Care­fully con­struc­tion

Finweek English Edition - - INVESTMENT -

The boom days that pre­ceded the global f inan­cial cri­sis of 2008/09 were in­flu­enced, to a large ex­tent, by a num­ber of sec­tors, most no­tably the plat­inum, but also con­struc­tion stocks as the 2010 FIFA World Cup, Gau­train and gen­eral in­fra­struc­ture spends boosted their prof­its and mar­gins soared. That was fol­lowed by a gen­eral mar­ket col­lapse, one from which con­struc­tion com­pa­nies have not as yet re­cov­ered. This was in large part due to the Com­pe­ti­tion Com­mis­sion in­ves­ti­ga­tions, but even when that was re­solved the stocks re­mained stuck to a large ex­tent.

So what do we look for when in­vest­ing in con­struc­tion stocks? First, and per­haps most im­por­tantly, is to un­der­stand that these stocks are very cycli­cal in that they are char­ac­terised by boom pe­ri­ods fol­lowed by bust pe­ri­ods. In be­tween, there will be long, un­event­ful stretches. This boom-and-bust na­ture of the in­dus­try means that we need to time in­vest­ments in this sec­tor, get­ting in dur­ing the long pe­ri­ods where noth­ing hap­pens, and ideally close to when the boom starts. Then, when the stocks are boom­ing, we need to exit as close to the top as pos­si­ble. But nei­ther of those is easy to do and as a re­sult I have de­cided to avoid this sec­tor.

That said, the first thing one should look at with a con­struc­tion com­pany is its or­der book. We re­ally need a lot of de­tail on the or­der book. What time frame are the or­ders over? What mar­gin is ex­pected? How risky is the or­der book? The first two are sim­ple enough for the com­pany to an­swer, the risk ques­tion is per­haps more dif­fi­cult. Cer­tainly, the com­pany would say that the risk is not higher than nor­mal, but what we have seen over the last few years is a num­ber of con­tracts that ended up be­ing loss­mak­ers, hurt­ing prof­its.

Also look at the sec­tors the con­struc­tion com­pa­nies are op­er­at­ing in, for ex­am­ple, con­tract min­ing, civil and roads. Some sec­tors are a lot more prof­itable and far more sta­ble. Con­tract min­ing, for ex­am­ple, can be great as such com­pa­nies don’t carry the risk of com­mod­ity prices fall­ing but in truth they do be­cause if prices fall, con­tracts can be can­celled. Fur­ther, min­ing com­pa­nies will typ­i­cally can­cel the con­tract min­ers be­fore re­trench­ing their own staff.

Then of course there’s a com­pany’s op­er­at­ing profit mar­gin. We need to look at this not only at group level, but also fo­cus on the dif­fer­ent sec­tors a com­pany op­er­ates in. Ideally, we should even scru­ti­nise the dif­fer­ent large con­tracts. As al­ready men­tioned, we would ideally like to know the pro­posed op­er­at­ing mar­gin of the or­der book.

Cash gen­er­a­tion is also very im­por­tant, not just the mak­ing of cash, but also how much a par­tic­u­lar com­pany has on the bal­ance sheet. Con­struc­tion is very cap­i­tal in­ten­sive and runs the risk of all sorts of cost over­runs and penal­ties. So a lot of cash is needed and while that looks at­trac­tive on the bal­ance sheet, it can soon slip away. So look for cash, but don’t bank on it as you would with a stock in a sec­tor such as re­tail.

An­other is­sue is ge­og­ra­phy. Af­ter the cri­sis, a lot of com­pa­nies headed for Aus­tralia or the rest of Africa look­ing for eas­ier prof­its. But Aus­tralia has its own chal­lenges right now and while the rest of Africa may seem like an easy win, it sel­dom is. Sure, mar­gins can be higher, but is the work ef­fec­tively be­ing man­aged out of South Africa or are the com­pa­nies tak­ing it se­ri­ously and op­er­at­ing on the ground? My view is that it only re­ally counts if the com­pany has a track record in what­ever re­gion it op­er­ates in. A new of­fice in some far-f lung coun­try may sound ex­cit­ing, but I want to see a track record of prof­its first.

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