Boss Score harvest: Morgan Sindall Plc (UK GB0008085614) – negative invested capital

Morgan Sindall ist one of the best scoring UK companies in my Boss Score screener, so I thought I might have a closer look into it.

Company description per Bloomberg:

Morgan Sindall Group PLC operates a specialist construction group. The Group’s activities include office design, fitting out, refurbishment, building contracting, property investment, and related specialist services. Morgan Sindall operates in the United Kingdom and the Channel Islands.

Traditional metrics look Ok, no “deep value” but “cheap”:

Market Cap 293.5 mn GBP
P/E 8.7
P/B 1.2
P/S 0.1
EB/EBITDA 5.4x
Dividend yield 6.9%

Other quick check Items:

+ company has no financial debt (GOOD)
+ management holds significant shares (GOOD)
+ however no majority shareholder (GOOD)
+ constant and high ROE/ROE/ROIC (GOOD)
+ long established operating history (GOOD)
+ relatively low beta against Footsie of 0.66 (GOOD)
+ almost no pension liabilities (GOOD, important for UK companies)
large intangible assets (TO BE CHECKED)
– low but stable margins (TO BE CHECKED)
UK only construction company (TO BE CHECKED)
– volatile free cashflows (TO BE CHECKED)
– increasing share count over the last decade (TO BE CHECKED)

So the big question one has to solve with Morgan SIndal is: How do they manage to have such stable margins although they are so razor-thin ? “Classical” competitive theory would suggest that a company with 1-2% margins is in a very difficult situation from a competitive point of view. Morgan Sindal howver seems to be able to constantly earn those razor-thin margins and turns them into great ROEs with efficient capital management.

Prof. Margin ROE ROA
31.12.1998 1.8% 48.4% 34.7%
31.12.1999 1.6% 30.7% 26.9%
29.12.2000 1.7% 29.7% 27.5%
31.12.2001 1.6% 27.4% 26.1%
31.12.2002 1.0% 15.9% 16.0%
31.12.2003 1.3% 20.0% 21.4%
31.12.2004 2.0% 27.0% 28.1%
30.12.2005 2.3% 27.5% 28.1%
29.12.2006 2.2% 25.4% 26.0%
31.12.2007 1.9% 25.6% 26.8%
31.12.2008 1.8% 25.0% 26.1%
31.12.2009 1.5% 16.4% 16.5%
31.12.2010 1.4% 13.9% 14.2%
30.12.2011 1.5% 14.4% 14.8%
 
Avg 1.7% 24.8% 23.8%

The table clearly shows the discrepancy between “moat like” returns on assets and “distressed” profit margins.

Interestingly, Morgan Sindall is also an extremely good long term performer. The longe term chart does only show this to a certain extent:

Over the last 20 years, Morgan Sindall was under the Top 20 performers of the UK small cap index, with an incredible performance of 15.4% p.a. vs. 4.6% for the UK all share index.

I guess the low margins are also one of the reasons, why Morgan Sindall is not the darling of UK stock bloggers.

Paul Scott for instance writes:

Construction company Morgan Sindall (MGNS) report a “satisfactory first half”. It seems to consistently throw out about 75p EPS each year, and pays 42p in divis. So at 615p it looks fair value. I don’t like this type of company with huge turnover £2.2bn p.a., and wafer thin profit of around £40m p.a., as they are only one problem contract away from a profits warning & potentially insolvency.

John Mc Elliot covered it a little in his Valueinquisition blog, but I think he didn’t buy and his blog is not very active anymore.

There is also a rather shallow article on Motley Fool Uk.

Sell side wise, the stock is covered from 8 analysts, 5 buys, 3 holds, the more recent recommendations were buys. So not a totally uncovered stock but definitely not in the spotlight.

Business model

The company is first and foremost a construction company. Additionally the provide “fit out” services for offices and “affordable housing” projects. A new business field is called urban regeneration.

A quick look into the balance sheet quickly shows where the capital efficiency comes from: Negative working capital

Let’s quickly look at 2010/2011 net working capital:

2010 2011
Inventories 146.0 141.1
Amounts due from constr. Cust 228.6 178.4
receivables 186.5 229.2
cash 108.9 148.6
  670.0 697.3
     
     
Trade payables -620.9 -667.2
amounts due construction contr. -78.8 -70.7
others -14.1 -39.4
  -713.8 -777.3
     
Net -43.8 -80.0
Net ex cash -152.7 -228.6

Nice business if you can get it, at least from a Working capital perspective. Where does that come from ?

A quote from the notes of the 2011 annual report:

The average credit period on revenue is 15 days (2010: 23 days). No interest is charged on the trade receivables outstanding balance. Trade receivables overdue are provided for based on estimated irrecoverable amounts.

and:

The directors consider that the carrying amount of trade payables approximates to their fair value. The average credit period taken for trade purchases is 28 days (2010: 25 days). No interest was incurred on outstanding balances.

