Head of Research at Imara S.P. Reid, Stephen Meintjies, has some keen insights into potential risks facing construction companies, Raubex and Stefanutti in particular, as well as sound stock picks for the industry based on the inherent concerns. The risk identified is based on the possibility of civil damage claims totalling about R300m for collusion. Imara has stated that the possibility of civil claims are âtoo material to ignore as clarity is soughtâ. Despite the potential downside impact in the short-term, it is expected that construction companies will come out with trading updates that show good progress, and identify stocks that could certainly prove to be sound long-term investments. Lessons have been learnt, and management have no choice but to deliver, regardless of potential claims. – LFÂ
ALEC HOGG: To discuss an estimation that listed construction groups Stefanutti and Raubex are at risk of some damage claims, is Stephen Meintjes, Head of Research at Imara S.P. Reid. You guys do really, good work there, Steve but, primarily, because you look at the whole Continent, youâve got people all over the continent. With the Competition Commission fines that were levied on construction companies, and now the possibility that there could be some kind of a knock-on effect. Is this something that companies around the continent have been considering or is it more a localised thing?
STEPHEN MEINTJES: I think it is very much more a localised thing although, obviously, what happened here could be noticed by other authorities elsewhere and looked into but we havenât heard anything.
ALEC HOGG: Because youâd think the profit margins that South African companies make outside of the boarders of this country, are so substantially higher than what they are in South Africa. There must be some kind of âfunny businessâ happening.
STEPHEN MEINTJES: Well…
ALEC HOGG: Or there could be âfunny thingsâ happening.
STEPHEN MEINTJES: There could be but we donât know of any. We, incidentally, have a separate team focusing on other African countries, so we wouldnât know the detail of that. Suffice to say that the South African companies, many of whom have been elsewhere in Africa for decades â have paid their school fees. They know their way around. There is a lot of competition, so although the margins are better they are not exorbitant.
ALEC HOGG: Not ridiculous.
STEPHEN MEINTJES: Yes.
ALEC HOGG: All right, so you decided to have a look at two stocks in particular, the Stefanutti stocks and Raubex. Why did you pick those two?
STEPHEN MEINTJES: Well, Stefanutti simply because it was by far the largest, relative to its size of all the fines imposed.
ALEC HOGG: Okay, so itâs most at risk if there are civil claims.
STEPHEN MEINTJES: Well, thatâs the way we reasoned. They paid over R300m to the Competition Commission, as a result of that whole process. Funnily enough, this was the same as three of the big four, Murray Roberts, Aveng andâŚ
ALEC HOGG: Where they naughtier, is that the reason?
STEPHEN MEINTJES: Well, relative to size, it would appear they were. The number of cases relative to size was quite high. They had about 15. The big ones (Wilson Bailey Holmes) had about 21 cases. These were rigged projects that were declared and…
ALEC HOGG: Which side did it come from, the stock side or the Stefanutti side? I remember there was a merger.
STEPHEN MEINTJES: I think theyâre pretty well merged. We didnât pick up the difference.
ALEC HOGG: Stefanutti had a really good reputation before the merger and stocks perhaps less so.
STEPHEN MEINTJES: Yes that is going back a while. I think it is very much in…
ALEC HOGG: But these fines were also going back a while. They are back to 2007 and before.
STEPHEN MEINTJES: Yes.
ALEC HOGG: So it would be interesting to see. Did Stefanutti buy themselves a lemon when they did that deal? Itâs interesting.
STEPHEN MEINTJES: Well, yes, we didnât go into that detail.
ALEC HOGG: Whatâs the exposure, though? Letâs go back now. If you were the person who paid who paid for the particular construction project, and has admitted to the Competition Commission that it did something wrong, presumably, just logic suggests that you might have a case against them.
STEPHEN MEINTJES: You might well have a case. In some cases, that weâve seen the companies concerned did admit to collusive practice. In our calculations, we assumed an inflated margin of say one-and-a-half percent, and so we did some sums along those lines and came to a number, which was Stefanutti stocks, worked out with the interest factor because, as you say, it is going back a long time.  The interest factor is quite significant. I think we actually came out of a possible civil claims liability of about 163, and with interest that added up to again, round about R300m.
ALEC HOGG: Could it wipe out another yearâs profits?
