This is not investment advice. Do your own research before taking a position in any of the securities mentioned in the post below. For full disclosure, I bought SSM shares at $0.79. Whilst I remain comfortable with that decision, I want to explain the risks/rewards of this business at today’s valuation.
Risks
Their business is unlikely to be scalable overseas because their client network (e.g. NBN or AGL) is localised & management are understandably not targeting offshore growth;
By nature, their business is clumpy and, whilst I am ok with earnings going up/down, I think it presents two risks:
The business will never attract a decent multiple due to earnings surprises
Worse still - management will overpay for an acquisition to “smooth” returns
Whilst their network/brand does provide Service Stream with some advantage – there is no real moat or at least not a material one.
Reward
Unlike most ASX engineering firms - it is not materially exposed to commodity cycles
The Lend-Lease Services (LLS) acquisition genuinely diversifies their business, it appears they did not overpay for LLS & this could (hopefully) reduce the need for unnecessary M&A in the short term
The implied valuation is quite appealing at NTM EV/EBITDA of c.5.2x
Current EV = c.$590m ($530m market cap + $60m LT net debt)
FY22E EBITDA = $113m ($120m management forecast less $7m of corporate costs)
The market knows all – so why is this EV/EBITDA so low? Value trap?
I imagine the market is not re-rating this company because:
They expect a further reduction in telecom earnings now that NBN is complete
Interstate restrictions mean that FY22 earnings are likely to disappoint
There is execution risk with the LLS acquisition, and it is unlikely that synergies will materialise
Whilst I agree with the risk of their near-term earnings, I think the LLS acquisition was a good long term decision because a) the entry multiple was ok and b) most of the benefits are cost-driven in Telecom/Utilities with a small amount of the benefit being new revenue in the transport sector (see below)
Valuation - sluggish growth but there's a margin of safety
*NOTE* Instead of building up a DCF, I have used a P/E approach simply because I do not know the capex/working capital requirements of the LLS business. Service Stream could have low cash flow/dividends in the short term due to the repayment of debt from the LLS acquisition.
As I said above, it is difficult to forecast cash flows for this business. However, I don’t think that earnings need to grow at a significant rate to justify today’s valuation.
Based on a consensus broker discount rate of 6.6% - the company only needs to generate EBIT growth of 4-5% capped at the current 12x P/E to justify today's price. This discount rate is likely to grow with interest rates - however, this earnings growth is a low hurdle.
Without giving you a definitive valuation - earnings have grown at c.10% in the past so I think there is a margin of safety in today's valuation even if FY22 earnings disappoint. The key unknown is if the LLS acquisition does not generate meaningful EBIT (something which is tough to know at this point)
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