A spate of less-than-impressive results by WBHO, Group Five and Aveng shows that market conditions might be worse than what investors initially perceived and has condemned the construction & materials index to six-year lows.
Strong order books by all three construction groups in previous reporting periods had sparked hope of an imminent recovery in a sector that has been in a miserable state since the 2010 Fifa World Cup boom. However, the latest numbers confirm that many of the order book projects were taken on with increasingly thinner margins due to intense bidding in the market, meaning no wiggle room so they quickly become loss-making endeavours if things go wrong.
Group Five’s interim results to end-December show that it has been hard hit, but the market was expecting its poor results following a profit warning in November. The profit warning came two trading days after the Competition Commission announced that it was referring collusion cases against Group Five and five other major construction players to the Competition Tribunal.
Blaming one-off restructuring costs, a poor operational performance in the civil engineering division and contract losses, revenue from continuing operations shrank 12% to R6.89 billion (1H15: R7.83 billion). Headline earnings almost halved to 109c per share (1H14: 204c).
Management doesn’t foresee any improvement in the next six months as they expect continued pressure on earnings from slow market order intake, ongoing restructuring costs in the civil division and the impact of delays on the commencement of the R4.6 billion Kpone Power project in Ghana. Earnings will also be affected by one loss-making project which is still ongoing and is due for completion this half.
The industry needs a boost from the economy and larger investments on infrastructure developments for profitability to improve. Unfortunately there are no signs of anything of that sort as Nedbank reports that announced public sector new projects for last year were R10.5 billion down from the R42.4 billion spent in 2013.
The economic outlook is also tepid with the most optimist forecast projecting dismal 2.5% GDP growth this year. Aggravated by weak commodity prices, it is hard to see where the sector’s recovery will come from.
Group Five says its order book for the next 12 months is 5% higher but the fact that close to half of that is from the South African housing & building and civil engineering markets doesn’t give us much comfort. Historically, margins from these segments have been below 2%, not very appetising.
On the positive side we like Group Five’s efforts to diversify its revenue stream, which has resulted in good penetration in the energy, oil & gas and transport sectors. The operating margins in these segments look better above 5%. We also notice that with an increased focus on investments and concessions, annuity income now constitutes a substantial portion of earnings and the order book, which provides a buffer. The balance sheet is solid and remains highly cash- generative with an asset underpin.
Group Five has shed more than a third of its market value since November which places it on a lowly price: earnings multiple of 8. After discounting for the uncertainties surrounding its prospects, our discounted cash-flow model shows that the market has correctly priced Group Five’s shares. We therefore issue a hold recommendation.
• Increasing exposure to growth sectors
• Government public infrastructure development programme may provide growth over the long term, supported by expansion into Africa
• South African market remains generally weak
• Overcapacity resulting in intense margin pressures
• Potential unrest in South African labour market
Nature of business: Group Five is a diversified construction services, materials, infrastructure and investment group. More than two thirds of revenue comes from SA and it also has operations in the rest of Africa and eastern Europe.
Analyst: Orin Tambo; Editor: Colin Anthony
Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, methodologies and definitions please click here.