SIFTING THROUGH THE RUBBLE OF JSE’S CONSTRUCTION FIRMS
Some companies have managed to clear a new space for themselves and are doing well, writes Shawn Stockigt
Since the boom years of the huge infrastructure spend in South Africa for the 2010 Soccer World Cup, the construction sector has not been an easy place for investors to make money.
The World Cup spend, together with megaprojects such as the Gautrain, led to some extremely profitable years for construction businesses. Fattened by these profits, companies launched ambitious global expansion plans, often using South African-funded capital structures. These projects were often based on overly generous global and domestic economic growth forecasts. Many of these plans, however, have proved detrimental.
Admittedly, not all of the construction companies’ woes were caused by factors within management control. Some failures may have been due to plain bad luck and the government’s continued failure to deliver the promised infrastructure spend. Add to these a few own goals by the government, such as allowing construction mafia groups to act with impunity, and it is no wonder that investor returns have been wiped out. The construction sector (those companies that survived, that is) on the JSE has lost more than 70% since 2010, against the JSE all share index gain of more than 160%.
All this has led to construction companies operating in an environment of razor-thin profit margins, leading to almost no margin for error at the operating level.
However, using the benefit of hindsight and sifting through the history of financial results, the management of these companies did make costly mistakes. Bad timing, and in some cases bad decisions, relating to aggressive offshore expansion plans (many involving Australia) resulted in ballooning debt which bloated balance sheets. This led to unsustainable capital structures and unsuitable (and expensive) acquisitions.
For some, the domestic and global economic downturns from 2020 may have, ironically, been their saving grace. These slowdowns forced many in management to admit that “business as usual” no longer applied. Companies were forced to review their business strategies and relook at their underlying assets to identify noncore assets for sale and restructure their balance sheets in order to survive.
Groups such as Aveng got the message and took drastic action. Aveng rightsized its business by selling off
Companies were forced to review their business strategies and relook at their underlying assets
noncore assets (more than a dozen businesses were disposed of). The group also targeted its capital structures, calling on shareholders for more cash in the form of a rights issue in 2021. For now, this seems to be working as Aveng has evolved into a simpler business with only two core assets. One of these is its Australian business McConnell Dowell, with a construction and engineering focus in Australia, New Zealand, Southeast Asia and the Middle East. The other is Moolmans, which offers services across the mining value chain operating across Africa. About 91% of the group’s revenue is now generated outside South Africa. This gives investors rand hedge exposure as it reports in Australian dollar, despite keeping its listing on the JSE.
With possibly the exception of Aveng and Raubex, Australia has proved to be costly for many of the South African construction companies that tried to gain a foothold there. WBHO is no exception and, after 20 years of operating in Australia, the group had to admit defeat. The parent company withdrew all funding of its Australian operation in 2021, forcing it into administration.
This has proved to be the correct decision. Shareholders eventually came to appreciate the benefit of the group not being dragged down by the Australian business. After initially plunging, the share price has rerated strongly.
The group has since shown that there is life beyond Australia and has been able to extract value from its South African, rest of Africa and UK operations. In its recently released results for the halfyear ended December 2023, headline earnings for continued operations (excluding Australia) came in at R9.06 a share against the comparable number in the previous year of R8.19. Revenue in the South African portion of the business jumped by 28.9% on the comparable 2022 number. This equated to R9bn of the total R13bn in group revenue. Good growth in South Africa was reported in both building and civil engineering, as well as the roads and earthworks divisions.
Despite dinner table talk, money continues to be spent on construction projects in South Africa, and WBHO highlights large-scale anchor projects in its results. In Gauteng the group is seeing activity in new builds for data centres, commercial office space and the residential sector. Good news for shareholders is that the group has resumed paying a dividend (230c a share). Dividends had been paused due to contractual obligations resulting from the impact on cash flows due to exiting the Australian business.
Looking ahead, there are more positive signs: the order book is showing resilience at R32bn. This indicates there are still healthy levels of available work in the construction sector.
Murray & Roberts has also been hit hard by economic pressures and general bad luck. Its subsidiaries in Australia are in voluntary liquidation. This has dramatically reduced the size of the group. Despite this, Murray & Roberts is still a global business and now operates in Africa and the Americas. It has become a predominately engineering and contracting services company with a focus on underground mining, renewable energy and power infrastructure.
With a reduced earnings base, the group has had to slash its debt levels. This was done through the sale of its 50% share of Bombela Concession Co (operator of the Gautrain) and other noncore investments. This has helped as net debt at December 2023 was at R247m against the R1.9bn it reported in December 2022. With a share price of R1.27 (at the time of writing) Murray & Roberts now has a paltry market cap of just under R600m, leaving some investors regretting that they didn’t accept the R17 a share that German group Aton offered in 2018.
But judging from its recently released set of interim results, Murray & Roberts may just have turned the corner. Though it reported a loss of 16c a share at the diluted headline per share level, this is an improvement from the 27c a share loss reported for the comparable 2023 first half. Its balance sheet has also improved.
PPC has also emerged from a huge restructure. It did this in much the same way as Aveng, by offloading assets and restructuring its domestic
Despite dinner table talk, money continues to be spent on construction projects in South Africa
and international operations and by attacking its debt burden. PPC now seems to be in a sounder financial position than it has been for many years. The group is streamlined and perfectly positioned for any domestic uptick in infrastructure spending.
In the meantime, it has benefited from its Zimbabwe operations, which as at its September interim results, were self-funding and in a position to return muchneeded cash to the holding company in South Africa. This has helped improve liquidity. Shareholders may now start seeing the benefits of a reenergised and strengthened management team with new CEO Matias Cardarelli, an industry veteran, at the helm.
Despite all the negativity in the sector, shareholders in Raubex and Afrimat have done relatively well. Raubex, counter to many South African businesses, has performed satisfactorily in Australia by being selective when tendering for projects, preferring to work on smaller, shorter contracts. This has proved to be a winning formula for it. Yet, despite being a serial outperformer relative to other construction companies, Raubex’s valuations still appear cheap on most metrics.
As we have written before, one seldom finds good value and good news at the same time. For some investors, using Warren Buffett’s “buy when there’s blood in the streets”, timing the sector has also paid off. Beady-eyed investors who picked through the skeletons of construction and construction-related companies over the past few years — when the bad news of the sector was at its worst — have generally done quite well.
For example, if you bought WBHO after it announced its decision to discontinue financial assistance to its Australian business, you would have returned about 63%. The same can be seen in Murray & Roberts and PPC, which have returned 67% and 76% respectively since the trough of their bad news cycles.
Looking ahead, the fortunes of construction companies could change
dramatically for those with a domestic focus if the government delivers on its promises to prioritise public infrastructure spend, as laid out in state of the nation addresses. The need for this spend is now clearly visible as public infrastructure generally continues to deteriorate.
Selectively, construction stocks are looking cheap from a valuation perspective. The order books of most construction companies seem to be growing. Add to this the prospects of good tailwinds, which could give a welcome boost. These include largescale private investment into electricity generation and (hopefully) increased spending on port and rail infrastructure.
This could all mean that, overall, construction companies may now be in better shape, structurally and financially, than they have been in years.
For some investors, using Warren Buffett ’s ‘buy when there’s blood in the streets’, timing the sector has also paid off