So a “Quick and dirt” calculation tells us: Morgan Sindall gets paid 15-28 = -13 days earlier than they pay their bill. 13/365*2 bn = 80 mn EUR on average “net negative working capital”, so the year-end numbers above are somewhat higher than average.

What I find even more amazing is the fact that property, plant and equipment is a mere 21 mn GBPs, the rest of the long term assets are Intangibles and special investments. Only 6 mn in property (freehold, financial lease) and 15 mn EUR in equipment.

They only have around 24 mn operating leases for buildings outstanding, so no big issues. So the Negative working capital is additionally funding all the fixed assets (excluding goodwill) and some more

So my stupid question is: Where do they get all the machinery etc. from ? The answer seems to be simple. Outsorcing. For example to Speedy Hire Plc as this web site shows.

Speedy Hire’s balance sheet is like the (bad) mirror image of Morgan Sindall: Lots of fixed assets, positive net working capital. Higher gross margins but very volatile. Operating cashflow looks better, mostly because of depreciation of the fixed assets.

Howver if we look at Speedy’s historical numbers we see that despite the higher net margins, the business model of Speedy Hire is much more volatile and returns less on capital:

NI Margin ROE
31.12.1998 4.0% 19.8%
31.12.1999 15.5% 26.9%
29.12.2000 -12.0% -17.4%
31.12.2001 2.1% 4.0%
31.12.2002 9.2% 17.9%
31.12.2003 10.3% 20.4%
31.12.2004 8.8% 18.0%
30.12.2005 8.7% 17.7%
29.12.2006 7.9% 17.1%
31.12.2007 5.0% 11.4%
31.12.2008 -11.4% -27.1%
31.12.2009 -5.2% -8.8%
31.12.2010 -5.4% -8.1%
30.12.2011 0.5% 0.7%
 
Avg 2.7% 6.6%

To me it seems that Morgan Sindall managed to pass on a lot of capital requirements and volatility onto its “partners” like Speedy hire.

Summary:

Despite being an UK construction company working on very thin margins, Morgan Sindall seems to have a very interesting business model. They run the firm as a whole on negative invested capital requirement (ex Goodwill) which is quite an achievement and seem to have outsourced a lot of volatility.

Together with the other positive aspects mentioned above, this definitely is worth a deeper look into it and the UK construction sector. The main question is if the comapny is cheap enough to offer a “margin of safety”.

To be continued……

<

6 comments

  • For a construction company I find Cash flow important too, because fluctuations of inventory ,& working capital in general are ridiculous.

    Cashflow is much more volatile here, which makes me raise eyebrows at those consistent earnings..

    In 2010 and 2011 EBIT was essentially equal at 41.8 and 40.8 million pounds.
    Meanwhile, changes in WC were -51.6 million pounds in 2011 and plus 53.7 million pounds in 2010!!

    Operating cashflow was hence negative in 2011 (-11.8) and positive for 2010 (90.6). See note 26 of the AR. That is very cyclical.

    They sold some sizeable amounts of PPE (4.6) in 2011, I don’t think that’s a good sign, although someone might know more about that? Might be very cost effective management, but if that is the case, why did the company spend the exact same amount of 17.8 million pounds on dividends in 2011 and 2010? And why do they pay dividends in a year with negative free cash flow..

    Overall the company burnt 39.7 million of cash in 2011, which wiped out all tangible equity in the business.

    I never like it if companies do not adjust their dividends. I think it is a sign of unserious management. And that’s what I think of that income statement too.

    And the balance sheet? Forgetting about Intangibles, this leaves the company with NO tangible book value. It was wiped out through the negative cashflow in 2011. Now a little tangible is back in H1 2012. But in 2011 H1 was better than the current H1, meaning 2011 H2 was devastating.

    And you have to live with the industry risk, construction is cyclical. This is no way attractive enough from my point of view.

  • Could be interesting, if the have there niche. The constructing business has very long cycles and we are heading downwards for long time I fear.

  • or good hedging/legal work.
    Wouldn’t buy for a concentrated portfolio, but I don’t see a problem for a small position.

  • In my opinion construction companies in general are cheap. This is due to as you mentioned “they are only one problem contract away from a profits warning & potentially insolvency”. I have picked up Metka (greece) and Astaldi (Italy) at what I felt distressed prices.
    Interesting would be how high the insurance is in case of project gone wrong.

    • That’s the thing with Morgan Sindall. They never had such a thing like a big contract gone wrong in the last 25 years and this includes at least 2 very severe recessions. So pure luck or skill ?

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s