STEPHEN MEINTJES: It pretty well would but if you regard that as a âone-offâ deduction, the evaluation is still quite favourable. We actually ended up with an add recommendation on the stock.
ALEC HOGG: Why havenât we seen any civil claims yet?
STEPHEN MEINTJES: I presume that thereâs quite a lot of detail work to go into and I presume that there could be negotiations going on. I would imagine it would be a lot easier to settle than to go into actual litigation.
ALEC HOGG: Have you spoken to any Directors? Are they…?
STEPHEN MEINTJES: Well, weâve given up trying because, for good reasons, they canât. There is not very much they can say. All they will say, in one case is that they have had a Notification of Potential Claims and most of them say they havenât received any claims as yet. Â However, about six months ago, there was quite a big noise from clients, mainly public sector – clients that they were jolly well going to claim, but it seems to have gone quiet.
ALEC HOGG: Well the Stefanutti share price – Iâm just looking at it now â has hardly moved in the past year. Itâs been a bit turbulent but it is back to where it was a year ago and the companyâs earnings is⌠Well they generate, as you say, somewhere in the region of the 300, cash generated per share is R303m. If there is a R303m hole that could be there, why are you still thinking that the evaluation is okay?
STEPHEN MEINTJES: Well we simply took the current earnings number and applied a PE to it and came out at about 11.60, funnily enough and then if you knock that once off amount off that valuation, you get to around R10.00, which is above the current price.
ALEC HOGG: So if you then step away from it, it offers good value, relative to other construction companies, or relative to the market, generally.
STEPHEN MEINTJES: I think relative to construction companies in general. It was showing a fairly reasonable value and that calculation of ours was we think the worst-case situation.
ALEC HOGG: What about Raubex?
STEPHEN MEINTJES: Raubex, the amount we mentioned was a lot less. I think it was about R38m or something, so it was a lot less and nothing as significant to them, as this would be to Stefanutti, if they were to be hit for that amount.
ALEC HOGG: And the interesting thing was that we did see management changes at Raubex but not at Stefanutti.
STEPHEN MEINTJES: Correct.
ALEC HOGG: What do you make of that?
STEPHEN MEINTJES: Well, again, itâs as you say going back a long time. I think in most cases, current management couldnât have been or, well in most of the cases, they were actually not there at the time.
ALEC HOGG: Steve, youâve been around a long time. Surely, from a companyâs perspective, it must be better to just get this out the way. If thereâs going to be a claim, discuss it with the potential claimants and the uncertainty is out of the way, and you can then move forward. Youâve seen the share prices and the construction shares have really done little in the last year, maybe because of this overhang.
STEPHEN MEINTJES: I think that is one of the factors. The other one is the mine. Quite a lot of the construction companies are involved in mining, and that has been a negative for the last six months. The other one of course is the fact that the Government Infrastructure spending, a lot of it, for example has gone into PRASA and Transnet – big sums there and then specifically, Eskom. Whilst the Government is spending elsewhere, most of the companies are still complaining that theyâre not seeing what they expected, so you still want to see that rollout and I think people are wondering where the Government is going to find the funds to maintain a high level of infrastructure spending. Those are some of the doubts but, look weâve got the big four, and theyâll be reporting or giving trading updates quite soon, so I think the market is going to maybe get a new lead from what they say.
ALEC HOGG: What are you expecting from those trading updates?
STEPHEN MEINTJES: I think they will, in general show fairly good progress. Wilson Bailey Holmes of course, said the other day that they are going to have to take quite a big impairment on their steel pipe operation in Mozambique but otherwise I think in general, they will improve.
ALEC HOGG: So, for long-term investors, this is the time to start looking at construction shares.
STEPHEN MEINTJES: I think one can single out a few. There are a few that we do like. We think Group 5, for example, covers a wide field. Theyâre also, dare we say it, in the tolling business in Eastern Europe, Zimbabwe as well as South Africa. That is quite a significant contributor to their earnings, they cover a wide range, and they are well spread into Africa.
ALEC HOGG: So thatâs your pick.
STEPHEN MEINTJES: Yes, I think thatâs, of the big ones, yes.
ALEC HOGG: Thank you. Stephen Meintjes is the Head of Research at Imara, S.P. Reid.
