This week the Small Cap team take a look at how they are gaining exposure to the investment thematic that is the infrastructure "boom". In doing so they take a look at a pair of stocks in their portfolio.
The term “infrastructure boom” is often referenced in media commentary. While a “boom” may be somewhat overstating the significance, there is clearly an increasing amount of investment moving into infrastructure projects. Deloitte Access Economics notes that engineering and commercial construction activity increased by 12% in 2017, with a pipeline of over 150 major projects valued at over $200 billion anticipated to come on line over the coming years.
This pipeline of new projects will support significant new construction and ongoing maintenance spend as outlined below for Australia.
Our challenge has been in identifying companies that have unique, market leading product/service offerings, that are well positioned to capture a meaningful portion of this spend, at attractive margins, while at the same time having a diversified customer base so they are not exposed to any significant single contract risk. As always, we also require the investment to offer compelling valuation metrics. Over the last month we have increased our exposure to the infrastructure sector through further investments in two such companies that meet our strict criteria:
1) SRG Limited
Diversified international engineering and complex services provider
Market cap: $144m
SRG is an engineering services company founded in 1961 to supply and install rock anchors for the Snowy Mountains scheme. Today it offers a diversified range of infrastructure, civil, building and mining services to a global customer base.
SRG has a market leading position in bridge works and bridge construction systems and has been designing, constructing, repairing and strengthening bridges since the 1960’s. As a recent example, SRG was part of a joint venture that in late March was awarded a project to build 2.1km of new roads and a new 320m long bridge in regional NSW by the NSW Roads and Maritime Services. SRG will provide the experience and systems to the joint venture project team for the construction of the balanced cantilever bridge.
SRG’s other key competency is dam construction where it is a global leader in permanent ground anchor design and installation. SRG recently formed a US joint venture which is targeting the estimated USD22b required to repair over 15,000 high hazard dams in the US.
During the month SRG undertook a capital raising to fund the acquisition of TBS Group (Farnsworth), a leading NZ based specialist industrial contractor in asset and infrastructure maintenance services. The acquisition expands SRG’s recurring service and maintenance exposure and provides a platform for further expansion in New Zealand.
It is a member of Total Bridge Services JV with Fulton Hogan and WSP Opus NZ which provides maintenance activities on the iconic Auckland Harbour Bridge.
The acquisition diversifies its service offering and will result in over 30% of its revenue being generated from outside Australia.
SRG acquired TBS at the attractive multiple of 4.2x FY18F EV/EBITDA and 3.8x FY19F EV/EBITDA resulting in a transaction that is highly EPS accretive (~30%). At the placement price of $1.60, SRG was trading on a FY19 PE multiple of less than 10x.
We have held a position in SRG since mid 2017. We have increased our holding through our participation in the institutional placement used to fund the TBS acquisition.
2) Traffic Technologies Limited
Australia’s largest traffic software and solutions company
Market cap: $16m
Traffic lights: TTI a leading supplier of LED road lights to the Australian market. It is the largest supplier of lights for major roads (Category V) in Australia. TTI’s latest release of LED lights has proven to be very popular, with cost savings of 60 per cent in power, and 80 per cent in maintenance. TTI’s new smart street lights also monitor vehicles and are used to feed into the controller to improve traffic light efficiency from 80% to 98%.
An example of TTI capitalizing on the infrastructure spend is a contract awarded to it by Fulton Hogan to supply LED road lights for the M80 Ring Road Upgrade in Victoria - a $300 million jointly-funded project of the Victorian and Australian Governments.
Traffic signals: TTI continues to be the dominant supplier of traffic signals to the Australian market.
Traffic controllers: TTI is also one of 3 licensees able to work within the SCATS (Sydney Coordinated Adaptive Traffic System) framework which is used also and operated in 27 countries and 37,000 intersections worldwide - regulating the sequencing and timing of traffic signals. 80 per cent of TTI’s revenue from this division now comes from offshore, across the Middle East, Asia, and the Americas – for example TTI controls 40% of Singapore traffic flows.
Smart City platform:
TTI has been successful in commercialising its “Smart City” platform “TST” - a wireless solution to monitor lighting and associated assets. TST’s intelligent remote sensors can gather information on a wide range of inputs which currently the environment, waste functions, pole tilt or damage, plus the management of asset maintenance.
The smart city platform is also able to communicate "V to X" (vehicle to infrastructure), which will become increasing relevant as new generation vehicles become more popular. V to X is emerging technology that enables vehicles to automatically pass along messages regarding road conditions, traffic flow, and obstacles before these appear in the driver's visual range. Vehicles are ‘connected to’ and receive signals from intelligent road infrastructure such as TTI’s.
In 2016, the Australian government launched its Smart Cities plan which sets out a national vision to enhance cities through smart policy, investment and technologies, and to manage the impact of growth on such things as congestion and traffic. A $50m Smart Cities and Suburbs program has been established to fund various Smart City initiatives.
Being able to control the technology in a key city asset such as street lights, places TTI in a very strong position as cities become more “connected” as per below.
TTI is likely to generate revenue in excess of $60m for FY18. At a 10% EBITDA margin, and adjusting for the interest savings following the recent capital raising, this is likely to result in a pro-forma NPAT well in excess of $2m. The market cap of TTI at the 3c issue price was $14m, implying a mid-single digit PE multiple.
This would suggest there is significant upside if TTI Management can demonstrate it can continue TTI’s recent growth. TTI’s growth is expected to be driven by increasing export revenue, and installation and maintenance revenue from:
Prior to the recent rights issue, we avoided TTI due to its high debt levels. As part of the equity raising, the company secured funding from a new financier and achieved a substantial debt forgiveness from their old banking partner. The company now trades on reasonable debt levels and has working capital to grow its business.
Directors and associated parties contributed ~$1.2m of the $6m raised, the proceeds of which were used to significantly improve TTI’s balance sheet.
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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.