Following on from a recent post it is time that I did some more research on Heijmans NV. The company like many in the construction industry was ill-prepared for the economic downturn beginning in 2008. Similar to many, cyclical companies they made the mistake of gearing up late in the cycle. The combination of operating leverage and financial leverage heading into a recession is rarely successful. The Chairman resigned in early 2008, once it was obvious that the writing was on the wall. A rights issue followed in 2009 to reduce the leverage.
P/E (10yr) 3.0
Who are Heijmans N.V.?
The company is incorporated in the Netherlands & has a history that spans over a century. Heijmans is focused across a wide range of construction & property related business, predominantly in the Netherlands, but also in Belgium, Germany and Britain.
According to the 2010 Annual Report, the revenue split is as follows:
Property Development 14% (0% of operating profit)
Residential Building 14% (22% of operating profit)
Non Res Building 8% (1% of operating profit)
Technical Services 7% (7% of operating profit)
Infrastructure 25% (45% of operating profit)
Belgium 7% (4% of operating profit)
UK 14% (9% of operating profit)
Germany 11% (12% of operating profit)
The company would seem to be in the midst of retrenching from foreign markets, with the exception of Belgium.
With the resignation of the Chairman in 2008, Heijmans recruited a new leader in the person of Rob Van Gelder. I have a long and fond memory of Mr. Van Gelder, in that as a young & inexperienced equity analyst many years ago, I had opportunity to meet with him several times as I pursued what turned out to be a very good investment in his company, Royal Boskalis Westminster. My memory of Van Gelder is that he runs a tight ship and is highly focused on margins and cash returns. In my dealings with him over a decade ago, I found him to be straight talking, patient and informative. Since his appointment, Heijmans has begun focusing on margin over revenue. This may sound obvious, but so many construction and infrastructure companies lose sight of profitability in the quest for iconic projects.
- A 3% fall in revenue during 2008 leads to a gross profit contraction of 30%,
- During 2008, Heijmans records a €13.6m operating loss (from a profit of €88m during 2007),
- EBITDA/Interest Paid coverage falls to 1.2x (Gearing stands at 103%).
- Chairman resigns & is replaced by Rob Van Gelder,
- Company announces it will launch a €100m rights issue,
- Heijmans begins to retreat from overseas markets and begins to refocus on its home market of The Netherlands (plus some business in Belgium).
- During this time the share price has fallen from €123 in late 2007 to approximately €10 in 2008.
- Dividend was suspended.
- 2009: Rights Issue completed and reverse stock split announced. Company makes a further loss during 2009.
- 2010: Disposal of UK subsidiary, Leadbitter.
- 2010: Return to profitability. Dividend re-instated. Van Gelder steps down as Chairman and takes up a position on the Supervisory board.
Heijmans ambition is to become the market leader in terms of sustainability, quality and profitability by 2015.
While that is rather prosaic, the reality of the challenge facing management is that revenue in the past year was €2600 million, which was similar to the revenue earned during 2004. Operating profit last year amounted to €48million versus €81million during 2004. The company needs to move ROE from 3.5% to the 11% earned some seven years ago. On an unleveraged basis, returns during 2004 were twice those in 2010.
Can profitability improve from here?
What is interesting about the firm is that the UK has been exited, but it would seem that at a very cursory level, the main drag on profitability would seem to be Property Development and Dutch Non Residential Construction. Both of these areas are barely profitable (if at all). So where are margins, and can they be improved on from here?
Profitability in this division has imploded from 8% during 2007, to break-even during 2010. Profitability depends on the timing and success of projects. During H1 2011, losses increased by €1m from the same time last year to (€4m). The company comments that the market is difficult. This is not unexpected given the broad uncertainty surrounding many European economies at present. Indeed it would be surprising if the any property development business was doing well in the present climate.
The number of houses sold has fallen by 7%, but the inventory of unsold homes has fallen marginally yoy. Inventory of houses under construction stands at 333 as opposed to 377 at the end of 2010.
The issue then is, how much risk as attached to this division until the broader situation improves? In this regard, the financial statements and notes are not much use. As part of the strategy forwarded by management, this division is likely to become a smaller into the future. In many of the financial releases from the company, commentary on the Property Development division seems to blend with commentary on Residential Construction.
Construction (Residential & Non-Residential)
I have looked at these two divisions together as it seems that the company only began splitting them out in 2009. During both 2007 & 2008 this division recorded almost €1bn of turnover in each year. On the back of this turnover margins were -5%. The combined turnover of the division has fallen to €620m in 2010, but the operating margin has improved significantly to 2.9%. The divisional split contained in the 2010 Annual Report reveals that it has been the Residential Construction division that has recovered most. Operating margins have increased from 1.85% to 4.15% between 2009 and 2010. Meanwhile, at the Non-residential side of the business, margins have improved from a loss of 0.9% to 0.4% profit margin. Given the lack of divisional split over the years, I simply have no clear picture as to where these margins stand in relation to their historical trend.
In terms of continued progress during 2011, there has been none really. Residential Construction has made an operating profit of €10m at the H1 stage, which is the same as in 2010 – this is especially impressive given that turnover declined by 15% during the year. At the half year stage operating margins in residential construction stood at 5.6% as margin was prioritized over volume.
