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A stock to make you smile

Few investors will get excited over an Australian based manufacturer — and given the fate of many its not hard to see why! However not all manufacturers are created equal, and when it comes to those that deal in high margin, high value, specialised products with brand differentiation, the future is far from bleak.

Enter SDI (ASX:SDI), formerly Southern Dental Industries, a Melbourne based manufacturer of dental products. Established in 1972, SDI began life producing your run-of-the-mill amalgam fillings, however over the years a concerted R&D effort has yielded a broad range of restorative and cosmetic dental products which are sold in over 100 countries.

Importantly, though the business has managed to grow its profits by an average of nearly 9% per annum over the past 16 years, and currently generates annual sales of around $60 million per year, SDI is still a relatively small company with significant growth potential. The global dental supply market estimated to be worth many billions of dollars, and growing, and SDI already has an established presence with market leading products, meaning the business is positioned very well indeed.

Can and will

Of course, having a large addressable market is one thing; capitalising on the opportunity is quite another! Nevertheless, there are a number of factors that allow for optimism with SDI.

The company has invested heavily into manufacturing and automation, which will act to significantly lower its production costs and thereby improve margins. Importantly, there is plenty of spare manufacturing capacity, which means greater economies of scale as volumes rise. While the high end manufacturing is done locally, products are packaged offshore in lower cost countries, which has further enhanced margins.

The company also has a strong focus on product development, with a large portion of pre-tax profit being regularly reinvested into research and development (R&D). That investment has helped the company produce a range of high margin, patent-protected products that will help move the company’s product mix away from the lower margin, undifferentiated end of the market for dental restorative products.

That being said, basic amalgam fillings remain an important source of revenue, but here the business is benefiting from two tailwinds: growing demand in developing nations, and lower input costs with the substantial decline in the price of silver (the key raw material).

Nonetheless, the future of SDI is certainly focussed on the higher value products which are stronger, longer lasting and cosmetically more appealing. And given that North America and Europe are the major revenue sources for SDI, it is set to benefit as consumers’ preference for these products increases. Indeed, cosmetic teeth whitening products are showing a strong increase in demand in the West, and SDI leads the market in direct-to-dentist products in the UK and Australia, and is number two in the US.

With 90% of sales denominated in foreign currency, the value of the Australian dollar has a large impact on the company’s bottom line. This can be either good or bad, depending on your view of the Aussie currency, but with most economists and the RBA forecasting a lower dollar in the years ahead, SDI could well get a nice little boost on this front.

Finally, the company has recently ramped up its sales and marketing efforts, significantly, with dedicated sales managers placed in key growth markets.

Appealing features

Beyond the growth opportunity, there are other features which act to make SDI an attractive proposition. The demand for dental products is reasonably immune to the economic cycle — people don’t generally put off necessary dental work just because the economy is in a funk.

The company also has an established brand name and reputation, which is very important to its customers (i.e. dentists) whose reputation is, in no small part, dependant on the quality of the materials they use.

Last but not least, there are also some reasonable barriers to entry for dental products, which are strictly regulated and require the approval of regulatory agencies, such as the Australian Therapeutic Goods Administration and US Food and Drug Administration.

Where to invest $1,000 right now

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Andrew Page is a Motley Fool investment analyst. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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