Big ones be­com­ing too ex­pen­sive

But there are al­ter­na­tives

Finweek English Edition - - Companies & markets - SHAUN HAR­RIS shaunh@fin­

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.”

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