Description

Idea: Long Sacyr Vallehermoso (Ticker: SCYR SM)

Thesis: Sacyr is a Spanish construction conglomerate. It is an unloved business that has transformed itself recently without most noticing. Sacyr had been in trouble for a few years when its stake in Repsol was requiring other assets to be pledge as well. Eventually Sacyr sold a property business to repay a lot of the debt associated with the Repsol stake. Meanwhile Sacyr has a fantastic concessions business that is only now ramping up. Using a Sum-of-the-Parts valuation metric gives me a target price of €4.6 compared to €2.2 currently.

Company information:

Sacyr is a Spanish conglomerate with 4 major segments, construction, concessions, services and industrial, as well as significant holdings in non-operating assets primarily a 8% position in Repsol. The construction, services and industrial businesses are cyclical and all are coming off recent troughs, and hence are still experiencing trough margins, while the concessions business has long-term visibility and is fairly resilient. This results in the concessions business producing the majority of the EBITDA and cash flows despite having a small revenue contribution. Sacyr’s non-core holding in Repsol has also recently recovered from the multi-year oil downturn.

Since these businesses are largely stand-alone, they will be investigated separately.

Sacyr Concessions

Sacyr Concessions is a leader in the management of infrastructure such as motorways, hospitals, transport hubs, etc. Sacyr Concessions has 36 assets in 9 countries, with 27 already operating and another 9 under construction. Most of the debt on Sacyr’s balance sheet is project finance debt related to the assets under construction in this business.

The business has shifted from being 70% Iberian, to less than 40% of revenues coming from Spain/Portugal and all the growth is coming from Latin American projects. Infact the backlog is now more than 70% international, so in future the business continues to diversify further.

The Chilean and Colombian exposure has grown in the midst of a slowdown (in Chile) and recession in Colombia. Both the countries are now recovering and growing faster on the back of a recovery in the commodities (copper, oil etc) that their economies are levered to.

The business’ backlog has been rapidly growing and increased 40% y-o-y in 1H 17 to €17,126m. This represents more than 31.2x the current concession revenue indicating strong growth in the business as a number of these projects start getting completed. The business has been capital constrained in the past due to turbulence in other businesses for Sacyr, and had to turnover assets (like sale of Portugal business etc) to fund growth but should be on more stable footing going forward.

There are a number of projects that are currently being valued using the equity method and they are not accounted for in this backlog, including the concession in Italy (Pedemontana – Veneta), the Mar 1 motorway in Colombia, and the Rome-Latina freeway which has a 43 year concession with a backlog of €12,250m.

Due to the high number of projects that have just been completed and are in ramp-up phase, the business has been a bit misunderstood. The construction sales (at almost 0% EBITDA margin) ramped up initially as the projects were being constructed but these have started to wind down and projects are launched and concession revenue ramps up. The concessions themselves will take a few years to achieve run-rate revenues. All this has meant overall business sales haven’t grown, and while EBITDA has been ramping up, it’s been from a low base. In addition the business has not thrown out a lot of cash so far but all this is set to change going forward. EBITDA will continue to ramp up, as will earnings and cash flows.

Note below comparable metrics for peers below:

Since Sacyr Concessions is smaller and at a much earlier phase in development, it will be growing earnings, EBITDA and FCFs considerably faster than its peers. Using Earnings or EBITDA or FCF, Sacyr Concessions should be given a slight premium to these comparables.

In addition Sacyr hopes to ramp up to 15% ROEs similar to ROEs of Atlantia and Vinci but behind Abertis’ 25% ROEs, and hence should achieve a similar P/B multiple of 2.8x. But since Sacyr still needs to ramp up its BV per share growth, a discount to this multiple is more appropriate at this stage. I have used a 1.5x P/BV.

Using all these metrics gives a range of valuations for the business and I have taken the average of these metrics.

Sacyr Construction

Sacyr Construction is an infrastructures company that handles all kinds of projects across the world: civil construction, motorways, underground and railway, buildings, airports, ports and hydraulic infrastructure. Construction is performed through the head units Sacyr Construction in Spain and Chile, Somague in Portugal, and SIS in Italy. The business suffered massively from the vicious downturn in the Spanish and Portuguese construction sector after the financial crisis and the European crisis. Spanish and Portuguese activity and backlog have collapsed, leading to decline in margins.

