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On the road again: Seven Group Holdings or Transurban?

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I think we can all feel that things are starting to return to the “new normal” in Australia despite a pick-up in COVID-19 cases in Victoria.

We can all see with our own eyes in everyday life that traffic and congestion is starting to pick back up as the domestic economy reopens. 

While we all get frustrated by traffic and congestion, it is clearly a factor you want to see if you believe in the V-shaped economic recovery as such.

On that theme it was interesting to see very up to date data released by monopoly toll-road operator Transurban (TCL) this week. This data point is worth examining as it’s as close to real-time data as investors can get. 

The strong recovery in traffic continued, with truck traffic continuing to be resilient. The slower recovery for Melbourne is driven by tighter restrictions and reduced airport traffic. Truck traffic continues to remain resilient, ranging from +2% to -6% for June 14 week in Australia. I continue to expect to see periods of traffic volatility as authorities combat ongoing virus outbreaks, I believe that the worst impacts are clearly behind us.

 

The rebound/resilience of truck traffic is encouraging and suggests the domestic industrial economy is recovering. While the charts above are short-term in nature, basically tracking the COVID-19 period, on a long-term basis they would look V-shaped and I’d suggest they are a leading indicator of a strong economic recovery in Australia over FY21. 

While I am not recommending buying expensive Transurban shares up here, in fact I’m more interested in selling it, I find their data sets very useful in putting numbers behind daily observations. TCL’s data confirms what we can all see and that is that traffic is heading back to normal. This is a good development and gives me confidence in continuing to back a Team Australia recovery in high quality industrial businesses with a cyclical element.

Last week I wrote the following for those who missed it. 

“If I ran Australian money I would be increasing my holdings in all four large cap Australian banks (ANZ,CBA,NAB, WBC), increase my holdings in discretionary retailers, led by Wesfarmers (Bunnings), JB Hi-Fi (JBH), Harvey Norman (HVN) and even Scentre Group (SCG) as people will return to shopping malls.

The final sector I would increase my holdings in would be those with exposure to infrastructure construction. Those include Seven Group Holdings (SVW) (which owns Caterpillar, Coates Hire and 10% stake in Boral), Boral (BLD) itself before it exits its trouble North American business and becomes a pure play Australian exposure and Lend Lease (LLC)…Perhaps it’s time to sell the defensive infrastructure play Transurban (TCL) to fund rotation to cyclical infrastructure construction plays” 

Today I want to expand a little on the investment case for Seven Group Holdings (SVW), a company whose diversified industrial exposure looks well positioned to capture the Australian economic recovery that will be fuelled by a combination of record low interest rates, record high fiscal stimulus and “confidence” (aka animal spirits) return to consumers and businesses as the COVID-19 threat eases.

In the interests of full disclosure, you should be aware that Australian Capital Equity, an entity controlled by the Kerry Stokes Family, owns 19.9% of Aitken Investment Management, while the Chairman on Aitken Investment Management, Warwick Smith AO, is also a Director of SVW. 

Seven Group Holdings recently updated investors about current trading conditions and their strategy. The analyst community upgraded consensus earnings estimates after that presentation by CEO Ryan Stokes and CFO Richard Richards.

I suspect many of you don’t know exactly what SVW owns and operates, so I’ll start at a high level. 

SVW is a diversified industrial, or what used to be described as a conglomerate. One of its attractions is its diversification, which is quite rare in corporate Australia nowadays.

SVW had $6.9b in assets with positions in industrial services, energy, media and investments. Its majority shareholder is the Kerry Stokes Family. 

The recent trading update and associated management conference call were positive, and as I said above, led to analysts upgrading consensus earnings estimates.

Below I am going to quote directly from the UBS analysts note from the management call which gives a good summary of the pertinent points” 

“We hosted SGH management for a “virtual” fireside chat. Our discussion with Ryan Stokes (MD/CEO) and Richard Richards (CFO) focused on current trading conditions in key end-markets (i.e. Australian infrastructure, mining and energy) as well as the recent strategic investment in Boral.  SGH provided a FY20 YTD trading update. WesTrac’s 11-month revenues are up 15% y/y vs. UBSe +14% (12m). While Coates Hire’s 11m revenues are up 2% y/y vs. Use flat (12m).  SGH also noted that WesTrac had recently won two major truck & ancillary fleet orders with FMG at Eliwana and Iron Bridge. These orders follow other fleet orders with Newmont, Rio Tinto and BHP. We size the total revenue pool for these fleets at over A$1bn and expect the orders to be delivered through FY20 -FY23, which underpins our revenue growth forecasts across these periods.

What is SGH’s intention with its 10% stake in Boral? SGH recently acquired a strategic position in Boral for a capital outlay of c. A$360mn, (vs. spot of A$430mn, i.e. 5% of Use EV). SGH noted that its screening process had identified   Boral   as   a   leading   Australian   industrials   business   with   some   current challenges around leadership, strategy, litigation and execution.  As Boral’s largest shareholder, we would expect SGH to leverage its position to influence strategic and value enhancement outcomes at Boral, particularly with respect to the shape of Boral’s business portfolio in the US.                

 A solid financial position with significant balance sheet flexibility SGH has secured over A$700mn in new funding facilities across an oversubscribe USPP issue and other facilities. We think SGH now has c. A$1.3bn of available liquidity providing flexibility around short- and medium-term maturities, Westrac working capital demands and any potential growth opportunities.

We are attracted to SGH’s two key operational and value drivers, Coates Hire and WesTrac, which are supported by ongoing infrastructure development and bulk mine production.  While the stock is trading at a headline FY21E EV/EBITDA of 8x, we think the operating EV/EBITDA is closer to 6x (excl. investments, associates, etc.) with Coates at 5x and WesTrac at 7x.” 

If you are looking for a way of playing an economic recovery in Australia, with an emphasis on exposure to infrastructure spending (Coates Hire) and bulk mine production (Westrac/Caterpillar) then SVW is a stock you should consider for your portfolio.

SVW remains on a P/E discount to the ASX200 which makes it attractive from a valuation perspective versus the quality, duration and diversity of its asset base. Paying 13.4x earnings at the bottom of the cycle is attractive in my opinion. 

The dividend yield around 2.5% is sustainable and an added attraction of the stock in what will remain an ultra-low interest rate environment for many, many years to come. SVW state their aim is to maximise return to stakeholders through long-term sustainable value creation. That return includes dividends.

I thought I’d finish with a conversation starter for your next dinner party…did you know that Caterpillar 793F mining trucks consume $3.9m in parts and maintenance over 10 years? That’s a business you want exposure to. 

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

Charlie Aitken is the Chief Investment Officer and founder of Aitken Investment Management. All prices and analysis at 27 June 2020. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.