distributor in Australia that operates in all its different market segments. The 5 acquisitions undertaken in 2021/22 have given Stealth the ability to substantially increase its product offerings, geographical footprint, fixed cost base and bargaining power with suppliers increasing its end market potential, and stickiness to existing customers while offsetting the impacts of inflation. As of the end of FY23 Stealth had fully integrated all of its acquisitions, with no more acquisition-related CapEx required.

Industrial distribution is a highly fragmented market in Australia with the largest business Blackwood only maintaining around 4% market share of a $110B domestic market.

Since Stealth’s last acquisition in May 2022, they haven’t acquired any more businesses and have been investing within their existing businesses to identify sales and cost synergies, improve sales capacity, cross-sell products among brands, and integrate front and back-end operations. The bulk of the CapEx is over, and Stealth is well-positioned going forward to benefit from their investments, through a lower cost base, and stronger sales pipeline.

Financials

2023 revenue was up 11.4% and after discontinuing a number of customer contracts for profitability reasons, revenue from continued operations was up 18%. Stealth key sales metrics all moved in a positive direction with sales per day (up 15%), sale value per order (up 17.4%), sales per employee (up 19.4%), and gross profit per day (up 31.3%).

Given Stealth’s cheap valuation and the low cost of debt through 2020/21 Stealth prudently used debt to fund its acquisitions, as a result, repayments have been masking the underlying growth of the business. Stealth paid back $1.6m in 2022, $1.6m in 2023, and only has ~$1m left in FY2024 then it has paid back all of its acquisition-related debt with the remaining debt mostly for working capital requirements. Given the heavy working capital requirements of the business Stealth chooses to fund its inventories through debt, given the strong inventory, equity and cash balance I don’t see this as a large risk given the debt is only short-term term meaning it has low-interest requirements and is only due to mismatches in payments.

The strong $5.6m in FCF up from -$0.1m in 2022 is a result of the decreased CapEX and the realisation of investments underpinning the strong growth within the business, total cash flow after repayments of debt was still $3m, increasing the cash balance by 63% (highlighting debt is payments mismatches not a cash shortage)

The Large CapEx of integrating and investing in the business is mostly over and I expect FCF to increase further as the debt rolls off and the business continues to realise the returns on its investments.

Outlook

Stealth has a number of ways to grow the business organically through opening new locations, realising operational efficiencies, gaining new customers, increasing sales with existing customers, strong cost control and margin expansion. The acquisitive approach is very valuable for low-margin capital-intensive businesses, Stealth has the ability to acquire companies very cheaply, integrate their businesses within their existing infrastructure and realise strong cost and sales synergies resulting in high returns on their investments.

Stealth has invested heavily in improving efficiencies and sales capacity and it is well placed to benefit from industry tailwinds.

Stealth has an internal FY25 target of 200+ stores with $200m in revenue at an 8% EBITDA margin. Up from its current levels of 70 stores at $111m in revenue with an EBITDA margin of 4.8%

Valuation

Stealth currently trades at a share price of $0.12- a market cap of $12m:

P/B- 0.8, 2.1x- FCF, 2.26x EBITDA, 13.3x Earning

My base case scenario is Stealth is able to grow revenues at 9% p.a and increases there profit margin to ~2%, payout 30% of NPAT as profit, with dilution of 5% across 4 years.

I suspect a fair multiple is 15x earnings given the strong revenue growth and margin expansion. In this scenario, I would yield a 38.64% return p.a.

You can see a range of potential outcomes in the figure above and to me there is incredibly strong asymmetry, with bearish scenarios even yielding very positive returns.

Even after using very conservative assumptions of just 9% revenue growth (18% in 2023), no consideration of acquisitions, and an exit PE multiple of just 15 Stealth still represents a forecasted IRR of 38.64% p.a across 4 years. The likely organic revenue growth of the business is around 6-15% with profit margins of 1.5-4%.

A revenue CAGR of 17% and profit margin of 4%, assuming an exit PE multiple of 15 would yield a ~70% IRR p.a across 4 years, while a revenue CAGR of 8% and profit margin of 1.5% would yield an IRR of 15.7% which highlights the severe positive asymmetry of the investment. Stealth trades at 13.3x earnings, which seems about fair however once the long-term debt rolls off and they are able to realise their cost and sales synergies they will have the potential to grow the company’s profit by 2-8x its current levels in the coming 1-4 years accompanied by a huge market potential and long runway for growth.

Risks/ important variables going forward

• Debt- acquisition-related debt is rolling off in the coming 12 months which will help boost margins. The large debt balance is a risk for stealth, however, given the defensive nature of customers and its products and the strong asset and cash balance I don’t see it as a large risk, however, debt is always risky, especially in hard times

• Margin expansion- The most important variable in the success of Stealth as an investment is the margin. With the integration of the acquisitions and the realisation of synergies, debt reduction and operating leverage I expect margins to severely increase to industry norms of 2-4% going forward, however, if stealth is unable to manage cost control and grow the business the upside will be limited.

• Acquisitions- Stealth has historically used debt and cash to fund acquisitions, however, the cost of debt has significantly increased, Mike Arnold being the CEO and largest shareholder has been very reluctant to dilute shareholders at a very cheap valuation, given their desire to acquire it will be important to see how stealth manages the situation in raising capital/ acquiring business, with  any poor capital raising or acquisition potentially lethal for the business and/or shareholders

• Liquidity- Shares in Stealth are tightly held and if things go bad there may be issues liquidating your position, however buyers will have the same issue :)

• Economic downturn- In an economic downturn industries like resources and construction are very cyclical and can get hit very hard in recessions, and in this case, stealth may face decreased demand from their customers despite the non-discretionary nature of their products.