Big ones becoming too expensive
But there are alternatives
INFRASTRUCTURE SPENDING SHARES were a top investment theme in 2006, and investors were handsomely rewarded. Over the past year, large construction companies’ share prices have gained from 70% to more than 100% – heady stuff, and more remarkable in that it was a fairly obvious equity sector to choose.
Government has committed to spend about R370bn on infrastructure development, and a number of private sector projects are planned or already under way. In addition, there’s the new airport and trade port planned for Durban, Eskom has serious capital commitments to build new power stations, and all the oil refiners have to upgrade and expand to meet cleanair requirements.
There’s also the Soccer World Cup in 2010. Large fixed-investment spending is planned around the event, and recent budget overruns to build new soccer stadiums indicate the final number will be huge.
All of which is a pretty unique invest- ment opportunity in South Africa, promising medium- to long-term appreciation of related beneficiary company share prices.
But for many of those companies, especially the big ones, the prospects are already in the price, and more. A number of building and construction company shares just look too expensive to buy now.
That could also be a dangerous view, given the exceptional prospects for groups such as Murray & Roberts, Aveng and Group Five. Feroz Basa, an analyst at Old Mutual Investment Group, admits that many analysts got it wrong. “The irony is that many analysts, including me, thought these shares were already fully valued at the beginning of 2006, yet we’ve seen these steep prices rise anyway, and they look like they are going higher, mostly on sheer hype.”
Can this continue? Maybe, but as Basa cautions, fundamentals for the big four construction companies’ earnings growth are underpinned by record order books, and the share prices imply nothing will go wrong with any upcoming big projects.
“Nothing will go wrong” is always a dangerous phrase in the investment world.
“There’s no room for error. If one of these companies has even one large contract that somehow goes wrong, we could see a sharp reaction in its share price,” he says.
So what do investors looking to benefit from the infrastructure spending boom do? There’s an interesting alternative, largely involving smaller-cap stocks, that still holds promise and arguably provides more certainty of stable and growing earnings – the companies that supply materials to the construction industry.
This involves about 10 stocks, mainly smaller companies but also large groups such as PPC. Yet this is where the potential seems to lie.
Anthony Sedgwick, fund manager at Polaris Capital who runs the three-year overall top-performing Nedgroup Investments Entrepreneur Fund, has this sector as one of his investment themes for the year ahead. “We remain convinced that fixed investment spending is the area where one can most confidently expect growth to occur in the domestic South African economy over the next five years.”
But he makes a distinction: “We also remain circumspect about the valuations of most of the building contractor businesses and retain our preference for the materials suppliers to the industry, where the valuations are more reasonable and the predictability of growth more accurate.”
Not all the shares are in the Construction and Materials sector, but ratings of the shares listed below as possible infrastructure buys are certainly less demanding than the large construction groups, which demand p:e ratios from 18 to 27 times, way above the market average of around 15. The p:e ratios for these smaller suppliers start at around 12, and only dominant cement supplier PPC gets a rating above 17 times.
There’s always more speculation attached to smaller-cap shares and some might not come through the way we think they should, but here’s our best bet on the second-tier infrastructure shares that should outperform the majors. • Afrimat • Buildmax • Cashbuild • Ceramic • Esor • Italtile • Masonite • PPC • WG Wearne
A number of the shares above are in Alida Jordaan’s Metropolitan Industrial Fund, which has returned 97% over the past two years to head its sector. She says: “For the big guys there’s always huge project risk, so I like the smaller companies because I think there’s enough work for them to benefit from.”