Finding value in the SA construction sector | Fin24
 
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Finding value in the SA construction sector

Oct 11 2018 10:59
Lloyd Gedye

South Africa’s construction sector is in major distress after a decade of decline.

The boom years leading up to 2010, which included projects like the stadiums for the soccer World Cup, Sanral’s road projects and Eskom’s mega coal-fired power plants Medupi and Kusile, are just a distant memory.

In addition, hundreds of billions of rands in promised government infrastructure spend has not materialised.

So far in 2018, Group Five’s share price has lost more than 93% of its value, while Aveng’s share price has lost just less than 98% of its value.

At the time of writing - at the end of September - Group Five shares were trading at 89c. A year ago, this was R14. Aveng was trading at just 4c per share, down from R3.11 a year ago.

Data analysis firm Timetric has forecast a compound annual growth rate (CAGR) of 1.57% for the construction sector between 2017 and 2021, with the key drivers of that moderate growth being investment in transport and logistics infrastructure, energy construction projects and the expansion of low-cost residential buildings.

The Bryte Construction Activity Monitor, released by the insurance company in July this year, reported a 45% increase year-on-year in insured construction activity in South Africa in 2017, rising to R61bn from R42bn.

However, the report acknowledges that the situation remains dire, with South African construction players exploring opportunities to supplement growth outside the country’s borders. 

But such opportunities come with their own challenges.

“With four of the top six large construction companies losing 50% to 75% of their share price in 2017, and some losing in excess of 90% of their value as at June 2018, these alarming losses are likely to have brought about irreversible change, as it may be too late for some key players,” reads the report.

The good times are gone

Wayne McCurrie, portfolio manager at FNB Wealth and Investments, points out that some of South Africa’s construction giants are now essentially worth nothing. 

In June this year, Basil Read, for decades one of South Africa’s big five construction companies, was placed in business rescue and the trading of its shares was suspended.

It was followed a month later by privately owned construction company Liviero Group, and in August by Esor Construction, a subsidiary of Esor Limited.

These former giants have blamed the “challenging economic environment” for their woes, as well as raising the issue of late payments and bemoaning the lack of government spend on infrastructure projects.

Things have become so bad for the construction sector that many fund managers indicated to finweek that they were no longer able to comment on the sector in depth, as they “haven’t looked at it for some time”.

One fund manager called the construction sector “largely uninvestible” because the big construction companies’ shares have become “illiquid”.

“A lot has been lost in the construction sector,” says Unum Capital analyst Lester Davids, explaining that fund managers were paying less attention to the sector because the time and effort required to assess investment options can’t be justified for stocks with such small market capitalisations. 

“The big companies aren’t even mid-cap companies any more, they are small-cap companies.”

McCurrie agrees. “It’s quite clear that the construction sector is taking strain like you can’t believe. It’s partly their own fault.”

He argues that local construction companies geared up “massively” in the good years (between 2002 and 2008), taking on a lot more overheads.

“They thought the good times would last forever,” says McCurrie. “The good times never last forever.”

Is there still value in SA construction?

The problem for investors now, says McCurrie, is that you don’t know when the bad times are going to end.

Mergence Investment Managers analyst Izak van Niekerk says he doesn’t think the “shake-out” is done yet. 

He argues that with insurance companies taking decisions to reduce their risk on insuring large building projects, more pain is ahead for construction companies.

Although Van Niekerk thinks that there are still opportunities in the sector, he warns that the risks are high, and insists that taking on that risk is too close to “speculating or gambling”.

McCurrie says a brave investor who takes a ten-year view on the construction sector could stand to make a lot of money. 

“The first five years will probably be real tough,” he says.

The government’s drive for empowerment within the sector is important to keep in mind, as this policy could result in smaller black-owned companies rising to the top. 

It also means that big construction companies need to ensure BEE compliance if they want to secure their share of government infrastructure projects.

However, Davids says that a massive roll-out in government infrastructure spend would be required if the market is to regain an appetite to invest.

A number of analysts and fund managers have highlighted four companies that might still offer value.

WBHO

Van Niekerk says WBHO stands out among its peers.

It is the largest South African construction firm listed on the JSE with a market capitalisation just short of R8.7bn. 

Of all the country’s construction giants, it has fared the best in these adverse conditions, keeping its balance sheet intact through prudent capital allocation.

“A large part of that is its management’s risk capital practices,” says Van Niekerk. “They are just better at it.”

In WBHO’s latest set of annual results, released in September this year, the construction company reported that its overall revenue grew by 17.3% to R18.1bn, while its Australian revenue grew by 29%, upping its contribution to group revenue from 56% to 61%.

Operating profit increased by 8.1% to R510m and headline earnings per share (HEPS) increased by 82.6%.

Van Niekerk says that WBHO has always tended towards less risky work, unlike competitors Murray & Roberts, Aveng and Group Five. 

WBHO’s core business has always been building office blocks and malls and when demand for these dried up in South Africa, it looked elsewhere.

WBHO sought to diversify significantly, increasing its investments in the Australian economy, pursuing new investments in the United Kingdom and increasing its projects in the rest of Africa.

This is illustrated by its order book of R53.8bn, with R32.6bn in Australia and R11bn in the UK. 

Only R8.7bn of its order book is based in SA - in fact, this order book was down 26% year-on-year.

WBHO entered the Australian market in 2001, acquiring a 40% stake in Probuild Construction. 

Today Probuild is a tier-one construction company in Australia, with a focus on Sydney and Melbourne’s residential sectors and WBHO’s stake sits at 85.6%.

