Seymour Whyte LimitedPrint this pagePosted March 4th, 2011 by...

Seymour Whyte Limited

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Posted March 4th, 2011 by Adrian Ezquerro


Seymour Whyte Limited (ASX:SWL) was established in 1987 by directors John Seymour and Garry Whyte and listed on the ASX in May 2010. SWL is now a mid-tier infrastructure development company whose operations primarily focus on servicing QLD, NSW and the ACT.

With a proven 23 year track record in civil engineering and construction, SWL has become a company of preference for government authorities and joint ventures delivering major and complex infrastructure projects. SWL has also been developing a presence in the commercial construction sector in QLD and NSW.



Figure 1. Areas of operations and services
Source: Seymour Whyte Limited - 2010 Full Year Results Presentation



Business Units and Capabilities

SWL provides strategic solutions to civil infrastructure projects across the following sectors:

Transport

SWL?s transport infrastructure projects are currently the primary revenue contributors. SWL focuses on the design and construction of roads, bridges, rail and aviation projects. The project size and complexity has increased significantly in recent times.



Figure 2. SWL Transport Project: Surfers Paradise Traffic Management Scheme
Source: Seymour Whyte Limited



Resources

SWL have delivered a number of diverse projects for the resource sector. These include the construction of reclaim tunnels, crusher, process plants, foundations, haul and access roads, bulk earthworks, truck wash facilities, drainage works and mine remediation works. A good example of SWL?s capabilities was shown through the design and construction of the Cowal Gold Mine Civil Works; a joint venture between SWL and Clough Limited (ASX:CLO).



Figure 3. SWL Resource Project: Cowal Gold Mine Civil Works
Source: Seymour Whyte Limited




Water

SWL have been involved in the delivery of water infrastructure projects for over 20 years, having built their first treatment plant in the late 1980?s. SWL has undertaken a range of projects including water and sewerage reticulation, pump stations, stormwater pipelines and water retaining structures.



Community Infrastructure

SWL has the capability to deliver bikeways, aquatic facilities, foreshore redevelopments, town centres and other community based projects.



Figure 4. SWL Community Infrastructure Project: The Cairns Esplanade Lagoon and Associated Works
Source: Seymour Whyte Limited



Building

SWL?s building unit is relatively new. In establishing this business unit and a new office in Sydney, SWL aims to leverage off the vast experience of senior staff originating from tier-one companies. SWL?s CEO Brian Riggall formerly was an executive with Baulderstone in Sydney for approximately a decade prior to joining the company; valuable experience which acts to de-risk their commercial building strategy.



Business Model

Independent Projects: Discussions with management lead us to the view SWL focuses on non-traditional alliance tenders and contracts. This typically results in greater margins for SWL and generally greater rewards when client objectives are met. Put simply, if SWL were to deliver a project on time and of high quality, they are then rewarded with a performance bonus on top of their standard project compensation. Given their experience and technical expertise, SWL are able to favour these types of projects to receive the good returns on resources employed.

Joint Ventures: Joint venture arrangements began in 2003 and has been a successful part of the business. It offers SWL access to significantly larger and longer term contracts, in time securing greater forward revenue and certainty for the business. Due to this, it has enabled SWL to tender for, and deliver, some of Australia?s largest and most complex infrastructure projects.

Without a doubt, the basis for the current business model of SWL is dependent on strong relationships with their key clients - State governments. Management noted that SWL will seek to continue to ?attract value seeking customers who place a premium on quality and certainty in outcomes for their projects?. When asked why the respective governments would keep choosing SWL for infrastructure projects, SWL management reiterated the desire for project quality, delivery efficiency and general reliability as key drivers. Such a relationship takes time to build, and having successfully delivered a range of high quality projects over a long period of time, it could be strongly argued that this is indeed a growing competitive advantage for SWL.

Principal customers of SWL:

Department of Transport and Main Roads, QLD;
Roads and Traffic Authority, NSW;
Brisbane, Townsville and Gold Coast City Councils;
Queensland Rail; and
Councils, port authorities, transport infrastructure bodies and selected private clients.
After discussions with SWL management, it has also become apparent that the company values its people. Such a reference would typically draw scepticism, however according to BRW, SWL has consistently been recognised as one of Australia?s best places to work.

