Find­ing value in the con­struc­tion sec­tor

Many would agree that the good times are gone for lo­cal con­struc­tion com­pa­nies. But ac­cord­ing to the ex­perts, pa­tience can re­ward in­vestors - if they pick the right com­pa­nies

Finweek English Edition - - Contents - By 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

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

Izak van Niek­erk An­a­lyst at Mer­gence In­vest­ment Man­agers

Lester Davids An­a­lyst at Unum Cap­i­tal

Wayne McCur­rie Port­fo­lio man­ager at FNB Wealth and In­vest­ments

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