Boss score harvest: Morgan Sindall (GB0008085614) part 2 – no investment

After part 1, I have to admit that I share some concerns some commentators raised:

– the lack of tangible book value combined with a P/B of 1.3
– the cyclically of the business which however does not really show in the balance sheet (yet
– volatility of cash flows

The first issue is something one has with almost all UK groups. Anglo Saxon companies are almost always “capital light”. I guess the reason is that there are so many active PE investors, raiders, activists etc., which make sure that a well capitalized company will not long stay well capitalized.

However, this pressure sometimes produces much more capital efficient business models. As we all know, price to book is not really a good value indicator. Let’s look at a small collection of construction companies with some multiples:

MORGAN SINDALL GROUP PLC 5.30 1.22 8.60 14.30 11.88 1.52 -0.03
STRABAG AG 9.81 1.25 11.77 10.90 3.05 -5.75 0.05
KONINKLIJKE BAM GROEP NV 11.42 0.57   9.62 2.86 -13.43 0.13
HEIJMANS N.V.-CVA   0.29   -8.84   0.38 0.12
BILFINGER SE   1.94 15.09 21.95 7.71 4.80 -0.02
VINCI SA 7.15 1.47 9.88 15.01 6.59 4.37 -0.06
CARILLION PLC 7.04 1.38 8.23 16.38 11.64 3.24 -0.06
KIER GROUP PLC 4.66 3.36 9.25 34.35 37.95 2.89 0.06
BALFOUR BEATTY PLC 6.62 1.71 10.86 16.22 8.24 1.72 -0.08
COSTAIN GROUP PLC 0.82 4.13 5.98 64.01 66.71 3.17 -0.01

Here we can see some interesting items:

Generally, the higher the ROE & ROIC the higher the price book valuation. With the exception of Kier, there is also a clear relationship between WC to sales and ROE and ROIC. Especially the Dutch companies seem to have to fund a lot of their working capital themselves. Interestingly those companies also operate at a loss level.

For me it is very interesting to see how the UK companies seem to have changed their business models to a certain extent.

Interestingly, the largest company Balfour seems not to be able to create any advantage out of their market share, which according to this list of UK construction market share for 2011 was around 15%.

On the same page, there are also a lot of news about the UK construction sector. All in all it doesn’t look pretty, it seems to be that 2012 seems to be even worse than 2008 at least in the UK. That might be the reason why UK construction groups look so cheap.

If we go back to Morgan Sindall, I see another issue: There is not a lot of mean reversion potential. Morgan Sindall is only 10% below its average profit margin. Historically they were values ~10 P/E and 4.7 x EV/EBITDA which is more or less where they are today.

Combined with a clearly donwtrending ROE (both, absolute and under “boss” definition”, I will pass over Morgan Sindall for the time being.

Nevertheless I want to follow up more on “negative working capital” companies because I firmly believe there is a lot of hidden value in such business models.


  • Good read, some things I hadn’t thought of.

    With regard to this:

    “Iw we go back t Morgan Sindall, I see another isse: There is not a lot of mean reversion potential. Morgan Sindall is only 10% below its average profit margin. Historically they were values ~10 P/E and 4.7 x EV/EBITDA which is more or less where they are today.”

    I’d go as far as to say that there’s negative mean reversion potential. The returns they earn are exceptionally. In the long term, I reckon either their working cash flow situation or their profitability will normalise – probably as a sector, too.

  • Look at the DM income statement, it’s really interesting and they also got negative working capital. I think negative working capital in an uncylical business, like consumer goods, is a realy good sign for a strong company.

    • the interesting thing about Morgan sindall is that they run on a negative capital basis even including fixed assets. The neither have operating lease liabilities which is the issue with most of the retailers.

  • The problem with negative working capital companies is that under a stress scenario where revenues are declining working capital becomes a use of cash rather than a source. It is also a pretty good sign that the underlying business is project based % of completion accounted which opens up another alley for concern – too much discretion in how profit is recognized.

    There is a distinction between return on capital businesses and margin businesses. Most E&C businesses are margin businesses. They are basically marked up labor + project management. Sophisticated project management of course.

    • PoC assets are only ~10-15% of annual sales so I don’t think this is a big problem. They seem to be able to bill on an ongoing basis which is very effective risk mitigation.

      Well, under s atress scenario, it is usually a problem for any company. I think it is less a problem for a constarction group than for instance a reteiler.

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