This week we look at two more unloved securities, CIMIC (CIM. ASX) and Service Stream (SSM.ASX). Both of them have been perhaps less than pleasant experiences for long-standing shareholders. With that in mind, is it potentially a good time to buy? After all, both of them sit in a strong thematic (i.e. infrastructure and commodities).
CIMIC Group (CIM.ASX)
This is one company that most Australian investors would be familiar with (or at the very least its predecessor, Leighton Holdings) and not for the right reasons. Governance issues, most recently including bribing the then Deputy Prime Minister of Iraq to secure a pipeline contract, have certainly raised some red flags. This has also been exacerbated by construction project issues, boardroom politics and slowing demand in the mining services segment. The last of these is potentially where we see the most upside and why CIMIC is even on our radar; we remain of the view that (despite the last week’s price action) we are very much in the infancy of a multi-decade bull cycle in commodities which will undoubtedly see a pick up in demand. This is also not mentioning the increased investment in infrastructure globally. To give some context, CIMIC’s last guidance indicated that they have a pipeline of relevant future tenders to the tune of $475bn AUD (up from $285bn AUD).
Moreover, despite the definite red flags regarding governance, CIMIC does have a reputation of a strong balance sheet and an ability to undertake large scale contract-mining and construction projects that create an effective moat when moving to tender. Substantial economies of scale allow the company to take on multiple projects and diversify across market cycles, though this could have been executed better in my opinion. Breaking down revenue as it currently stands: 65% Engineering and Construction, 25% Contract Mining and 10% Services and Property Development.
We continue to see substantial upside given the pipeline in Australia (Eastern Seaboard) and across the Asia Pacific region (where they still operate as Leighton). At the current run rate, the business has already been awarded work in hand up to $10.4bn in Australia for 1H21. To put this into context, the full year of 2020 was $6.6bn. In my view, we will continue to see this pipeline grow, especially coming out of lockdowns as governments look to stimulate growth. On a more strategic level for the business, some key catalysts to come will be the potential divestment or listing of their services arm, Ventia (the brand that does the asset management and maintenance). Returning once again to the reflation thematic, the business’ cost of financing and their debt issuance in the European markets has seen them reduce their cost of financing from 2.2% to 1.9%; given that a significant portion of this is fixed (especially the longer term Eurobonds), any uptick in inflation should again act as a transfer to the shareholders.
On the negative side, CIM’s 50% sale of Theiss, now the largest contract mining services provider on the planet, was potentially a bad move despite the rhetoric around “introducing a partner to “support growth and diversification”. Never has anyone of reasonable business acumen come to the conclusion that the sale of a business to a hedge fund would be conducive for longer term growth. The other 50%, by the way, is now effectively owned by Elliott Management (i.e. a Paul Singer outfit). Singer is the man termed by the New Yorker as the doomsday investor, a rather apt elucidation in my view.
Arriving at the numbers, revenue came in at $1.7bn and NPAT at $208m, an apparent decline of 34%. However, stripping out the Theiss numbers (due to the sale), first half numbers were actually higher by about 1.5%. Furthermore, CIMIC has maintained NPAT guidance for 2021, $400-430m AUD, and our view is that this remains on the conservative side. Assuming that this is the case, one could easily see a medium term catalyst for a re-rate on the underlying security. I make this call based not only on the unwinding of the Covid impact (delay in contract awarding) but also on the additional pipeline assuming a conversion rate in line with their historic trend. Using that as a scenario, my expectations are that NPAT will come through marginally higher than guidance at $440m AUD.
Importantly for the dividend starved investor and assuming that they keep the current payout ratio of circa. 63%, it implies a dividend yield of 4.3%.
Red Flags & Risks: The biggest red flags with CIMIC, despite their engineering capabilities, strong balance sheet and scale, are the consistent governance issues. Company politics almost always seem to get ahead of them and there doesn’t seem to be a coherent strategy for longer-term growth. It’s the classic case of a good brand, product and technical capabilities with bad optics and overall management. The focus on PPP (Public Private Partnerships) is the right move but one hopes that they don’t repeat history with how they go about this aspect of the business.