The company has tilted this business to international opportunities and now 85% of the backlog is international. But the continuing decline in the Spanish business, which only now appears to be levelling off, has continued to weigh heavily.

As the Spanish business stabilizes and the international business continues to recover, allowing a recovery in margins, 2017 is likely the trough year for the EBITDA of the business. Considering it’s the trough year, it would not make sense to value the business on this year’s EBITDA. More appropriate is to apply the appropriate 4.5x multiple (that ACS trades at for 2018E EBITDA) to Sacyr’s 2020E EBITDA and discount the value for two years at close to its WACC of 10%.

Sacyr Industrial and Sacyr Services: Valoriza

Sacyr Industrial is present in Spain, Peru, Ecuador, Colombia, Chile, Bolivia, Panama and Mexico, and is the result of the integration of various companies. It comprises of the following business areas:

1. Engineering and energy: Sacyr Industrial is one of the leaders in the Spanish energy sector, and it is also a pioneer internationally in conventional and renewable power plants, in cogeneration plants, and in the development of biomass, solar energy and geothermal plants. It also operates and maintains power plants and industrial facilities.

2. Environment and mining: Sacyr Industrial is one of the leading international companies in the design, construction and operation of waste treatment and waste-to-power plants. It also has experience in mining and processing plant projects.

3. Oil&Gas:  Implementation of refinery, chemical and petrochemical, gas handling and treatment and liquefied natural gas (LNG) projects, and the transportation and storage of this type of fuel.

4. Electrical facilities: Engineering, development and the construction of high-voltage electricity lines, electricity substations and low-, medium- and high-voltage facilities.

Sacyr Services consists of services provided by Valoriza, with a presence in Spain, Australia, Algeria, Portugal, Chile and Oman, and specialising in the management of the following services:

1. Environmental: which consists of

1. Municipal services: Leader in management of concessions in the main Spanish towns, street cleaning, collection of municipal solid waste, gardening and maintenance of green areas, management of parking meters and towing services.

2. Waste treatment: Builds and operates plants to treat municipal solid waste, packaging, and batteries, treatment facilities for construction and demolition debris and landfill gas removal, and plants for biomethanation, incineration, and waste-to-energy production, as well as facilities to treat, compost, and thermally dry the sludge from wastewater treatment plants.

3. Regeneration: this area encompasses water quality control, atmospheric control and recovery of landscapes and woodlands.

2. Water: which consists of

1. Engineering, development, construction, maintenance and operation of all types of water-related plants (drinking water and water purification plants, desalination plants, tertiary treatments and recycling, industrial waste water treatment, agricultural treatment, etc.)

2. End-to-end management of the water cycle under public sector concessions or in the private sector.

3. Multi-services: provided through the following companies:

1. Valoriza Facilities: Group company specialised in the integral cleaning of buildings, facility management services, ancillary services (porter services, gardening, etc.), energy and social-health services.

2. Valoriza Conservación de Infraestructuras: Group company that specialises in the maintenance and upkeep of roads and other specific infrastructure: dams, irrigation channels, etc.

3. Cafestore: Group company specialised in the operation of motorway service areas (third leading Spanish operator in this market), and in the management of restaurants and cafeterias at large facilities: hospitals, transport hubs and public and private buildings.

These business have similar characteristics, similar to other business services companies out there. Since each of the sub-sectors can be lumpy, it’s best to combine the two businesses financials and forecast joint revenues/EBITDA. The combined divisions have been growing at more than 20% over last two years. The growth rate has been tapered to single digits in the forecast.

Using a 8.0x 2018E EBITDA multiple that has been growing at 20%+ for two years, is very reasonable

Non-operating assets

Sacyr has two significant non-operating asset stakes. A 15% stake in Itinere Infrastructures, which is accounted for as “held for sale” within the concessions business, and a 8% stake in Repsol.

Stake in Itinere Infrastructure

Itinere Infrastructure is a concessions business. Although it’s a private company it does publish its accounts. It owns a number of motorways in Spain as shown below.

