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……
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