Description

Long Stefanutti Stocks

All values are given in Rand

In the current bull market one has to look pretty far and hard to find a decent and well-run company at a PE of around 1-2. Stefanutti Stocks is one of these white elephants.
To give some other metrics as to its cheapness. Given the current fully diluted market cap of 305 million, the company made capital expenditures in the last half year of 255 million, of which 219 million was growth capex. The company is trading below net cash if you exclude working capital (due to “Excess billings over work done” – i.e. already billing on work in progress), cash flow from operations before working capital changes has been around 400 million Rand for the last 5 years, and it’s price to tangible book ratio is just around 0.2.

The Sector

The South African construction sector has been experiencing years of headwinds. After the almost simultaneous mining boom and the 2010 World Cup construction boom, the South African construction sector has entered a perfect storm in a way. Low business confidence due to Zuma mismanagement, the end of the mining boom and the low amount of public spending on infrastructure has created a very large gap between the investments by many construction companies made in the years around 2010 when everything looked rosy and the current order books in the construction sector.

The result? In 2013 PWC made a report on the SA construction sector mentioning the leading 10 listed companies. This has happened to the companies mentioned in the report since then:
- Aveng went down by around 95 percent since then and has been trying to sell their construction subsidiary
- Basil Read has dropped +95% since then, trying for many years to turn around the business
- Esor (also known as EsorFranki) has dropped +85% percent just like …
- Group Five, which has also been selling divisions to try to survive.
- Murray and Roberts only halved by selling its construction arm (for less than zero after a few prominent screw ups) and focusing on their international businesses which deliver mining services and design oil and gas platforms.
- Protech Khutele went under in 2014 and was liquidated.
These were all respectable and renowned companies, some are more than 100 years old.

A few of the companies mentioned in that report did decent:
- Calgro M3 Group did well because they are an active housing developer, and the housing market has been pretty strong in SA
- Wilson Bayly Holmes-Ovcon (WBHO) did pretty good as well given the circumstances
- Raubex Group only did well because they have an aggregates and bitumen business which produces around 2/3rds of their operating profit.

The last company, Stefanutti Stocks, had been pretty stable over the complete period if you take out some one-time issues (a few bad contracts in 2013, a government collusion ruling against them for which they had to take a provision – like all major SA construction firms actually - and some impairments). And these one-time issues have never been even remotely life-threatening. The share price in contrast does seem to show something entirely different, and I think that is mostly related to the performance of the other comparable companies.

Diversified Operations

Stefanutti Stocks has a few divisions active in different fields, but all related somewhat to construction. This diversification has enabled it to be somewhat resistant to the current building and infrastructure malaise in South Africa.

The name Stefanutti Stocks itself is the result of a merger/acquisition of “Stefanutti and Bresan” together with Stocks (known until 2000 as Stocks and Stocks). The Stocks business dates back to 1946. In 2000, Stocks went through bankruptcy even though the construction business had always remained profitable on an underlying basis. The problem was that it was carrying too much debt from their property portfolio for the construction business to cover. The property was sold off in the restructuring and the profitable construction business was acquired/merged in 2008 with Stefanutti for 1.1 billion Rand by an equity offering.

Mechanical and Electrical: The story here is a bit similar to my earlier write-up about Consolidated Infrastructure Group. They were active in the same space but have been downsizing this division. They cater to private and public customers (mostly mining and electric utility).

Structures: The company has a highly regarded structures division but here the lack of large building contracts is weighing on this division since they make precast structures for large projects (think power plants, bridges, but also mining with precast structures for declines etc..). So no large projects means smaller profits. In a way, this division is like an option. Just a few years ago it used to be the division with the largest profit margins at Stefanutti and was earning 100-150 Million rand a year on average (or about half the current market cap).

Building: Well, the name says it all I guess. The story here is the same as with the structures division but with smaller margins (no competitive advantages here). The lack of business confidence in SA has meant that very few large projects have come to the market in the last few years. Here I would use the same approach and just consider this an option for when the SA construction sector returns to growth. In this division is also a 50% stake in Al-Tayer Stocks LLC, a UAE based interior fit-out company which on its own is probably worth half the current market cap.

Roads, Pipelines and Mining Services: Is an amalgamation of other divisions.
The pipeline subsidiary was acquired in 2011 for 300 Million Rand (about the current market cap) at a then PE of a little less than 5. Maybe they paid a bit too much here given the euphoria with the nearby Rovuma basin gas discoveries, but still gives an indication as to its current cheapness.
Mining Services: they mostly do open pit design, contract mining and building evaporation ponds but also some mineral processing (including a new JV in Africa with Dawsons Group of Australia).
Part of this division was formed when Stefanutti acquired ECPM for 42.7 million rand in 2007, or for less than 4 times 2007 earnings.
Currently, this segment is responsible for the majority of profits.
Given the improved outlook (general sentiment and management guidance) it is anticipated that the profitability should increase here.

The company is also active in other African countries, mostly Botswana, Lesotho, Mozambique, Namibia, Nigeria, Swaziland, Zambia and the United Arab Emirates.

Management

Somewhat unique in this company is the culture. The founder had a book written together with a journalist after a series of interviews about how he founded the company and his experience running it. He now sells it with all proceeds going to charity. A book was written about the background of the company mentioning important company credo’s like “revenue is vanity, profit is sanity and cash-flow is reality” and downsizing is more important than chasing unprofitable contracts. This book is freely available to download in the IR section.

Controversies:

The company was involved in a collusion scheme in which almost every major South African construction firm was involved. They were fined and made a deal with the government where they would assist Black owned construction companies reach certain targets within a few years.

Shareholder Ownership:

Major owners are Sanlam Group, Coronation Fund managers and PSG, 3 funds which are large but on average have beaten the index over the years (but just by a small margin). Management Owns about 7.5% of the outstanding shares, of which the CEO owns just around 4.5% of the shares outstanding. Besides aforementioned, there are no interesting things to deduct from the ownership list of the shares.

Risks

The CEO, Willie Meyburgh (64) is about to reach retirement age.  I consider this a big negative given that he has a very good reputation and has managed to run the company in a competent manner during a difficult period.

Another negative is that the company has a large amount of receivables against some governments in Africa, mostly related to roadworks. The amount is a bit more than 400 million Rand. The company claims that the amounts are not in dispute and are being paid but at a slow pace.

Conclusion

While not really an attractive sector, this is one of the cheaper companies I have come across in a very long time. Management has been above average and created shareholder value in an industry and time when almost every listed competitor has been destroying it in bundles by chasing unprofitable contracts. With the improving outlook in both mining and oil and gas, it is reasonable to assume that the mining and pipelines segments should provide at least the same earnings power going forward (and maybe an improvement given the high capex in recent years by the company) while offering the optionality of improved earnings if and when the South African construction market should improve.

The strong balance sheet gives some added reassurance against short term uncertainties.

Catalyst

- Real earnings showing through (last year the one-offs distrorted these)
- Improvement in the sector and SA public spending
- Reinstatement of dividend