It’s key figures are shown below. All of its motorways are experiencing healthy traffic growth.

Key figures

Using these figures the company calculates the value of its shareholding to be Euro 280m.

Stake in Repsol

Sacyr owns a 8.05% stake in Repsol, the integrated oil and gas company. Repsol is a listed company. In three stages in Sep 2016, Dec 2016 and then in April 2017, Sacyr pre-sold forward contracts of 20m shares at €10.7, 30m shares at €11.92, and the remaining 72.2m shares at €10.9 respectively. At the same time it purchased call spreads to retain control and upside in the business.

Repsol has given detailed calculations in its annual report what it considers to be the “value in use” or intrinsic value of the Repsol shares and won’t consider selling them below this value. This is why it held on to the Repsol stake as it had to pledge more assets on the debt secured to the Repsol and eventually sold its property management business Testa to reduce the debt.

Repsol has a fantastic downstream business that held up very well even as oil price crashed, and cushioned the overall business. Repsol hence has sustained its earnings and cash flows and is currently one of the cheapest on a P/E or EV/DACF basis.

Meanwhile oil has gone into 6 month backwardation for the first time since April 2014, indicating a tightness in the spot market. This has been caused by surprising uptick in demand driven by broad based global gdp growth and stronger EM demand growth in particular.

Repsol has also yet to respond to the recent rally in oil and is likely lagging it. It’s upstream business has a breakeven of mid-40s while its downstream business continues to be very resilient and is performing well. Repsol is likely to strengthen further from here closer to its peers EV/DACF average, which will take Repsol to €17.5, 15% or so higher than here. I assume current trading price as base case and my target price for high case.

GUPC Claim

In 2010, Sacyr bought a 48% stake in Grupo Unidos por el Canal, S.A., which held the contract to install the third set of locks in the Panama Canal. GUPC completed the project in May 2016 and the locks were operational in June 2016.

The project ran well over the budget. GUPC claims that multiple changes in the design, change in physical conditions (mass balance), disruptions, material costs and other factors led to the project running over budget and it is claiming the excess amount from the Panamian Govt. GUPC filed for claims totalling $3,953m. As the offical Dispute Adjudication Board (DAB) is proceeding slowly with reviewing the claims, GUPC has moved the case to the ICC’s Arbitration Court in Miami.

According to Sacyr, the independent expert DLF Associate, Ltd. updated the report analysing each claim on Feb 2017 and establishing a fair estimate of the amount that the company can expect from each. Its conclusion is that the company should reasonably expect to recover $1,954m. As $338m have accrued to date, a further $1,616m are pending collection. Sacyr is due a share of 41.6%, and therefore can reasonably be expected to recover $672.4m. This value has not been used in the base case valuation. I have not used any amount in base case as the timing is completely uncertain and hence only used this amount for the high case.

Sacyr valuation

Putting together all the valuation on Sacyr, the base case yields a price more than double, while the high case yields a price almost triple. Even the low case is 70% higher.

It’s very likely that the intrinsic value is higher than the base case as Repsol is likely to trade up from here given recent Brent price action, and there’s likely to be some, albeit not all, recovery from the GUPC claim. My target price would be closer to the high case of €6.7 but some patience is required. Either way, current trading price of €2.2 makes no sense.

As a catalyst, Sacyr has mentioned its own valuation of intrinsic value in Repsol in Dec 2016 annual report to be between €16.3 and €17.2. In its June 2017 update it recalculated this intrinsic value range to €14.8 to €16.0. Hence it’s likely that Repsol will soon be above the value that Sacyr has itself declared below which it will be unwilling to sell. Sacyr has not disclosed the upper end of the Call Spread it purchased above which it does not receive any benefit from Repsol share rally, but it did mention that it is above Book Value which is €18.8 for Repsol. Hence it’s possible that Sacyr decides to sell the Repsol stake when it’s trading in the €17-18 range.

Catalyst

Repsol share price rally / sale
Itinere infrastructure sale
GUPC claim comes through
Repsol dividends used to deleverage
Spanish construction bounces back
Sale of concessions business at crazy multiple