Structural Monitoring Systems - Changing Aviation Safety
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In recent weeks and months I have been discussing global markets as a whole from a macro level identifying the risks and opportunities that exist as the world enters the late stages of what has been one of the most untrusted and hated bull markets of our time. This week I wanted to return back to local soil and discuss the only stock we hold in our proprietary trading book long-term.
As a prop trader our focus on the desk is more on “trading” short-term and less on “investing” long-term. Our holding period ranges from several seconds to several weeks. Rarely do our holdings last longer than a few months. It would have to be very compelling and rewarding to stick with such a trade for that length of time.
There are several reasons for this. Firstly the most obvious one is that I can predict with far more accuracy where a particular asset or financial instrument will be valued at in a day, a week or a month’s time. I have far less confidence in being able to predict its value in two or five years time. Anything can happen over such a long time horizon, another GFC, a flash crash, war, natural disaster, political upheaval or even just poor decision making by management – anything is literally possible. Even the so called safe as houses stocks like the property trusts that seemed to be great dividend payers and perfect long-term investments were decimated in the GFC and now mostly trade at a fraction of their prior values.
I literally never invest with the preconceived intention of holding a stock long-term. I may end up owning it for years but I continually reassess the investment every week and every month being prepared to sell if it no longer is attractive (or enters a downtrend). Too often investors fall in love with stocks – even from the very beginning of their investment – and ignore warning signs and falling prices believing in the long term it will come good. Sometimes it does, most times not and in the meantime there has been a huge opportunity cost. Remember you can always come back to an old investment and reinvest when it eventually begins to perform.
I once fell in love with a stock, believed every piece of information the CEO and Chairman fed me and was rewarded with enormous ongoing profits. Then the tide turned and I ignored the falling share price instead continuing to believe management’s story and what a consistent winner for me this company was. Eventually I sold out and gave back a large portion of the profits I had made. Never again. I learnt the hard way. Not as hard as losing all my money but nonetheless a painful exercise.
Returning back to my single and only long-term investment – Structural Monitoring Systems (SMN). I first discovered this company when it appeared on many of the scans and models that we use to look for market moving opportunities way back in May 2014. At the time the share price was breaking out from a long 6 month consolidation and volume was picking up. An interesting chart pattern led to me to researching the business and I liked what I discovered.
SMN has been for well over a decade developing its patented CVM technology or otherwise known as Comparative Vacuum Monitoring which is used to detect and monitor metal fatigue in real time. Metal and other components all experience structural deficiency over time so naturally it is crucial for safety and efficiency that any such component malfunction or fatigue as it is better known is identified and rectified quickly. Metal in aircraft, infrastructure (such as bridges) and buildings are all crucial components that if fail can result in serious damage and even loss of life.
SMN’s CVM technology is a process that detects fractures, corrosion and cracks in metals and other structural materials. Without explaining the technology in depth, the system has a variety of sensors across the components which are pressurized and if any damage to the components occurs the sensors will detect a change in the atmospheric pressure resulting in identification of a failed component. The technology is very basic and simple in its process, is able to be deployed across of wide range of applications and importantly has a self-check mechanism so it can detect if any of its own sensors have malfunctioned and require replacing. An important feature when the integrity of the technology is based on the assumption the sensors are working properly. I could delve very deeply into the technology, the industry and the wide variety of uses but a great research piece has already been released from Mac Equity Partners which can be found on the SMN website here http://www.smsystems.com.au/content/investor/asx-announcements.asp
The most crucial point for SMN is its current testing operation with Boeing and Delta Airlines which when complete will be put forward to the Federal Aviation Authority (FAA) for approval of use in the airline industry. Such approval will be a company maker and hugely positive for SMN and the value of the CVM technology in the industry. It will become the industry standard for testing and monitoring the structural integrity of aircraft. This is equivalent to Phase 3 trials and awaiting FDA approval for a biotech, however, the probabilities of approval for SMN are much higher than that for any biotech and most importantly the share price has barely appreciated.
For over a year now SMN has been running with Delta and Boeing and in-flight programme testing its sensors across several of its fleet. The data being collected goes towards putting a case forward for official approval and rollout. Airline operators want the CVM technology to be used in testing structural components as it is a significantly more time efficient process than current manual testing and inspection. The costs of grounding planes for routine inspections can be anywhere from $500 to $1400 per hour in foregone profit. Multiply this across a fleet of airplanes and the costs quickly accelerate. Delta engineers have indicated that foregone profits are in the many millions of dollars. Add to this direct costs of grounding an airplane for inspection, which include the cost of technicians to inspect components with some requiring as many as 100 man hours to access a section of a plane that only requires 10 minutes to inspect. Based on this CVM can save an airline between $40,000 to $90,000 per plane, per year.
The size of this market is significant. Currently there are approximately 25,000 commercial aircraft in uses globally with mainline aircraft (non-regional) at over 16,000. Savings for the industry by adopting CVM has the potential to be $1.3 billion when only accounting for large airplanes (using the Mac Equity Partners model).
SMN expect approval to be given by the end of year and Boeing to begin replacing manual inspections initially across its 737 aircraft (5400 planes). It’s been a long process for the company but it is now at the brink of major success and the potential upside in value is difficult to determine. But considering that currently at a market capitalization of $60 million there is little being priced into the share price for success. Many biotechs trade at significant premiums to this (>$200 million), whilst still being many years away from any FDA approval and still require major funding for trials. I can see SMN quickly being valued at $300-$500 million following approval.
With little stock on issue and very little speculative run so far the past 12 months has the share price hold its ground when so many other flighty stocks have been “pumped and dumped”. The share price has recently starting to build as news continues to surface of further evidence that CVM technology will obtain FAA approval and change the landscape of aviation maintenance and safety. For the reasons of this probability, upside potential and steady share price performance SMN is the only stock across our holdings that has stood the test of time.
Greg is the Head of Proprietary Trading at Global Prime and has over 20 years of experience as proprietary trader and high level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank. He has been involved across all asset classes including commodities, bonds, currencies and equities right across the globe.
After a 10-year career within the comforts of the large investment banks and research firms he branched out on his own to form his own proprietary trading firm successfully building the business into a multi-million dollar trading operation that turned over a billion dollars a year. This same team now runs the proprietary trading desk at Global Prime, risking their own money in line with the firm's and client's capital.
Greg has appeared on CNBC, Channel 9 - Business Sunday programme, a guest columnist for the Australian Financial Review, a regular author for Personal Investor, Wealth Creator and Shares magazine and is the former Treasurer of the Australian Technical Analysts Association.