OHLA - Building the new order
All,
Please find our unchanged analysis here.
OHLA is once again on the naughty step with the Spanish competition authority (CNMC), albeit in the company of its domestic competitors. Whilst a fine is never pleasant, the health of the domestic and foreign construction market is more important for OHLA's wellbeing. Inflation and raw material availability continue to hurt construction activity, but that needs to be viewed alongside raised government spending plans and emerging political will to assist the industry in addressing costs. Whilst waiting for both shoes to drop, the challenge for management is defending cash and building up the order book.
Infrastructure investment delayed in the inflationary environment:
- With >€500m of liquidity OHLA can afford a couple of quarters' delay in contracts awarded by the government. As the order book fills, the equity market will become more enthusiastic. Data from the EU/US shows sequentially there is a slowing in orders but that year on year there is still an improvement.
- Central government funds are mainly time-limited. The expenditure is still coming but a little slower than we hoped and there is an incentive for politicians to spend the available cash before it is gone.
- The ECB and NY Feb are both forecasting inflation peaking in H122. The ECB expects inflation in mid-4 % by H223.
OHLA order book value is being heavily discounted:
- There will be two key value drivers for OHLA 1) Order book growth: There needs to be continued evidence that growth in the construction business is materialising In Q1 OHLA’s order book was just under €6bn, which was ahead of our expectations. The next two quarters are unlikely to see significant acceleration given procurement timetables.
2) Cost pass-throughs. Raw material prices and labour costs are continuing to rise. Lower margins in civil engineering mean these costs cannot simply be absorbed. In response, US states are enacting legislation to protect civil projects. Spain has also enacted inflation recovery legislation for government contracts signed pre-2021.
- The explosion in equity risk premia and the risk-free rate since February have hurt our investment thesis. Our current valuation on the equity is €0.78 per share vs €1.26 back in February.
- We will update our DCF model after the half-year stage.
Legacy costs timing, not inflation are the key:
Our analysis has legacy costs as being broadly in balance, however, timing on settlements could provide a temporary headwind for liquidity. As an example, the largest piece of litigation is the Sidra project which represents a potential €111m liability (€200m if Orascom avoids its guarantee). This would challenge OHLA’s liquidity albeit not fatally. The inflationary environment will have only a marginal impact on costs, interest is contractually fixed in an arbitration case.
OHLA's Spanish business is not disrupted by the fine:
- The presence of all the key market competitors in the dock, means that there is no real threat that OHLA or the other sanctioned companies will be excluded in future contract bids.
- A €21.5m fine for OHLA is not excessively painful in the context of available liquidity.
Positioning:
- We have a long position of 4.3% NAV in the bonds and 3.5% in the equity, our entry to this trade was mistimed. From today we would expect a return of 10% from the bond portion and 30% from the equity leg (Current price €0.58 – model value €0.78) in the next 12 months.
- The current market environment in civil construction has deteriorated, but the contracts are in abeyance rather than cancelled. Once materials availability has improved and inflation has reduced these contracts will materialise. OHLA has sufficient liquidity to manage these challenges.
I look forward to discussing this with you all.
Aengus
Inflation expectation Source: ECB