We recently researched Seven Group Holdings (ASX:SVW) in The Dynamic Investor after the Company released results for the six months to 31 December 2023 (1H24).

Earnings in 1H24 were significantly ahead of consensus estimates. The core Industrial Services business units delivered +40% EBIT growth. In addition, Boral’s 1H24 result was another factor in SVW’s better-than-expected EBIT performance.

In fact, the significant turnaround in the performance of Boral (72% owned by SVW) has been a key factor in the outperformance of SVW shares since late last year. With SVW shares now trading at all-time highs, we consider whether current levels still present value.

About Seven Group Holdings

SVW is a diversified operating and investment group with interests in the industrial services, media and energy sectors. The Company’s industrial services division includes:

i. WesTrac (100% owned by SVW), the sole authorised dealer of Caterpillar products in NSW, Western Australia and ACT. WesTrac is one of the largest global Caterpillar dealers (by sales) and is exposed to mining investment/production and infrastructure construction.

ii. Coates Hire (100% owned by SVW), which is the largest nationwide industrial and general equipment hire company with a strong national footprint. Coates services a diverse range of end markets including engineering, mining and resources, infrastructure and, manufacturing.

iii. Boral, an ASX-listed company (ASX:BLD). Boral is Australia’s largest construction materials and building products supplier.

Key Fundamental Drivers

Core Industrial Services Businesses Benefitting from Strong Demand

WesTrac reported sales growth of 27%, supported by Machine sales +23% and Product sales +30%. Product growth was achieved through 6% higher parts volumes, and component rebuilds. Machine sales growth reflects strong demand for new equipment sales and aftermarket activity.

EBIT margin grew by 38 basis points to 11.4%, in part driven by productivity benefits flowing through from investments in store automation, and operating leverage. However, EBIT margin expansion was limited, given that persistent skilled labour scarcity continues to constrain WesTrac.

The demand outlook remains very strong across all parts of the business, with > $250m invested into working capital in 1H24 to support growth.

For Coates Hire, revenue increased +2%. While there was strong underlying demand in its core end-market exposures, this was mostly offset by some delays in major infrastructure project commencements. Despite the modest revenue growth, EBIT grew by +10%, with the EBIT margin expanding by 210 basis points. The EBIT margin expansion reflects the ongoing push to increase operating leverage through network optimisation.

Over the medium-term, SVW see many opportunities to grow revenue (organic & inorganic) in its largest end-market exposure of engineering (predominantly large infrastructure). In particular, the business is leveraged to significant Australian infrastructure and construction investment forecast over the next seven years ($1.7 trillion). Coates Hire is positioning itself to capitalise on this demand with a dominant (28%) and growing share of Tier-1 infrastructure and construction customers. The business also stands to benefit from an increasing pipeline of renewable energy infrastructure.

In addition, further EBIT margin expansion is expected to be driven by scale, productivity benefits, and branch network optimisation.

Is FY24 Guidance Too Conservative?

For the 2nd time in FY24, SVW raised its FY24 group EBIT growth guidance to “mid to high-teen growth” (previously high single digit to low-teen growth). The upgrade is underpinned by the strong Industrial Services performance in 1H24, with the company now expecting 20-25% EBIT growth in FY24 (was low to mid-teen growth) from WesTrac, Coates, and Boral.

The upgraded guidance implies a weaker 2H24 (1H/2H EBIT split of 55%/45%) across each of the Industrial Services businesses and appears conservative given:

i. Increased investment in working capital.
ii. Robust infrastructure-led activity for Coates and Boral. Further, SVW’s proposed takeover of its minority interests in Boral increase the Company’s exposure to these strong macro trends.
iii. Expectation of further EBIT margin growth at Coates Hire. This reflects SVW’s focus on boosting fleet utilisation and cost discipline from network rationalisation.
iv. Ongoing fleet growth at Coates Hire, in addition to the continued rollout of higher-margin services.
v. At Boral, consistent sales volumes and favourable Average Selling Price performance in 2H24 (vs 1H24) should support 2H24 revenues. In addition, strong margin performance is expected on the back of ongoing measures to contain costs and promote operational efficiency.

Gearing Has Declined Quicker Than Expected

Supported by a strong increase in operating cashflow, as well as sale of non-core portfolio assets, net debt has been falling in recent periods, to $3.71b as at 31 December 2023, down from $4.0b as at 30 June 2023 and $4.48b as at 31 December 2022.

Gearing (on a net debt/EBITDA basis) as at 31 December 2023 fell to 1.9x and is well below the target of 2.5x. In context, gearing has fallen from 2.8x as at 30 June 2022 and much quicker than expected, given that the Company, at its AGM in November 2022 indicated that it intended to reduce gearing to 2.5x over “the next 12-18 months”. In addition, the acquisition of Boral under the Maximum Consideration of $6.25 per share results in SVW’s gearing increasing to 2.2x on a pro-forma basis. Importantly, this is still below the 2.5x target.

Despite a step-up in CAPEX, group free cashflow is expected progressively expand over FY24-26, which in turn support further deleveraging of the balance sheet.

Fundamental View

We highlight several factors underpinning our positive fundamental view:

i. Strong EBIT growth potential for the core industrial businesses, which is underpinned by both strong long-term macro tailwinds. In addition, there are internal initiatives that support further margin expansion in WesTrac and Coates Hire.
ii. Boral’s operational performance continues to improve, with a stronger EBITDA margin outlook over FY24-26 driven by greater cost control. In addition, the potential full takeover of BLD also provide margin upside from synergies and greater efficiencies under SVW’s control.
iii. Following an improvement in the share price since our recent report, the 1-year forward P/E multiple has expanded from 15x to 16x. Notwithstanding, the current multiple is considered undemanding in the context of an attractive EPS growth profile of ~20% over FY23-26 on a CAGR basis.

Charting View

SVW is in an uptrend and it seems to be sticking to a well-defined channel. SVW is a hold here as we should continue to see it trend higher, and any dips back to lower part of the channel, such as near $38, are a buying opportunity.

 

Michael Gable is managing director of Fairmont Equities.

 

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