Daily Equity Report

The construction sector has, over the course of about 5 years, experienced a full cycle. Construction companies by their very nature are quite cyclical. The reason simply is that paying someone to build roads and bridges every day isn’t as important as paying someone for drugs (medicine) on a daily basis.

The graph below that maps the share price growth of Group 5 versus the Construction sector and the ALSI since the end of 2004. They all end up fairly close to each other, but you will see how the construction sector has been much more volatile.

While demand for pharmaceutical products doesn’t change too much over the short term, demand for construction companies’ produce can and does vary quite a bit. Governments are generally a large customer of construction companies and they tend to go through phases of under development and overdevelopment. Construction can and does also get used to help growth when economies are weak (this is a case in point particularly in China at the moment). It therefore stands to reason that construction companies will be more attractive when a country is in a phase of overdevelopment and less attractive when there’s a lack of development occurring.

Remember though that the attraction, or otherwise, of a company should not overly influence your decision on whether or not to invest in the company. Price is critical in the analysis. When construction companies were experiencing booming order books at record margin they appear to be very attractive, but the price more than reflected the good news. We are now at a point where many construction shares are painting a bleak picture, and it might just be the time when they are becoming more attractive as investment propositions.

Group 5, the 5th largest construction company listed on the JSE, released interim results this morning that make for some interesting reading.

The company is mainly exposed to the construction sector (74% of profits) and has therefore been operating in a tough environment where many projects have been shelved or cancelled in the private sector, and where government hasn’t been as efficient in awarding contracts.

The tough market conditions are reflected in revenue contraction of 4% and profit growth of 12%. Profit growth in the face of declining turnover has been achieved as a result of improved margins. The dividend declared is up 9% when compared to the previous first half of the financial year.

What interests me the most about the results is that cash on the balance sheet equates to R3.24bn and the company has no debt, while its market cap on the JSE is R4.26bn. Clearly the company has a lazy balance sheet, but the market’s implying that the company (other than its cash) is worth only R1.02bn. With earnings of R 533mn for the 12 months ending 31 December 2009 the PE multiple placed on Group 5 less its cash is a lowly 1.9! The quoted PE is higher at 6.1, but these multiples are extremely low compared to the market. The company doesn’t need great earnings performance for its share price to do well as there is already a lot of bad news priced into the share.

As always the key to investment success is not the popularity of your portfolio, but rather the price you pay for each share in your portfolio.

Enjoy your weekend!

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966