My Expectations: Cheap! Especially given the broader thematic around infrastructure and the segments CIM operates in. Despite the less than stellar performance in the share price, our fair value estimate is about $35 AUD… the potential for 70% upside.
Dividend Yield: 4.3%, assuming a price $20.30 AUD.
Service Stream (SSM.ASX)
It has been a rather eventful year so far for SSM; rather cringeworthy for the shareholders but we are of the view that at these levels it makes for an interesting investment proposition. The share price having lost close to 50% since the beginning of the year in a bull market leaves us quite certain that long term investors aren’t happy campers. For those of you unfamiliar with the business, SSM engages in asset life-cycle services to the utilities and telecommunication sectors. That’s another way of saying they design, construct and maintain much of the infrastructure that you see around you, from your broadband to your gas connection. Given the nature of the industry they operate in, scale is potentially the most important factor in terms of long-term sustainability as well as consistently locking in longer term contracts.
On the first count (i.e. scale), the business has a history of acquiring in order to diversify, initially with Comdain in 2018 which has contracts across water and transmission. More recently, SSM has managed to get their hands on the entirety of the services division of Lendlease. Herein lies the problem with the recent price action. We will start by saying that we could see this situation being handled substantially better. It started with a leak from the AFR before shareholders got to find out and price action that saw massive selling pressure preceding the announcement. It was almost as though someone knew that there was a cap raise on the books... But now let’s have a look at the deal itself. The business will now acquire 100% of the services segment with an EV of $310m. Accounting for debt the purchase price is $295m and it would’ve bought out the business at an EBITDA multiple of 6.9x. Management guidance indicates that post-acquisition synergies should lead to a strong EPS accretion of about 30%, a rather nice target for the shareholder to think about.
So, does this make sense? In our view this further diversifies the business revenues, away from just telecommunications and utilities, to now broader capabilities in specialist design and construction. Not to mention a customer base which includes some of the largest public and private sector clients in Australia. Overall, it was done at a reasonable price and makes a great deal of sense from a strategy perspective. Personally, I would love to see them make a play for Ventia (mentioned above) which would make the group a force to be reckoned with but that is perhaps a pipe dream as the addition of Lendlease should keep the business busy for a while yet.
Returning to the bread and butter of the business, we like what we see. The contracts are reasonably long in duration and the business should have greater diversity in customers following the Lendlease acquisition. On the teleco side, their most important agreements are the NBN Unify and the Telstra field operations which are cumulatively worth $1.3bn AUD over an 8 year period. On the utilities side, the business has continued to secure contracts, the most recent being SEQ Water and NSW Operations.
Getting into the numbers, first half EBIDTA of $40.2m AUD and strong cash flow generation with working capital remaining at 1.3% of revenue. The business also maintained its payout ratio which, in retrospect given the acquisition, may have been a little on the ambitious side. Though Covid put a dampener on revenues, especially in the telecommunications segment with delays in client procurement, we should see continued recovery throughout 2021 with perhaps the exception of NSW. Interestingly, the acquisition of Lendlease should see combined revenue now at $1.7bn AUD and EBITDA of $120-125m AUD (management guidance). On the flip side, the company would have added close to $123m AUD in debt, manageable if things go according to plan.
Red Flags & Risks: The biggest risks come from the integration process and their ability to retain existing customers as well as find cost outs. Continued Covid related risks also persist, especially in NSW now, which does place stress on the telco segment.
My Expectations: When one considers the business’ current market capitalisation in comparison to the forecast group EBITDA, we think that SSM could be exceptionally cheap. We don’t expect payout ratios to stay within the current 50-60% range for another 12-24 months but, at the current share price, the investor will potentially lock in a yield of 10-12% over the longer term.
Dividend Yield: The most recent dividend was 0.025c per share but post-acquisition we expect (perhaps hope is more appropriate) that further distributions will be delayed for the year. After that, and using the current share price of 90c, a yield of 10-12%.
For those of you looking to get in, it may be worthwhile to hold out for below the SPP at 90c.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.