One of the more conservative investment strategies is to buy and hold growing, dividend-paying companies with honest and competent management and plenty of room to grow over the very long term.
We've had some success with that already: for example, My Net Fone Limited (ASX: MNF) is up 60% (not including dividends) since I recommended it in September 2013. Meanwhile, Servcorp Limited (ASX: SRV) is up 34% (not including dividends) since Motley Fool contributor Peter Andersen and I suggested it. However, there is one other high conviction stock that remains around the levels I myself bought in. I am referring of course to 1300 Smiles Limited (ASX: ONT), the owner or manager of 27 dental practices.
It has to be said that when I first suggested the company it was very much in vogue. Perhaps, the market has simply remained too well informed about it, and current shareholders are too rusted-on to panic and sell at low prices (as I hoped they would). Indeed, despite going through a rough period resulting from the closure of the Chronic Dental Disease Scheme, the company's share price has mostly stayed around $6, valuing it at $130 million. That's a lot for a business that reported profit of just over $2.5 million in the last half – based on that half's results, it's trading on a hypothetical P/E of 26.
I can only imagine that shareholders like myself are holding on because of the company's defensive qualities, frankness with shareholders and reasonably satisfactory dividend yield of over 2.1% (based on the last half). Most of all, current holders understand that difficult circumstances for the dental industry are actually an opportunity for 1300 Smiles. That's because the company is a net buyer of dental practices and, as Warren Buffett has famously pointed out, if you intend on being a net buyer, it's a good thing if prices go down.
Indeed, the company recently announced its biggest acquisition to date, BOH Dental Group. I am pleased about the acquisition: Worst case scenario it is P/E accretive and in any event it is good to have more exposure to prosthodontics, if that doesn't benefit from the ageing population, then I don't know what will. The central Brisbane practice is expected to contribute $1.2 million EBITDA in FY 2015. To put that in perspective, I expect EBITDA for FY 2014 to be $9.5 – $10 million (including all acquisitions). If they beat $10 million, I'll be smiling.
Because the company only acquires from time to time, it's possible to discern a level of organic growth. I expect to see that in most years because there is always the capacity for new dentists, and part of the company's brief is to improve the revenue earned by dentists. On top of that, the last three acquisitions have been funded by cash, and the company remains debt free. This is actually quite rare for a roll-up, and to my mind these features distinguish 1300 Smiles from other aggregators such as G8 Education Ltd (ASX: GEM) and Valeant Pharmaceuticals Intl Inc (NYSE: VRX).
I think it is quite reasonable to expect about $12 million EBITDA in FY 2015. Allowing $2.5 million for depreciation and amortisation, and then another $3 million for tax, that gives us NPAT of about $6.5 million. That will bring us down to a more palatable P/E of 20. I consider it more likely that the company will surpass these expectations than fail to meet them, but we will see soon enough.
My 1300 Smiles shares might be expensive, but I'm willing to pay up for a company that has top tier management (in both honesty and competence), a business with favourable economics, and plenty of room to grow. I remain a believer in the company's long-term prospects and consider it a reasonable long-term buy at current prices.
