News that Tata Steel and Thyssenkrupp have agreed a preliminary merger of their European operations provided a welcome boost for the local steelmaking industry, and it could also provide a fillip for ancillary sectors. As the UK’s largest structural steel specialist, Severfield (SFR) falls within that category, and there are compelling reasons to suggest that the Yorkshire-based group is now undervalued after a rough period for its shares. Indeed, the share price is down by 28 per cent since early May, leaving the shares trading on a single-digit forward PE ratio and at a wide discount to peers. The weakness may be attributable to reservations over the company’s return on equity relative to rivals, or simply adverse sector sentiment. Either way, we think there are good reasons for buying the shares at the current level.
Solid order book
UK infrastructure projects
Returning excess cash
On track to hit 2020 profit targets
Indian orders down slightly
Low ROE relative to peers
True, a small decline in the order book reported in this month's annual meeting update could be seen as a worry. However, at £221m at the start of September, the UK order book was still in line with normal levels, typically equating to eight to 10 months of annualised revenue. The domestic order book is also nicely diversified across several sectors, with fabrication work in London commercial and retail contracts. Major projects completed in the Capital in the 12 months to the end of March 2017 include Wimbledon No. 1 Court, Tottenham Hotspur's new stadium and 22 Bishopsgate.
Further down the track, there’s potential in store from infrastructure projects such as Hinkley Point nuclear power station, HS2 and the expansion of Heathrow airport – subject to political vagaries, of course. The group highlights a strategically important balance between lower-margin industrial work and higher-margin commercial work, often secured by convincing engineers and architects to switch designs from concrete to steel.
At the start of September, orders at the group’s Indian joint venture were also slightly down from three months earlier, although that could simply be a question of timing, particularly given an “encouraging level of new opportunities”. And the repayment of the joint-venture's term debt in June 2017 should benefit profitability this year.
The recent update followed a strong year to the end of March, during which the group made good progress towards its goal of doubling pre-tax profit to £26m in the four years to 2020. During the 12 months underlying pre-tax profit rose 50 per cent to £19.8m following a jump in operating margin from 5.7 per cent to 7.5 per cent. Return on capital employed (ROCE) increased from 9.7 per cent to 14.6 per cent, while the Indian joint venture clicked into profit for the first time.
The balance sheet also looks strong and is supported by an impressive record of cash conversion. Operating cash flow before working capital movements last year was £25.1m, up from £17.9m. It was the third successive year in which cash generation has exceeded 100 per cent of underlying operating profit; that obviously isn’t sustainable in perpetuity, but it is a clear pointer to strong cash-flow management.
| SEVERFIELD (SFR) | ||||
| ORD PRICE: | 63p | MARKET VALUE: | £188m | |
| TOUCH: | 62-64p | 12-MONTH HIGH: | 88p | LOW: 52p |
| FORWARD DIVIDEND YIELD: | 4.4% | FORWARD PE RATIO: | 9 | |
| NET ASSET VALUE: | 51p* | NET CASH: | £32.6m | |
| Year to | Turnover | Pre-tax | Earnings | Dividend |
| 31 Mar | (£m) | profit (£m) | per share (p) | per share (p) |
| 2015 | 202 | -0.2 | 0.1 | 0.5 |
| 2016 | 239 | 9.6 | 2.9 | 1.5 |
| 2017 | 262 | 18.1 | 5.1 | 2.3 |
| 2018** | 263 | 20.2 | 5.6 | 2.5 |
| 2019** | 268 | 23.9 | 6.7 | 2.8 |
| % change | +2 | 18.3 | +21 | +12 |
| Normal market size: | 5,000 | |||
| Matched bargain trading | ||||
| Beta: | 0.23 | |||
**Edison forecasts *Includes intangible assets of £56.3m, or 19p a share | ||||
