Seven Group Holdings on the way to $10

Chief Investment Officer and founder of Aitken Investment Management
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Seven Group Holdings (SVW) remains the only stock with any form of mining services exposure I recommend.

However, while Seven Group Holdings does generate a large percentage of earnings from the WA, NSW and ACT Caterpillar (WesTrac) franchises, that earnings weighting is falling, and unlike all other mining services related companies, comes into the downturn with the strongest balance sheet and highest liquidity ratios in its listed history.

Invest in the family

I see Seven Group Holdings more like a listed Family Office vehicle. With Australian Capital Equity (the Kerry Stokes Family) controlling 67% of the register, you are basically co-investing in a vehicle that replicates the sector and asset allocation, plus gearing levels, they are satisfied with. This is a good thing. The company structure is below.

The company describes one of its objectives as “ensure an efficient capital structure and maintain prudent levels of gearing”.

“Retain sufficient balance sheet flexibility to fund the working capital needs of operating businesses through the cycle and to pursue growth and investment opportunities”.

It would be fair to say the first half FY14 result confirms that objective has been met.

Gearing is not a problem

In recommending Seven Group Holdings over the years, the common pushback from potential investors has been “it’s too highly geared”. Fast forward to today and that is an inaccurate statement. In fact, I would argue that Seven Group Holdings is under-geared.

As at December 30, net debt to debt plus equity (gearing) was down to 15.6%, from 19.7% at June 30. Net debt fell from $764 million to $615 million. Cash and cash equivalents rose from $431 million to $524 million.

If you assume the $857 million listed equity portfolio is liquid, which I am assured it is, then adding that to cash and undrawn facilities of $1.078 billion, means Seven Group Holdings has $2.46 billion of available liquidity at its disposal. That is quite a war chest for acquisition or further diversification.

What I do like, is the first move the Seven Group Holdings board has made with that large war chest is to announce an 11.9 million ($100 million) on market share buyback. That tells me that the Seven Group Holdings Board feels that SVW shares are undervalued (we agree). While some might say 11.9 million ($100 million) is not a huge buyback, when you take into account that it is extremely unlikely (see also zero chance) that the Stokes Family (ACE) will sell any shares into the buyback, the buyback is actually 11.7% of the remaining free float of the company. That is a VERY significant buyback.

Increase in dividend

The other shareholder friendly move from the SVW Board is the lifting of the dividend payout ratio. The 1H FY14 payout ratio was lifted to 53%, which puts Seven Group Holdings on a 5.00% fully-franked annual yield, or 7.2% grossed up. Seven Group Holdings is underpinned by its attractive yield (“the board aims to maintain and grow the dividend over time”) and, from March, an active on market buyback program.

What is also important for Seven Group Holdings sentiment is that there are signs that capital sales trends in Australia’s for Caterpillar equipment have bottomed and product support revenue growth (maintenance & parts) is returning. Combined with a 25% reduction in headcount, suggests FY14 will be the earnings trough for WesTrac.

It’s worth remembering that Caterpillar equipment is absolutely essential in the bulk minerals production process. For every one million tonnes of annual bulk commodity production, a given mine needs one CAT 250t dump truck. Produce 50mtpa and you need 50 of them, working 24/7.

CAT is a production growth and efficiency play. It is quite different to other mining services companies. They are helping the big miners in their productivity drive.

Driverless caterpillars

I caught up with Seven Group Holdings Don Voelte (CEO), Richard Richards (CFO) and Ryan Stokes (COO) last week and the most interesting aspect of the meeting was a discussion on autonomous trucks (driverless trucks). Yes, it sounds like a science fiction movie, but hear me out…

An autonomous 250t CAT truck saves a mining company $1 million per year in driver costs (5 drivers, full-time rotation). You also get greater truck productivity and less wear and tear. Safety is also better with automation.

BUT the big saving for the miners is all the fly-in-fly-out costs (FIFO) and ancillary services that mine workers expect (accommodation, food, pay TV, etc.).

Seven Group Holdings reckons the bigger savings for the miners are in these areas and that is why there is such a push to autonomous trucks and shovels.

The productivity gains autonomous gear brings to their customers (+ maintenance/parts) is not widely understood, nor is the just-in-time parts deliver service WesTrac has commissioned from a new state of the art warehouse in Perth.

The other point is the big miners can’t put equipment maintenance off forever. You are starting to see the maintenance cycle pick up again and Seven Group Holdings make good margins in this area.

I am bullish on the WesTrac business, particularly now that I understand the broader mining customer benefits Caterpillar equipment automation brings.

Other exposure

In the other Seven Group Holdings businesses, I am looking for an East Coast pick up in the 45% owned Coates Hire investment. Residential construction and infrastructure upgrades should drive demand for Coates equipment and I suspect you have also seen the EBITDA bottom in the Coates JV.

Seven West Media (SWM), 35% owned by Seven Group Holdings, has also bottomed and is entering an earnings upgrade cycle. I think Seven West Media looks extremely cheap (10.1x, 7.7% grossed up yield) and I wouldn’t be against Seven Group Holdings creeping in on another 3% of SWM. In fact, there would be worse things that Seven Group Holdings could do with its war chest than buying out the minorities in Seven West Media.

The 100% owned investment portfolio, run by Ryan Stokes, has done very well, beating all relevant benchmarks and adding value to the group. While the investment portfolio could be liquidated to fund a bigger acquisition, the point is, as a stand alone earnings and asset price stream, it is more than carrying its cost of capital.

Basically, I have come to the conclusion that FY14 is the trough EPS year for Seven Group Holdings and FY15 and beyond will see EPS growth, both organic and potentially acquired. Our estimates below show you are being paid 5.00% fully-franked at the bottom of the EPS cycle.

The people in charge

My final, but not least important attraction, to Seven Group Holdings is the board and management. The CEO used to run Woodside Petroleum, while the board includes individuals who have run Coca Cola Amatil, JB Hi-Fi, Nine Network, Seven Network and UBS Investment Bank. It’s a strong and diverse board.

I continue to recommend buying SVW, collecting the 20-cent fully-franked interim dividend and being on the register before the significant on-market buyback commences.

My 12-month price target on Seven Group Holdings is $10.00 and the stock remains a high conviction buy. I note Seven Group Holdings has recently underperformed Caterpillar (CAT.NYS). I expect this gap to now close in favour of Seven Group Holdings.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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