Investment Matters

A Dislocated Duo

Price- value dislocation - Emeco

We have previously highlighted Emeco as the posterchild for price-value dislocation (i.e. where the price of a stock is significantly away from the value of the company) we have recently seen in the markets.

As at today, Emeco’s share price has doubled from its low on 23 March.  Yet it is still very much the same business.

More dislocation

Two more companies can be added to this dislocator’s list: Intega and Cardno. Why have they have fallen and what are they worth?

We spoke with management and former senior executives for an update on COVID and the impact it has had on in markets in the US and Australia.

Our assessment remains that both companies are incredibly cheap.

Why have they fallen (and why are they so cheap?)

COVID 19 has led to an appreciable sell-off of shares in both companies.

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As we have written, the recent sell-off has been a combination of a market structure event (with large financial players having to quickly sell out of their positions) and weariness around the impact of COVID 19, particularly on low margin businesses, those with operating leverage (businesses with a high degree of fixed costs) and/or financial leverage.

Both Intega and Cardno, being predominantly “people” businesses, tick all three of these three boxes.  However, once again it is a case of theory versus practice, as our meetings proved.

For most of their operations, it has been business as usual – with COVID-19 having a limited impact. Many of the services they provide have been deemed essential and have continued uninterrupted – with their backlog of work remaining solid.

Furthermore, management of both companies are confident they have put in place appropriate measures and contingencies to allow them to adapt should the COVID-19 related disruption continue.

This includes close monitoring of their liquidity, a positive dialogue with their lenders and measures to reduce operating costs.

They also see any fiscal stimulus in the form of infrastructure spending as being highly favourable for their near-term growth. The likelihood of this is increasing given current economic conditions.

Why haven’t their share prices recovered?

We have been happy to buy at current prices.  However, the stocks of both companies have been thinly traded.  To illustrate, only approximately 3% Cardno’s February market capitalisation has traded in the past 2 months.

Companies like Emeco or Commonwealth Bank have traded around 20% of their market capitalisation.  For other companies such as Afterpay this is closer to 100%.

Without a significant level of trading (liquidity) it is very difficult to achieve price discovery, particularly in a market that is so volatile.

What are their shares worth: Cardno – a simple valuation based on multiples

We see Cardno as being worth more than double its current share price.  Even a simple, conservative valuation reveals that its price is well below its value.

Cardno made $9.2m in net profit last half (underlying).  Its market capitalisation is $102m.  Annualising its first-half profit the company’s earnings base is $18m per annum.

At current prices, it has an earnings yield of 17% or P/E of approximately 5.6x.

That is low and should be closer to 9x (if we assume the company can grow at around 2%).

Looking at it another way, valuing Cardno’s America’s business on its own (and normalising its contribution to a more conservative $10m in profit) on a reasonable multiple of 9x gives us a market value of approx. $90m – close to Cardno’s current market cap of $102m.

Put simply, at today’s price you are buying Cardno factoring in negative growth and mostly paying for its Americas business only.

In contrast, over the next few years its earnings should grow to closer to $25m and will benefit significantly from additional fiscal stimulus.

 

What are their shares worth: Intega – a much more simple valuation

We see Intega as even more under-priced - worth three times what it trades at today.

To illustrate: a key business within Intega is Raba Kistner. Raba Kistner is a recently acquired construction materials testing, geotechnical engineering consulting and project management business.

The company was acquired for approximately AUD73m in late 2018.

The business generated approximately USD7.1 m in operating profit for the year when acquired, after a period of strong growth. In Intega’s most recent half-year report, Raba Kistner contributed approximately USD5 m for the half.

Annualised (and taking currency changes into account), Raba Kistner now produces 50% more profit. In speaking to former and current management, this is with continued opportunities for growth. Simplifying, Raba today, based on the previous transaction, should be worth around $130m.

Raba Kistner was approximatly 50% of Intega’s operating profit in the first half.  At current prices, Intega in its entirety can now be purchased for $124m (Enterprise value – or what you would pay to buy the business as an acquirer).

Therefore, at current prices, you could more or less buy the entire Intega business for the value of Raba Kistner alone.

A simplification, yet it highlights the dislocation in the company’s share price.

How do we see both businesses performing?

Cardno and Intega will benefit from efforts by governments (in Australia and in the US) to stimulate their economies post-COVID-19 via infrastructure spending.

This is in addition to benefiting from already established infrastructure pipelines in the US and Australia over the next 5 years.

Intega, in particular, has considerable room to grow organically and through acquisition. This is through taking advantage of regional dynamics and relationships with larger engineering and construction companies.

Over the long term, both should be supported by the ongoing need for infrastructure spending and environmental remediation as economies and populations grow.

This growth profile does not at all reconcile with how they have been priced - which presents a real opportunity.

How will value be realised?

Given how thinly both are traded, the value may be reflected through a corporate action (a takeover offer by either a financial buyer or trade sale) rather than on-market.

Both companies see the demerger executed last year as a clear positive. Operationally, it enabled a separation of two different work cultures with different overhead requirements and eased conflicts of interest encountered when bidding for projects.

Furthermore, Cardno and Intega have both been a long-standing position for Crescent Capital (a private equity firm).

Given the incentive structures build in a private equity model (with performance being measure on an IRR basis), Crescent are motivated to create value from their investment in Cardno in a timely manner.

The timing of when this value is realised is uncertain. Yet as past examples have shown (such as Aveo) this disconnect does not often persist for long.

A dislocated duo, however, we see that their value remains in place.