Seven Group Holdings (ASX:SVW) recently released earnings guidance to the market. It indicated “low-teen EBIT growth” for its two key operating businesses WesTrac and Coates Hire. This was ahead of consensus EBIT growth estimates of ~10%. However, investor concerns around weak operational performance of the recently-acquired Boral and elevated gearing level as a result of this transaction have impacted sentiment. With a recent recovery in the share price, we revisited the investment case for SVW in The Dynamic Investor. Is the guidance strong enough to compensate for potentially uncertain operating outcomes for Boral?
About Seven Group Holdings
Seven Group Holdings 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 national footprint of around 160 branches and over one million pieces of equipment across 22 product categories, employing more than 3,300 employees and has over 16,000 customers. Coates services a diverse range of end markets including engineering, mining and resources, infrastructure, manufacturing, construction, agriculture and major events.
iii. Boral (72.6% owned by SVW), an ASX-listed company (ASX: BLD) which is Australia’s largest construction materials and building products supplier.
Key Fundamental Drivers
WesTrac – Favourable Long-Term Trends Emerging
The Company recently provided guidance for WesTrac to generate low-teen underlying EBIT growth in FY23. In contrast, WesTrac recorded FY22 EBIT growth of 6%, which was ahead of guidance for low single-digit growth. SVW expects WesTrac demand to remain strong for mining products and services. The significance here is that the acceleration in product support sales from 4.3% in 1H22 to 13.3% in 2H22 underpinned a very favourable mix shift in trends, which in turn enabled WesTrac to maintain very resilient EBIT margins during an inflationary environment.
Demand for mining products and services is expected to remain strong “over the next decade”, with customers extending fleet lives through re-builds which supports high margin parts/service demand as miners eventually move towards the fleet electrification. The business is also positioned for exposure to the future facing metals that will underpin the energy transition, where demand and production is accelerating. The Company continues to see customers extending fleet lives through rebuilds, reinforcing the support activity. The fleet life extension is likely tied to the eventual evolution to electrification of mining fleets.
Further, Caterpillar’s material investment in autonomy and energy transition Research & Development should ensure that WesTrac will continue providing market leading solutions for customers. In particular, customers have reported up to 30% productivity improvement using the CAT AHS (technology) solution. Moving forward, the electrification requirement presents opportunities for WesTrac, given that it is well positioned to benefit from CAT’s partnerships with global mining leaders on zero emissions solutions.
Coates Hire – Operating Leverage & Asset Utilisation Improving
At the recent trading update, the Company provided guidance for Coates to deliver low-teen underlying EBIT growth, with fleet expected to expand by ~5.5% to $1.9b over FY23 through disciplined fleet investment and management of disposals.
Coates customer activity remains solid due to a robust economic industry environment. Momentum from FY22 has continued steadily into FY23 and is supporting an encouraging outlook with operating leverage and asset utilisation increasing.
Demand for Coates’ hire equipment is leveraged to the ~A$1.1 trillion infrastructure investment expected through to 2025. As a result, time utilisation has continued to improve with this theme, despite heavy east coast rainfall.
Improved Cashflow & Assets Sales Expected to Lower Gearing Levels
SVW aim to reduce gearing from 2.8x to 2.5x over time. The reduction in gearing down to 2.5x (which is likely to take place over the next 12-18 months) is expected to be supported by improved operating cash flow generation, given the WesTrac fleet deliveries scheduled for 2H23.
While the Company has indicated that it would be comfortable with a gearing level of 2.5x, there is scope for further deleveraging (towards 2x) should the Company divest its 15% stake in the Crux gas field and assuming a conservative asset valuation for Crux. Importantly, there is scope for an even greater reduction in gearing should the Crux asset realise a higher sale price reflecting high energy prices.
Fundamental View
The shares are currently trading on a 1-year forward P/E multiple of ~11x, which is towards the bottom end of the recent trading range and below the 5-year average multiple of ~13x. We do not consider the current multiple to be demanding in the context of a 3-year EPS growth profile of ~13% on a CAGR basis.
Given the strong results from the core businesses (WesTrac & Coates Hire), coupled with the reducing debt and gearing profile, we contend that the challenges at Boral (which accounts for ~15% of overall valuation) do not materially alter the attractive investment case for SVW. In particular:
i. The growth outlook for Coates and WesTrac to be supported by ongoing strength in Australian mine sustaining CAPEX, and increasing domestic infrastructure investment.
ii. Given the market-leading positions of WesTrac and Coates, coupled with the offering from these two businesses providing customers with leading solutions, SVW has ability to navigate inflationary pressures through better pricing power, where the Company intends to avoid long-term fixed price contracts. Further, these businesses operate in positions further up the value chain, in sectors where customer activity is less susceptible to demand changes from inflation.
iii. Beach Energy (ASX: BPT) – which accounts for ~20% of overall valuation – is a direct beneficiary of energy price inflation, both through spot price exposure on liquids sales, and increasing levels of uncontracted and repricing gas volumes.
Charting View
Seven Group Holdings broke out of an ascending triangle in mid-November and then started to trend higher. In the short-term, it does look as though it is ready to consolidate again. This means that we are likely to see some dips back towards $20 – $20.50. That would provide a better entry point for investors.
Michael Gable is managing director of Fairmont Equities.
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