OHLA – Looking down the pipe
All,
Please find our updated analysis here.
As we emerge from the Covid pandemic governments are seeking to kick start the economy through infrastructure investment. As a result, OHLA is now beginning to see significant growth in its pipeline of work. Free cash flow is turning positive but is modest and is likely to remain so, although it will benefit from the end of onerous project costs by end of 2022. Inflationary pressures in raw material and labour costs will need continual managing with clients. We see significant upside in the equity of OHL, we also like the coupon on the SSNs and see some pull to par as management look to refinance ahead of the PIK element increasing. We are increasing our long position in both.
Growth spending, growth in costs:
- Post the covid pandemic governments are looking to prime economic growth with infrastructure growth. US President Biden has had a USD1.2trn bill passed and the EU has approved funding for spending of up to €750bn on infrastructure projects. There is pressure to get these funds allocated and to get projects started. These civil projects will be lower risk (and lower margin), than development assets.
- OHLA's ability to compete in bidding for contracts was significantly enhanced in 21Q2 when its banks extended their performance guarantee lines (from 6 to 12-months). By Q4 the construction order book was 24% higher year on year (9% sequentially) at €5bn.
- Cost inflation remains a risk and whilst some state and semi-state contractors in the US and Europe are now voluntarily inserting cost inflation clauses into contracts there will be pressure on all sides.
- This is an industry rather than an OHLA problem, however civil contracts are rarely on a cost-plus basis so managing execution is still down to OHLA.
- Orders remain skewed towards the US (46%), but we expect some rebalancing as European orders grow (backed by the EU infrastructure program).
- Investment in concessions will be modest (two in 2022) with OHLA taking under 20% of the equity. These will be concession projects as opposed to construction projects renegotiated into concessions.
Is consistent Free Cash Flow coming?
- OHLA generated €60m in free cash flow in 2021, but this included proceeds from asset sales and part of the Cemenosa settlement, excluding these flows FCF was still slightly negative.
- Our model has free cash flow generation from 2022 - 2025 of around €125m (excluding the remaining €80m from Cemenosa due in Q122).
- This will be boosted by the absence of drag from legacy costs after 2022.
- This will cover interest (€32m per annum) but little else. This is a perennial problem for construction companies.
- There is plenty of cash on the balance sheet to cover contingencies, but it does underline the importance of working capital discipline as the book grows.
New shareholder's long-term plans?
- The Amodio family are now the largest shareholders in the company at 26%. Mexico based Amodio's control CAABSA, a LATAM focused construction group.
- OHLA and CAABSA have signed a cooperation agreement, they will continue to compete but will collaborate. This should allow OHLA to avoid the bidding errors that cost it dearly on previous Latam projects.
- The Amodio family has no immediate plans to take a majority stake in OHLA, but in have not ruled it out in the future.
- We could see a merger led by OHLA to redeploy capital raised in Europe to Latam, this would be a negative for the equity. We don’t discount it; however, we do not see it as something at the forefront of anyone’s mind for some time.
Litigation is in balance but will have a long tail:
- We see the costs/recoveries in the litigation book as largely balancing out. The biggest claim is Sidra where we size the potential liability as a maximum of €100m (or €200m if partner Orascom manages to void its guarantee). A large sum but manageable. Some timing risk remains, which the company will be able to over via cash. Disputes can and do take years to resolve.
Valuation:
- The core construction business is worth €718m at the high end of our DCF model. OHLA has projects which we value at €353m. Canalejas is the largest with a valuation of €198m, this project is likely to be held for some years to maximise its value as it matures
-In addition, there is the Cemenosa settlement of €162m.
- The litigation claims virtually net out with around a €1m exposure. The largest component is the Sidra project in Qatar, we calculate exposure here at €111m. There is also litigation between Qatar and Orascom (OHL’s partner in Sidra), if Orascom were to win that litigation the cost of Sidra could rise by €91m.
- We model excess cash at €200m and debt is €649m
- This gives a market value for OHLA of ~€720m equating to a share price of €1.32. Our price target for the next 12-months is €1.20 equating to a market capitalisation of €710m
Positioning:
- We are increasing our long position (post tender) to 4.3% NAV in the bonds (+1%) and 3.5% (+1%) in the equity. We see a return on this position of 17% in the next 12 months.
- OHLA is currently tendering for part of its SSNs which will bring our position in the bonds down and into the range we are aiming for.
- There is a lot of work coming down the pipe for OHLA and the move away from developing assets to a focus on contract manufacture of infrastructure will provide some protection from exposure to inflationary pressures. There may also be timing issues on the closing of individual litigation, but OHLA has sufficient liquidity to manage this.
I look forward to discussing this with you all.
Aengus
E: amcmahon@sarria.co.uk
T: +44 203 744 7055