value and opportunity

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:

Name	EV/EBITDA T12M	P/B	P/E	ROE LF	ROIC LF	PM LF	WC to Sales
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.