The non-residential division has gone from a small profit in H1 2010 to break-even in H1 2011. Revenue has grown by 5% yoy while profitability has gone into reverse – does margin over volume not apply in this division?
The infrastructure division has actually improved its operating margin in the past 5 years. From a margin of 3.8% on €945m of revenue in 2005, the division now has a margin of 4.8% on revenues of €714m during 2010. Further improvement in the level of profit was recorded at the half way stage this year, with operating profits of €14m versus €10m in the last year, while margin has continued to increase yoy. Turnover has risen by 23%, down to good weather leading to efficiencies in road building). The order book is down.
As a division, Technical Services appears in the annual reports about four years ago. Since then, the unit has remained profitable. Operating profit margins have fluctuated between 2.4% and 5%. Margins at the half way point this year were 1.1%, which while ahead of H110 margin of 1% are behind the full year margin of 2.4%. Turnover fell by 25% during 2010 and continued to fall this year, with a 9% decline yoy during the H1 results. I can find very little information regarding this division, which is mildly off-putting to say the least.
The international division used to contain business units in Belgium, Germany and the United Kingdon. Given the exit from the UK division (Leadbitter) the business is now focused on Belgium and Germany. Any infrastructure work in Belgium will be undertaken through the overall Infrastructure division as opposed to the Belgian division.
The UK division has been sold to a JV of Leadbitter management and a French company (backed it would seem by Bouygues. The division has been consistently profitable throughout the past 6 years, with margins improving from 2.3% in 2005 to 3.3% in 2010. Leadbitter has been sold for €47m, which was recognised as a working capital receivable until the sale had completed. Consequently year-end working capital was over stated, and year-end cash was understated by the proceeds of the sale. The sale of Leadbitter has led to a €6m gain on the disposal over the value in the Balance Sheet.
The combined business units of Belgium and Germany generate revenue of approximately €529m at a margin of 2.3%. Similar to other business units within the company, this is a higher margin on lower turnover when compared with 2009. The combined level of operating profit during the first half of this year amounted to a fat zero (from €1m of profit during H110). While Belgium moved back into profitability (2.8% operating margin), Germany reversed its way into a loss.
In the past 6 years, peak margins for both Germany and Belgium are north of 3%.
In terms of profitability, the key to overall group margins improving to the average achieved in the past decade would be for margin uplift at Property Development and Non Residential Construction, followed by improvements in Technical Services and Germany. If this can be achieved there is no reason why Heijmans cannot achieve a group operating margin of 3%. The reality is however that given the state of the property market, it is unlikely that Property Development will attain historic margins anytime soon.
Balance Sheet – P/B implies Asset Overvaluation?
With the stock trading at €7.65 per share, this implies a P/B of 0.28. Such a level of valuation implies that the net assets on the balance sheet are overvalued to a significant degree – is this the case?
Balance Sheet – H1 2011
I am going to revalue the balance sheet using reasonable discounts to achieve a stressed fire sale price that considers the amount of accumulated depreciation that has already been put through the books.
|Heijmans – Balance Sheet||Carrying Value||Discount||Value|
|Property, Plant & Equipment|
|o/w Land & Buildings (i)||51.0||0%||51.0|
|o/w Other PPE (ii)||42.0||25%||31.5|
|o/w Land under Construction||4.5||10%||4.1|
|Real Estate Investments (iii)||6.5||25%||4.9|
|Investment in Associates (iv)||3.4||50%||1.7|
|Other Investments (v)||70.9||25%||53.2|
|o/w Strategic Land||356||15%||302.6|
|o/w Property Work in Progress||160||10%||144.0|
|o/w Other Inventory||54||10%||48.6|
|o/w Construction Work in Progress||187||10%||168.3|
|o/w Income Tax Receivable||7||0%||7.0|
|o/w Trade & Other Receivables||377||5%||358.2|
|o/w Trade & Other Payables||496||0%||-496.0|
|Other Current Assets||303||0%||-303.0|
|Implied Equity Valuation||168.4|
|Current Mkt Cap||124|
|(i) Land & Buildings has been depreciated by €43m from the gross B/S value.|
|(ii) This relates to PPE beneficially owned under finance leases. They have been depreciated over 3-10 years.|
|(iii) Have seen €2.6bn of accumulated deprecation & €0.5bn of impairments.|
|(iv) Value is the actual equity value, as opposed to B/S carrying value.|
|(v) Loans to JV’s & other associates.|
I used the Eurostat Property index to judge what type of discount that I should apply to property related inventory. According to this (experimental) index, with the index starting in 2005, the index value for Dutch residential property is 103 currently.
Like any valuation methodology, I will concede that I could use any arbitrary value to fit my thesis. There is no doubt that I could have been harsher. Using the assumptions that I have used I have derived a figure that shows some reasonable upside. What is interesting is the Heijmans closest competitor, Royal BAM Group, trades at 0.55x P/B on a Balance Sheet that contains significantly more debt than does Heijmans. To be fair it would seem that historical ROE’s at BAM are somewhat higher than at Heijmans (but this is not presently the case).
All in all, there is a lot to like about Heijmans in that it meets my primary criteria:
(i) It is good value on which ever valuation methodology that I use,
(ii) Margins on a group wide basis are not at peak levels (though some divisions are),
(iii) The balance sheet is improving.
I will be keeping a close eye on this stock and will look for an opportunity to take a position.