Shares in construction supplier SIG (LON:SHI) today dropped 20% as it revealed that poor construction sentiment was affecting its sales. We have a drop in early trade of around 20%:
The share price has oscillated around over the past couple of years and we are back to levels seen in 2016. The price has remained in a reasonably wide range of 100-150p as Brexit uncertainty has weighed heavily on this share and today is no exception.
SIG could be described as roofing specialists, and distribute products and services to small and medium enterprises to mainly UK and European users. Given that every building has a roof, this is not a bad niche at all to specialise in, and over the years they have built themselves into supply chains and become an integral part of overall construction.
It sounds impressive, but on first looks results-wise this seems less so, and SIG are quite similar to many of the contractors they supply: slow top-line revenue growth, small margins and some heavy losses due to business impairments. As we can imagine, the business is heavily tied to the fortunes of the wider construction sector, and this hasn’t been plain sailing in the past couple of years.
What’s gone wrong at SIG?
The warning comes in today’s trading statement. It’s not good news:
The Group has been reporting during the year a deterioration in the level of construction activity in key markets and highlighting a number of key indicators pointing to further weakening of the macro-economic backdrop, notably in the UK and in Germany. This deterioration in trading conditions has accelerated over recent weeks, and political and macro-economic uncertainty has continued to increase.
This perhaps comes as no surprise with Brexit due to commence at the end of October. This commentary has formed the basis of previous profit warnings for SIG as well.
Some balancing actions are mentioned:
Management is taking ongoing actions to address the continuing market weakness. Further benefits from transformational initiatives and the Group’s normal seasonality are still expected to deliver a stronger second half. However, the recent further weakening of the trading backdrop as the Group has entered its traditionally strongest trading months of the year means that the Board is now anticipating, in both the specialist distribution and roofing merchanting businesses, significantly lower underlying profitability for the full year than its previous expectations.
Not a single number mentioned in the whole statement: it would have been useful for this to be quantified, even if it is a broad number.
Perhaps some welcome news for investors:
The Group is today separately announcing that it has entered into agreements following competitive processes to sell its Air Handling Division and also its Building Solutions business, which when completed will significantly strengthen the Group’s balance sheet.
This could be significant: a look at the accounts shows that Air Handling produced £148m in revenues and £14.2m profit.
A Quick Skim Of SIG Business
One unsatisfactory thing that jumps out straight away is the heavy use of adjustments which give a misleading look to those interested in the top line figures. For instance, the 2018 profit before tax was £75.3m, this drops to a measly £17.9m after tax, as there are adjustments of £46.9m. Some of these costs refer to the exit (and impairment) of businesses, but the main item is a heavy £27.7m of restructuring costs. This item also featured heavily in the year beforehand, and given the large number of moving parts to the business, restructuring may not even be that exceptional. At the very least, this trend will continue.
This effect does not seem to be reported on the broker notes (available on Research Tree), and in my opinion it would be an error to calculate a value for business based off the back of this.
A bit of better news is that the business is heavily cashflow positive, perhaps not a surprise given that they are selling real products for real money. Heavy depreciation charges saw cash flow from operating activities at £95.6m after tax, although there have been plenty of expenses along the way to make this neutral for the cash balance. Dividends are a major expense, totalling £22.2m, as well as finance costs of £14.1m. Going against this are the sale of business units, and the repayment of debt, which has been heavy (over £130m in the past two years).
Capex costs are relatively large and previously ate up almost half of cash flow, although this number has come down sharply in the past two years to around 25%. With something like 265 locations to maintain it may be possible to envisage that even a low maintenance level of capex would be quite significant; capitalising £100,000 of plant and equipment per branch per year already leads to £26.5m. There is also a small pension deficit.
The debt pile could be a worry here. Total borrowings stood at £274.3m, although this figure has come down. Adjusted for ‘real’ profits this could be seen to be quite a high level of debt, but covenants are not mentioned. The sale of the Air Handling segment could make quite a large inroad into this pile depending on the price. The current pile of cash is large and there should not be immediate worries.
Is It Good Value?
Sentiment could not be worse currently across the wider construction sector. There are plenty of warnings out there from companies such as Kier, Brady, Keller to name a few. Although in different sectors the commentary is quite similar: an unmentioned Brexit being responsible for macro conditions being poor, and many customers holding off on spending for a while until clarity resumes.
Whether it is good value depends on your view on what these numbers will be, as no forecasts are available apart from the significantly under expectations comment. The sale of business divisions should bring the balance sheet back to a healthy position, but there is no real guarantee on how long this might take, or what the proceeds of these sales are. What we do know is that there are plenty of adjustments to be made to profits. There are many moving parts to the business and continued restructuring seems inevitable at a time when many of the rules change.
A further black mark is that as recently as 2018, the company had an accounting scandal which resulted in employees leaving after profits were over-stated. This may be historical but enough to give this a swerve from now on. Should there be signs of their divisions being sold at a good price and an end to restructuring there could be a good recovery, but it seems that at present, things will get worse before getting any better. 3/5.