SWL management believe their focus on the recruitment, and retention of, quality people is a further competitive advantage. In a post flood employment market where skilled workers will be in significant demand, such a workforce is a valuable asset for SWL.


Outlook and Risks

It could be strongly argued that macro-economic forces and long term investment trends support the industry within which SWL operates. ABS statistics reveal the total engineering construction activity (in $ terms) on an annual basis has more than doubled since 2002. The Construction Forecasting Council estimates long term civil engineering works in NSW and QLD will trend upwards over the next three years. Forecasts also project road and bridge expenditure to trend above $13B per year over the same period.

The underlying demand for the building of roads, bridges and buildings is a long term trend that is worthy of consideration and will certainly benefit the better quality contractors such as SWL.

The graph below highlights the depth of the forward order book for SWL in 2011 and 2012. SWL have confirmed that they expect approximately 20% year on year revenue growth during this time and have exhibited confidence of continuing this trend.



Figure 5. SWL Prospects: Forward Order Book
Source: Seymour White Limited - 2010 Full Year Results Presentation



SWL highlighted recent project wins have further augmented their already strong forward order book. Contracted work in hand now totals $399M, spread over the balance of the next three years. This is a good situation; however, the risk then shifts from tendering to execution. Maintaining margins and executing projects well is what turns revenue into profit for companies such as SWL. Getting this part of the job is critical and management failings in project execution can be painful - just ask recent shareholders of Nomad Building Solutions Limited (ASX:NOD) and Downer EDI Limited (ASX:DOW).

Given their strong forward order book, a further positive for SWL is that they can now focus on tendering for higher margin projects (in the near term). This coupled with the potential accrual of further performance bonuses augers well for the financial performance of SWL in FY2012 and FY2013.

The recent widespread flooding in Queensland will likely have a two stage effect on SWL. Long periods of heavy rain and inundation may well lead to short term project delays for SWL, the most notable of which being the Ipswich Motorway Upgrade. Management have subsequently noted they expect a deferral of some revenue from FY2011 to FY2012. There is a longer term silver lining for SWL; one cannot imagine a better time to be a preferred civil engineer and construction company for the Queensland Government. Thus it appears some short term pain for SWL may well be compensated with longer term opportunity.

A further risk that may arise relates to capacity constraints - too much work and not enough skilled labour. Being an employer of choice will help, but this is no doubt a factor all companies in the sector will need to be cognisant of.

Longer term geographic growth for SWL will be facilitated by the impending ?National Prequalification Harmonisation? policy to be introduced in 2011. This will essentially make it easier for SWL to roll out their business beyond their current eastern state footprint.



Management

In analysing the company financials and meeting with management, it would appear SWL is a well managed company. A focus on profitability, margins and balance sheet strength is matched by their desire for a good quality workforce and exceptional project outcomes.

Management ownership is high with directors owning a total of 63% of SWL. This provides a high level of vested interest for management to continue to act in the best interests of long term investors.

It is important to note that at this point in time 77% of shares in SWL are held in escrow until 1 April 2011. Whilst there may be no fundamental reason for a sell off at that point, investors should be aware that this may well be the case. Those who took part in the IPO would have already realised an impressive gain and may be tempted to lock in some profit. The flip side of this however, is that it may provide an atmosphere where astute long term investors can take advantage of a price that is trading below our estimate of value.



Valuation



Figure 6. MyClime Valuation: Seymour Whyte Limited (ASX:SWL)
Source: www.myclime.com.au





The current financial position of SWL is very sound, with the key fundamentals all instilling confidence for the fundamental investor. The balance sheet is very strong, with no intangibles and net cash of over $30M. The high level of cash is somewhat necessary and allows SWL to fund larger projects over the coming years. It also provides a useful buffer in case the company is met by tougher future market conditions.

Profit has grown strongly year on year over the previous five years, and profitability has been exceptional. Recent commentary from SWL confirmed forecast profit for FY2011 will largely be in line with FY2010, with profit growth projected to return in the years thereafter.

We currently project NROE to level off at approximately 48% over the next three years. Operational cash flow has been lumpy over the review period. According to CFO Craig Galvin this is mainly due to project related timing differences.

