Description

Description

SCYR SM (Long): 2.57 euros

Market Capitalization: 1.7bn euro

Summary

For those familiar with the historic Sacyr, you may remember it as an engineering and construction company (“E&C”) with a large investment stake in Repsol. If that is your last memory, it is time to revisit as SCYR has transformed itself into a concessions business that uses the E&C as a competitive advantage to build concession assets that it then owns.  Concessions are great, inflation protected assets and SCYR’s concessions have 25-year average contracted lives. Due to limited sell-side coverage, historical legal issues, a Spanish listing and a complicated balance sheet (where most debt is at the concession level and non-recourse), in our view the company remains significantly undervalued.  The company agrees that it is unduly cheap and to help remedy the situation recently announced a strategic review to monetize assets.  Our positive view has three components: 1) significant EBITDA growth over the next 3 years, 2) a growing mix shift to higher multiple, long duration concessions business, and 3) the sale of assets that crystallize value and reduce net debt.  We believe the combination of debt reduction, inflation indexed revenue contracts and continued earnings outperformance will drive the stock meaningfully higher over the next 12-18 months. In our base case, we see 82% upside to 4.69 euros.

Company Overview

Sacyr has three main segments: Concessions, Engineering/Construction and Services.  Let’s start with the smaller two segments and save the best for last. 

Construction: This segment is not dissimilar from other engineering and construction companies.  It typically focuses on industrial and oil & gas facilities in the countries that Sacyr operates (Spain, Italy, Chile, Colombia, Peru, Mexico, US).  The contracts over the last two years are almost all cost plus and the company has not had any significant charges in years.  It is largely a feeder into the concessions business (50% of backlog is for concessions and 50% is for third parties).

Services: This is largely a facilities and road maintenance business.  It also provides O&M services for waste treatment plants.  As we will detail later, the company is seeking to monetize part or all of this business.

Concessions: The crown jewel asset for SCYR is the concessions business.  This business receives cash flows from numerous asset types (highways, transports, hotels and airports) spanning 15 countries and 65 projects.  The business is a high IRR business distributing >$200mm of cash per year.  One of the premier assets is the recently completed Pedemontana toll road which is a 39-year contract expiring in 2061 located in the wealthy, northeastern region of Italy with high congestion.  It is also worth noting that Sacyr recently won its first US concessions (University of Idaho) and sees further growth opportunities in the US.  Unlike some of its publicly traded peers, Sacyr’s business is not impacted by declines in highway traffic or airport traffic.  This is evidenced by the durability of earnings during COVID while larger peers saw significant earnings declines.

The link below to their recent investor day is a good starting point to learn more about this segment.

Sacyr 2021 Concessions Investor Day

Management Targets

Brief History

Sacyr has meaningfully underperformed the market and its peers, up only 14% over a 5-year basis and down considerably since 2006.  There are a couple reasons why the equity has underperformed.  The first reason is Repsol.  The company initially took a 9.2% stake back in 2006 in Repsol (oil/gas E&P and refiner) for 2.86bn euros.  As an E&C, you receive a ton of upfront capital prior to starting a project and former management decided to use this “float” capital to buy its Repsol stake.  This turned into a major mistake as they bought at elevated prices and then over-levered Sacyr’s balance sheet into a market downturn.  It took Sacyr many years to navigate its exit from the Repsol stake and reposition its balance sheet.   The second reason is the Panama Canal. Sacyr was a member of a consortium that participated in an expansion of the Panama Canal.  The initial budget was $3.6bn but there were $3 billion of cost overruns, a significant portion of which was assumed by the consortium in which Sacyr was a 41% participant.  While Sacyr is still trying to recover these excess costs, it has not had much success. 

Why now?

After a period of extended underperformance, we believe we are now at a key inflection point.

