This month’s microcap fund snapshot is of the Saville Capital Emerging Companies Fund. I asked Jonathan Collett Principal at Saville Capital what was one of the more interesting stocks from the current microcap portfolio and he highlighted IDT Australia Limited (IDT: ASX)
What does IDT do firstly?
Established in 1975, IDT operates in the pharmaceutical industry providing a flexible and comprehensive service from early stage API (Active Pharmaceutical Ingredient) development through to finished drug formulation, clinical trial research and scaled commercial manufacturing for global distribution. Based in Boronia (Victoria), IDT’s manufacturing facilities are fully cGMP compliant and are regularly audited by the US FDA and Australian TGA. IDT is predominantly focused on high potency and very specialised drugs, having undertaken work for multiple global pharmaceutical companies including Pfizer, Johnson & Johnson, Roche and Bayer.
Why does Saville Capital like IDT?
IDT appealed to us as a classic turnaround story with significant valuation support (it was trading below NTA when we first started researching the Company), combined with potential upside from exposure to the burgeoning medicinal cannabis sector, without the risks of being an owner/producer.
By way of background, while IDT’s business model had proven to be successful and generally profitable over time, in order to extract greater leverage from its expertise and materially increase utilisation of its manufacturing capacity, it undertook a strategic shift in late 2014 by acquiring 23 US generic drug products for US$18m. However, the reasons behind this decision were quickly undermined as the barriers to entry for new US generics were substantially lowered via shorter review periods and the number of potential buyers significantly reduced due to consolidation in the wholesale sector, leading to pricing erosion of between 5% and 60% across IDT’s portfolio.
Following a strategic review, IDT decided to sell the majority of its generics portfolio to ANI Pharmaceuticals for US$2.3m in April 2018, and instead focus on advancing a select generics portfolio (primarily Temozolomide, an oral brain cancer drug distributed by Mayne Pharma) and build upon its existing Contract API and Development businesses. In a further positive development, IDT entered into an agreement with Cann Group Limited (ASX: CAN) during August 2018 to provide manufacturing support in relation to medicinal cannabis-based product formulations intended for supply to patients.
After an initial meeting with management, our interest in IDT was piqued upon a thorough review of its FY18 result, particularly its 2H. Revenue increased from $5.0m in 1H to $8.3m in 2H, while its underlying P&L improved from a loss of -$3.1m in 1H to a profit of +$0.2m in 2H. Most importantly, it transitioned from a gross operating cash flow deficit of -$6.2m in 1H to a surplus of +$1.2m in 2H. When coupled with an NTA of $31.2m, underpinned by a net cash position of $14.0m and PP&E of $18.7m (over half of which is land and buildings), the investment proposition appeared compelling when compared with a market cap of $31.8m (it has since increased to $41.5m).
Furthermore, if we look back over time, only a decade ago IDT was generating revenue of >$30m, EBITDA of >$12m, NPAT of >$7m and an ROE of >20%, with much the same fixed asset base as what it has today. Hence the turnaround potential of this business was clear, should management be able to execute.
Interestingly, since our entry into the stock, IDT has announced an on-market share buyback of up to 10% of its issued capital (commenced on 10 October), citing its improved financial performance over the recent period and noting its forward projections indicate that a portion of its cash position is now surplus to requirements. Since then the buyback has been quite active, purchasing stock at prices up to $0.17 (the allowable limit is $0.1785).
Who is the management team behind IDT?
IDT is led by Dr David Sparling who became CEO in July 2018 after he had served in that role in an interim capacity since February 2018. Prior to that, David was Vice President of Corporate & Business Development, having joined IDT in May 2013. David holds honours level degrees in both Veterinary Science and in Law. He is an experienced senior executive, having previously held roles as CEO and Chairman level in ASX listed companies.
Does the valuation for IDT stack up in Saville Capital’s view?
Assuming IDT can grow its revenue back to >$30m over the next 5 to 10 years and restore EBITDA margins to c.35% (they peaked at 40%), then we value the Company at $0.25/share (vs current share price of $0.17 and our entry price and NTA of $0.13). This DCF valuation ignores the upside from potentially becoming a manufacturer of choice in the medicinal cannabis sector.
Saville Capital is forecasting revenue to grow from $12.9m in FY18 to $17.4m in FY19 and $22.6m in FY20, with EBITDA growing from -$2.0m to +$2.5m and then +$5.5m over the same period. If our forecasts are correct, then IDT is trading on an FY20 EV/EBITDA multiple of 5.6x and an FY20 P/E of 15.3x with still considerable forecast growth potential thereafter, particularly if it can get back to its peak historical earnings (or beyond).
