1300 Smiles Limited profit drops 36%, but don't start selling!

This stock has a brighter future than its recent results suggest.

a woman

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The 1300 Smiles (ASX: ONT) half-yearly report begins with the words, 'I am pleased to report to you…', an unusual opening line for a company reporting a 36% percent drop in net profit. As the managing director notes however, this period's fall in profit comes after the removal of the government's Chronic Disease Dental Scheme (CDDS), which both removed government subsidies and caused an artificially high first half 2013 profit figure as people rushed to complete treatments before the CDDS expired.

Judging from the information provided in the report, 1300 Smiles is on track for a modest decrease in full year profit, although without the huge government subsidies in the form of the CDDS, FY2014 looks to be the new benchmark to which future profit figures are compared. 1300 Smiles' dividend for the first half also fell 35% compared to the record high of 10 cents per share last year and 8.6 cents in 2012.

It is a fairly sizeable decrease that may leave some shareholders a little disappointed; however in the context of a 29.6% drop in total revenue I believe shareholders are lucky to receive a dividend at all. Many other companies that carry debt (1300 Smiles does not) would not pay a dividend this half at all.

As some readers may know, I recently wrote an article about why I wasn't buying 1300 Smiles. While the timing of this result may make me look clever, I was not referring to short-term revenue drops caused by removal of the CDDS and other government subsidies in my article. My reluctance to buy centres on what I believe are long-term challenges facing the dental industry at large.

Fellow Motley Fool contributor Claude Walker pointed out that 1300 Smiles may in fact be largely immune to these changes given its ability to 'cherry pick' profitable dental businesses as they are listed for sale. 1300 Smiles is also a comparatively small business and a small increase in the number of dental centres owned could increase earnings in the order of 25% or more. Furthermore the closure of the CDDS makes it less likely that other large dental care providers could emerge to challenge 1300 Smiles, which further improves the business' defensive qualities.

Foolish takeaway

Now is not the time to be selling out of 1300 Smiles. Long-term shareholders will be aware that the revenue drop this half was flagged by management at least 12 months in advance when the government announced the closure of its CDDS. Those same shareholders also enjoyed a bumper 1H 2013 which including record dividends.

Despite my personal reluctance to own the business, I conclude that the ~15% decline in Smiles shares after the profit drop was announced may in fact provide the opportunistic investor with a buying opportunity.

Motley Fool contributor Sean O’Neill doesn’t own shares in 1300 Smiles. 

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