Construction is a difficult business. It is essentially commoditised, that is we do not really care, who builds something for us, as long as they build it cheaply. Therefore, margins tend to be thin, costs need to be controlled, staff turnover is high, safety is a constant challenge, the business is labour intensive and requires large amounts of working capital. In addition, the industry is highly cyclical and is yet to emerge from the last trough, the post-Football World Cup hang-over. This is not an industry that I would typically invest in.
Diversified construction major Stefanutti Stocks Holdings (SSK) is in the middle of this challenging industry, in a South African market that is reluctant to invest in a political environment that remains unconducive to investment. The company, is well diversified into all facets of the industry, with operations in marine, civil, structural, mechanical, steel, buildings, mining, petroleum in South Africa, Southern Africa and the Middle East.
From the latest annual results, it is evident that times are tough: revenue is down 8%, margins are contracting and they make reference to overall cost deflation in the industry. The financials are marred by impairments for businesses that were acquired during the boom time, fines from the competition commission and forex losses resulting from a strengthening Rand.
However, when we ignore the perfect storm that has hammered current results, when we start digging through all the once off items, we start to come across several metrics that show a healthy, if not flourishing, company that is trading at fantastic bargain prices:
- This is a huge company. They did R10bn in revenues last year. This tends to be forgotten at the current market cap of only R630m.
- If we adjusted some of the once-off items in the earnings, we get a company that is trading at a PE of 4.
- They have a pile of cash at R1.1bn. Yes, that is about 1.7 times their market cap in cash. In fact, the business remains VERY cash generative. They have operating cash flow of almost R400m. The means it’s trading at less than two times cash flow.
- They are trading at 43% of their current TNAV. Yes tangible NAV. In theory they should be able to liquidate their assets, pay off their debt and then pay almost two times the value of the business as a special dividend. But, why would they do that, if they are making so much additional cash each year?
- They have an order book that means that even at current margin, cash flow can be maintained. It stands at about 1.4 times annual revenue. About 30% of work is outside RSA and this is likely to grow, as those economies mature and make the best of their demographic and resource advantages.
In summary, this is a company that hiring and growing into Africa, that is generating healthy cash flows and that stands to benefit from the pent up demand for infrastructure in Africa. The company is also extremely cheap and I am therefore doubling down my position in the business.