Severfield-Rowen, H1 Results

There are few signs of encouragement in UK construction demand and pricing; this, together with previously announced cost overruns, will further delay an earnings recovery. Indian operations are looking to achieve a maiden profit this year and investment is planned to support further expansion.

H1 In Line With Lowered Expectations
The June pre-close statement pre-warned that the H1 result would contain a disappointing £1.5m PBT result. Competitive tendering and internal cost overruns in the UK were both factors here. Activity levels are broadly stable overall, but a merger of three UK operating companies is to take place later in the year in a measure designed to bolster margins. Note that a cash inflow was achieved in the period and an unchanged (though uncovered) H1 dividend of 1.5p was declared. Outside of the UK, the Indian JV is making tangible progress and further investment has been announced, probably with more to come.

Margin Squeeze Reduces Estimates
The UK construction market remains tough, with softening demand in some areas and keen pricing. Severfield’s revenue run rate appears stable, but we have taken 170bp off our expected FY12 operating margin (to 3.7%) to explicitly incorporate cost overruns and current conditions. This translates to a net £4m (32%) reduction in expected FY12 PBT. FY13 estimates have been lowered by a more modest £1m (-6%). Lower tax rates dampen these effects at the EPS level. Market pains are being felt more acutely among sector peers (with losses evident) and, if anything, this may strengthen the company’s medium-term market position.

Valuation: Building Value
Near-term valuation multiples are inflated by bottom-of-the-cycle earnings estimates. We have previously outlined a mid-cycle fair value illustration in excess of 200p for Severfield’s industry-leading UK operations (see March Outlook note). Granted, in current conditions, market position tends to be obscured by shorter term considerations but we maintain that this will re-assert itself as demand for construction steel improves and stand by this valuation. The Indian JV is making progress and we will ascribe a stand-alone value to it once the profit model is more established. Taken together, we believe that there is significant earnings and valuation upside on a medium-term view. While a UK upturn is the primary catalyst to realise this currently, India will become increasingly important.

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