In June 2017, WBHO acquired a 40% stake in the UK’s Byrne Group for R229m, upping its stake to 80% a year later. 

The company also acquired a 60% stake in Manchester-based Russells Construction Limited and a 32% stake in sister company Russell Homes.

Van Niekerk says that while WBHO makes much lower margins in Australia than it did in South Africa, its UK investments has the potential to achieve reasonable growth.

Davids points out that the WBHO share price has hovered between the R140 and R150 mark for almost 10 years.

“They are not under the kind of pressure that their competitors are under,” says Davids. “So there may be a bit of value there.”

At the end of September, WBHO’s share price was trading at R152.90, down from a 2018 high of R173.20 reached in late February.

Van Niekerk says WBHO’s shares are trading at a fair price.

“They are the best of the group, but it is not a good sector,” he says.

Murray & Roberts

Murray & Roberts (M&R) is the second-largest construction firm listed on the JSE,  with a market capitalisation just short of R7.2bn.

But some fund managers question whether it can still be classed as a construction company - because it has essentially shifted into mining. 

This transformation will probably ensure M&R’s survival as several of its former competitors go under. 

In November 2016, M&R sold its South African infrastructure and building business for R314m to a consortium led by the black-owned Southern Palace Group.

M&R also offloaded its steel fabrication and erection contracting business Genrec to Southern Palace for R185m after a proposed sale to private equity and advisory firm Nisela Capital fell through.

In Australia, M&R is involved in the underground mining sector through its drilling subsidiary RUC Mining Contractors and in the oil and gas sector through Clough, an engineering and construction firm that operates in the hydrocarbons and marine minerals infrastructure markets.

In its latest annual results, announced in August, M&R’s oil and gas order book had increased by more than R1bn to R6.4bn, including significant projects with mining companies BHP and Alcoa in Australia and Rio Tinto in Mongolia.

Its total order book was sitting at R30.1bn, with 41% of the projects based in the SADC region.

Davids says that although picking a South African construction company to invest in is a bit like picking “the best of a bad bunch”, M&R would be his first choice. 

He points out that the company has a good net cash position, and insists that there is some value to be found.

“It’s diversified into Australia and has even got some work in Mongolia,” he says.

But Van Niekerk believes that M&R offers a lot less risk control, which investors need to consider, compared to a company like WBHO. He says unforseen delays on risky projects can often lead to losses. 

Raubex

Raubex Group is the third-largest construction firm on the JSE, with a market capitalisation of just above R3.6bn.

While it has fared better than some of its competitors, the decline in the construction sector has certainly left scars: in May the company was forced to close two of its civil engineering subsidiaries, L&R Civils and Strata Civils.

In Raubex’s last set of annual results, released in that same month, the construction company reported that its overall revenue fell 5.1% to R8.54bn, however HEPS rose by 13.3%.

Overberg Asset Management director Gielie Fourie says Raubex has a strong balance sheet, with a quarter of its market cap held in cash.

He says that while Raubex is primarily a road and bridge builder in South Africa, it has had to diversify its revenue streams. 

The company now also has renewable energy construction projects, has started renovating old buildings in cities and has moved to diversify internationally.

Its work for Sanral as a portion of its order book had dropped from 23% to 12% in the 2018 financial year.

According to Van Niekerk, Raubex has moved into low-risk, more traditional construction work with lower margins. 

However, he says, Raubex is also a vertically integrated company, which gives it the opportunity to supply its own inputs. 

This would assist with margins in these tough times.

Raubex’s renovations business, Raubex Renovo, has a secured order book of R926m, while Raubex Infra has secured work worth R678m on two wind farm projects.

In January this year, Raubex acquired 70% of the Westforce Construction Group, based in Perth, Australia, for R60m. 

Raubex is also involved in building an 18?000m2 mall and a hotel in Cameroon for multinational group Actis and its Ghanaian partner Craft Development. 

It also has a R1.2bn road project with the Zambia Road Development Agency.

At the end of September, Raubex was trading at R21, down from a 2018 high of R22.50, which the share reached in late February.


Calgro M3

Calgro M3 develops affordable residential units. Its market cap is just above R1.6bn.

Calgro’s share price has mostly bucked the downward trend in the sector, up just short of 70% over the last five years. 

However, so far in 2018 it is down about 38%, and is trading at around R10.

Van Niekerk says that Calgro M3’s involvement in the residential housing market – where there is still demand – is a less risky niche than most in the construction sector.

Calgro M3’s primary areas of focus for its residential property development business will be to “roll out the existing pipeline” of 54 376 opportunities, with an unescalated revenue of R25.3bn over the next six years.

However, two of its properties - Fleurhof in south west Johannesburg and Sunset Village Flats in Scottsdene, Cape Town - faced land occupations earlier in the year, which CEO Wikus Lategan has admitted will be an increasing risk faced by the company in future. 

Davids agrees that illegal occupation must be considered a risk. 

However, he says the company’s diversification into the residential rental investments market and cemetery business has created new revenue streams that will grow.

According to Fourie, Calgro M3 has a “very long” pipeline and a strong balance sheet and he feels the construction company is “totally undervalued”.

“The price could go up a lot,” he says.

Calgro M3 entered the residential rental investments market to secure annuity revenue for use as operating cash and is expecting a return on equity of 20.5% on the group’s investment of R4bn.

Calgro also has big plans to expand its cemetery business, Memorial Parks, which it sees as a high-growth business. 

The cemetery business hopes to increase its profit contribution to the company to 10% by 2019 and eventually to 33.3% by 2021.

This article originally appeared in the 11 October edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

investment  |  sa  |  construction
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