Capital management has thus far been of good quality. Despite their recent IPO, SWL have raised minimal new capital and have paid an increasing level of fully franked dividends over time. Management stated their intention to continue growing organically, and it certainly seems they have adequate capital to self-fund this strategy.

We have selected 48% as our Normalised Return on Equity (NROE). We have derived a Required Return (RR) of 15.5% which takes into consideration the risks of investing in this business.

RR
15.5%
NROE
48.0%


Using the above inputs and the equity per share, MyClime produces the following values:


2010
2011
2012E
2013E
Value
$2.32
$2.78
$3.31
$4.03
Value Change (%)

19.8%
19.1%
21.7%
The following valuations are based on analysts? forecasts and are subject to change.





Figure 7. SWL: Value & Price



Figure 7 above reveals SWL has been strongly growing intrinsic value both pre and post listing on the ASX. The current market price is currently trading at a meaningful discount to the estimated values of FY2011 and beyond.



Figure 8. SWL: Earnings and Dividends



The strong financial performance, bright future prospects and high owner-manager quality all paint an impressive picture regarding the investment grade of SWL. The recent flooding and cyclone disasters in Queensland will negatively impact the operations of SWL in the current financial year. Looking through the shorter term haze though, reveals medium to long term trends and macro-economic conditions that could well support the ongoing growth of SWL.

Shorter term headwinds have recently created some volatility in the price of SWL. Such short term volatility may be accentuated by the impending April release of 77% of shares from escrow. This may well create an opportunity for longer term investors to purchase a part share of SWL at a significant discount to intrinsic value.



Share this article
7 March 2011 - 10:32pm ? Hazm
said
Sorry for being a bit vague, but what does "escrow" mean and what are the possible down sides to this?
8 March 2011 - 3:49pm ? mitchell@mycli
said
Hi plawson,
Shares being held in escrow essentially means that those shares cannot be sold until a certain point in time ? in this case, 1 April 2011. It was stated in the prospectus for SWL that 77% of its shares upon listing would be held in escrow (i.e. cannot be sold) until 1 April 2011.
The implications of this include a greater free float of shares should management decide to sell down some of their holdings post 1 April. If the amount of selling is to be meaningful this may have some downward pressure on the market price in the short term. This is however speculative as management may not end up selling much or any at all - we shall see. Further, this has no impact on the longer term value of the company and may only impact price in the short term.
8 March 2011 - 7:15pm ? Hazm
said
thankyou, it makes a lot more sense now.
7 March 2011 - 11:03am ? Adrian Ezquer
said
Thank you all for your posts.
Good question Paul - in the commentary on the SWL valuation I have noted a few things that are pertinent to your query. When we initiated coverage on SWL:
"SWL is currently a highly profitable business. Coming off a very low equity base, SWL has recorded very high levels of profitability over the past 5 years. As the equity base increases however, it will become increasingly difficult for SWL to maintain such levels of profitability."
In the most recent update, I noted "SWL is currently forecast to achieve NROE of 48.3% in 2011, 50% in 2012 and 51.5% in 2013." I have a reasonable amount of confidence that SWL can achieve the profits required to drive this level of profitability in the near future. Further commentary on the recent valuation update alludes to why I believe this to be the case: "In discussing the outlook, management highlighted recent project wins have augmented their already strong forward order book. Contracted work in hand now totals $399m, spread over the balance of FY2011, 2012 and 2013. SWL accrues performance bonuses if project targets are met. This, coupled with a good level of work in hand, gives SWL a good opportunity to grow further value over the next few years. Executing and maintaining margins will be an important focus during this period."
Contemplating what is a sustainable level of profitability into the future is an important aspect of company valuation. If you'd prefer to be more on the conservative side, you can always input a slightly lower NROE number.
I hope this helps.
Regards, Adrian
5 March 2011 - 6:02pm ? paul.nichols@card.
said
Would appreciate further comment on why the steadily decreasing ROE is projected to break trend, and hold at FY11(F) levels?
Thanks
Paul
5 March 2011 - 1:31pm ? athomson@convince.
said
Good analysis Adrian.
A THOMSON
4 March 2011 - 8:10pm ? lyn
said
Thank you. It looks worthy of consideration.
Lynne
4 March 2011 - 2:17pm ?
said
Thanks it was not on my radar and is now in the little black book