1. We believe the company has garnered sufficient scale in the concession business to see an upward multiple re-rating (path to exceed current targets of $1bn/85% of mix by 2025). 
2. The company was recently added to the Ibex 35 in June of 2022. 
3. The company is an inflation beneficiary given CPI-linked contracts (Italy being the most sensitive, followed by Chile, Colombia and Spain).
4. Repsol - With regards to the stake in Repsol, through a combination of derivatives expiring and being exercised, Sacyr has dramatically reduced its exposure.  It now only has 20mm derivatives which is worth approximately $35mm at today’s stock price.  We foresee this final slug of exposure being fully monetized as the company works to reduce recourse net debt.
5. Panama Canal - At this point, there is about $80mm of potential cash outflow in a worst-case scenario if it loses again (repaying $80mm from the Panama Canal Authority).  Conversely, there is an extremely bullish case (which we view as unlikely) where it can collect 40% of the $3 billion if it ultimately prevails in 2024/2025.  However, based on recent outcomes, we view this as unlikely.  Either way, the liability here has been dramatically reduced and will no longer be a meaningful downside risk to the equity.
6. Radiales - The R3-R5 radials were a set of motorways carried out by a consortium of companies including Albertis, Sacyr and ACS (Sacyr’s stake is 25%).  Sacyr built some highways and operated the concessions. In 2009-2010, the projects went bankrupt because the traffic did not approach minimum levels. The highways had 660 million euro of debt in the hands of the banks that were sold to distressed funds that acquired the debt at discounts north of 80%.  These hedge funds are attempting to recover the debt through legal proceedings.  In a worst-case scenario, Sacyr’s 25% exposure is 58mm euro, which we account for in our valuation despite the company being optimistic about deprovisioning this amount in the future.
7. Value crystallization / Debt Reduction – Due to the languishing performance, the board has announced a strategic plan which we believe will potentially drive meaningful near-term upside through divestments.

Divestment Process / Strategic Alternatives

The board has laid out a plan to divest 49% of the services business, 49% of the water business and 25-45% of the Colombian concessions business.  Based on precedent transactions and business mix, we believe the services business can fetch 7-9x EBITDA (Urbaser was acquired at 9x while FCC SM trades at 7.4x).  On the Colombian business, the company values the entire business at $474mm.  The company is currently hiring investment bankers and is expecting indicative bids in Feb/March allowing for closing during calendar 2023. 

As part of this process the company will continue to rotate assets in the concessions business, which will provide another source of cash.  Historically, the company has been able to monetize assets at 16-20% IRRs, far in excess of the 8-12% initial target IRRs.

With these two actions, combined with free cash flow from the core business, we believe the company can achieve recourse net debt of $0 by YE23 from an estimated $500 at YE 2022.

Valuation

Base Case

The concessions business is valued using a discounted cash flow on the future cash flows on a country-by-country basis.  The valuation uses an average discount rate of 8.7% across the portfolio.  We include a lift for the recent Canal Del Dique contract win in Colombia on Dec 12^th, 2022.

Key discount rates by region: USA – 5.75%, Italy – 6.07%, Spain -7.06%, Colombia -11.44% and Chile -10.83%

Key long term CPI by region: USA – 2%, Italy – 2%, Spain – 2%, Colombia – 4.5%,, Chile – 3.6%

Bear Case

Key discount rates by region: USA – 6.5%, Italy – 7.5%, Colombia -20%, Chile – 20%.  We assume some losses in the construction business in 2023.  We also assume it will be unable to divest any minority stakes.

Furthermore, we adjust CPI downwards by 50bps in every region from the base case.

Bull Case

Key discount rates by region – USA – 5.5%, Italy – 5.5%, Colombia -10%, Chile – 10%,  Spain – 6%

Furthermore, we increase CPI linked inflation upwards by 50bps in every region relative to our base case

Includes recent Canal Del Dique win

Appendix

Catalyst

Concession project awards

Divestitures

Accretive asset rotations to drive net debt reduction (company has a history of exiting investments at 16-20% IRRs)

Potential credit upgrades in 4Q23

Risks:

Foreign currency

Market concerns over companies with high debt

Geopolitical concerns in Chile/Colombia (would impact new growth pipeline, not existing concession assets but we believe risk here is limited)

Adverse legal rulings