We recently researched Seven Group Holdings (ASX:SVW) in The Dynamic Investor after the Company reported better-than-expected result for the six months to 31 December 2022 (1H23) and upgraded the group earnings guidance. The latter included an upgrade to earnings growth expectations for key assets WesTrac and Coates, from “low-teen” percent growth respectively, to “mid-teen” for WesTrac and “high-teen” for Coates. We initially recommended SVW as a BUY on 29 November 2022, when the share price was $20.68 per share. Given the strong re-rating in the shares since our initial recommendation, we re-assess the investment case to see whether there is a further re-entry opportunity.
Overview of 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)Given the strong re-rating in the shares since our initial recommendation, we re-assess the investment case to see whether there is a further re-entry opportunity., which is the largest nationwide industrial and general equipment hire company with a national footprint of around 130 branches and over one million pieces of equipment across 22 product categories. It employs 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
Higher Levels of Investment in WesTrac Expected to Constrain Margin Growth
EBIT margin for WesTrac improved by 14 basis points to 11.1% on the back of: i) Stronger sales in both products (+13%) and machinery (+33%), ii) Pricing traction and, 3) Disciplined execution that helped to support increasing operational leverage.
EBIT margin expansion over FY23/24 is constrained by working capital constraints. WesTrac is maintaining higher working capital to support customer deliveries, despite supply chain constraints moderating over 1H23. SVW will continue to invest to support growth however still expects WesTrac working capital and operating cash conversion to normalise over the medium term.
Coates Hire Benefiting from Continued Tailwinds
Both operating leverage and asset utilisation are increasing, as the business driving operational improvement through strategic technology investments in fleet management, transport, and asset utilisation, in order to improve the efficiency of the business and its ability to serve customers. In 1H23, EBIT margin of 25.9% expanded by 183 basis points, which was driven by improvements in: i) Costs, ii) Technology improvements, and iii) Improved time utilisation (61.7%) with some regions above 65%.
Coates Hire continues to benefit from elevated customer activity. SVW reported strong east coast demand through infrastructure projects and improved penetration of industrial solutions services in the east coast (where Coates Hire’s branch footprint is most heavily represented). Demand for Coates’ hire equipment is leveraged to the ~A$1.1 trillion infrastructure investment expected through to 2025. Time utilisation has continued to improve with this theme.
Boral Turnaround Has Begun
One highlight from the result is that the risk to SVW’s investment case from Boral has eased. In a trading update issued to the ASX in November, Boral (ASX:BLD) noted several short-term challenges, including continued significant inflation, cost pressures from delays caused by wet weather, as well as uncertainty as to whether price rises and operational leverage will deliver margin expansion. BLD’s 1H23 result showed a turnaround in performance under new management, with impressive sales volume and margin expansion.
Improved Cashflow & Assets Sales Expected to Lower Gearing Levels
Gearing (on a net debt/EBITDA basis) as at 31 December 2022 was 2.7x, which was slightly lower than the 2.8x reported as at 30 June 2022. SVW still intend to reduce gearing to 2.5x over the next 12-18 months. The reduction is gearing down to 2.5x is expected to be supported by improved operating cash flow generation, given the WesTrac fleet deliveries scheduled for 2H23.
There remains 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. The sale of Crux is a potential near term catalyst, with discussions continuing with parties in due diligence. Importantly, there is scope for an even greater reduction in gearing should the Crux asset realise a higher sale price reflecting high energy prices.
Seven Group shares have re-rated from a 1-year forward P/E multiple of ~11x at the time of our previous report to ~13x at present (and broadly in line with the 5-year average multiple).
The growth outlook and strong operating momentum for both WesTrac and Coates are well understood by the market and have been well rewarded, as evidenced by the recent re-rating in the shares. However, while the medium-term EPS growth profile remains solid (~15% over FY22-25 on a CAGR basis), we contend that: i) Reducing gearing levels (with the sale of Crux a near-term catalyst) and ii) Delivering evidence of more consistent operating outcomes at BLD (management is guiding for improved operating leverage), as well as for Beach Energy (where more consistent production is required) – are the next key catalysts for a further re-rating in the shares.
SVW has run strongly into the old high above $24. It is likely to find some selling pressure here so in the short term we would be looking for a dip back towards the $22 – $23 region as the next buying opportunity. A break under that would be viewed as a negative.
Michael Gable is managing director of Fairmont Equities.
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