Global Construction Services Limited (ASX:GCS) was listed on the 14th August 2007 at $1 and offers a range of products and services to the commercial, residential, resource and industrial sectors of the WA economy.

GCS was established in July 2003 following the acquisition of Security Scaffolding, the operators of which had been servicing the WA market for 25 years. Since establishment, GCS has undertaken a growth strategy aimed at diversifying the group’s geographic exposure, product and service offering via a combination of acquisition and organic growth.

Of interest to investors is that a number of GCS staff (including the MD) were involved in the establishment and development of Perth Construction Hire Group (PCH), a company which has grown from a WA based construction business (similar to GCS) to a provider of scaffolding and other construction equipment and services internationally. Thus, some of the current management team have a history of success in another listed company.

Figure 1.Organisational Structure
Source: Global Construction Services Limited

The groups stated objectives is to “further establish its position in the Western Australian market and develop a presence in new sectors through a mix of organic and acquisitive growth”. It is rapidly pursuing this objective, having acquired a range of businesses and established a presence in a number of new areas since listing.

Figure 2: Products, Services & Sectors
Source: Source: GCS Investor Presentation, Preliminary FY10 Financial Results

Divisions

The company has three distinct operations or divisions.

Commercial

The commercial construction sector includes office, retail high rise, residential, hotel, factory, health, entertainment and recreation projects. Revenue in the original (GSC) commercial sector business is typically earned from medium (6-12 month) contracts which generally involve erection and dismantling services and engineering & design services. The acquired CASC Constructions operations provides formwork, related labour services, engineering & design services and the supply and laying of concrete. It tends to have long term fixed price contracts and therefore this business has the risk of cost overruns.

Figure 3: Non Residential Building Work Done – Western Australia
Source: Australian Bureau of Statistics

In 2010, 75% of group revenue was generated from commercial operations (Figure 5). The value of non-residential building work has continued to grow in recent years albeit at a slowing pace.

The group noted in its FY10 results that it had over $90M of committed contract work in hand. $79M relates to the provision of formwork for the Fiona Stanley Hospital Project in Perth to be completed over the next 20 months (as at 30 June 2010). $24M relates to the Bookfield Multiplex City Square project in the Perth CBD which had 12 months to run (as at 30 June 2010).

With no further updates since the full year results regarding contract wins, it will be interesting to see what is announced at half year.

Residential

The residential construction sector consists of construction sites for two to three storey developments by residential builders.

Figure 4: Residential Building Work Done – Western Australia
Source: Australian Bureau of Statistics

Although the dollar value of residential building work in WA continues to grow, the rate of growth is slowing. Revenue in the residential sector is typically generated on a short – medium term contractual basis.

Resource & Industrial

The resource and industrials sector includes customers from mining sectors and processing plants. Although this division contributes the least to group revenue, given the large amount of oil and mining projects in the region, it represents a possible growth area.

Figure 5: Segment revenue as % of total, 2010 FY
Source: GCS Financials

Growth Plans

The group has a clearly stated growth strategy comprised of both acquisitive and organic growth. It aims to grow via expanding its products and service range to create an enhanced offering to its customer base and allow for cross selling of new and existing products and services. The group also aims to broaden is customer base in both new sectors and geographically. They have done this since establishment by branching into the commercial and industrials sectors, also establishing facilities in areas to the North and South West of the Perth CBD.

Other possible growth areas include the provision of equipment for maintenance services and the provision of temporary seating that can be used for public events. Both of these represent small divisions of the current group.

Valuation

Figure 6. MyClime Valuation: Global Construction Services Limited (ASX:GCS)
Source: www.myclime.com.au

As outlined earlier, GCS has made a number of acquisitions since listing as part of its growth strategy. These purchases have been made primarily via existing cash and debt facilities. A small $500K equity raising was utilised in the purchase of the concreting businesses (Newave and Blueline). An equity raising in FY09 however was made in order to increase working capital and strengthen the balance sheet.

Net Debt to equity is towards the upper end of our desired level, reaching a high at 65.4% in FY09. At the end of FY10, net debt to equity was 44.9%.

Despite the number of acquisitions made since listing, intangibles as a % of equity has fallen steadily. Goodwill represents 100% of intangibles ($16.29M Commercial, $7.81M Residential – FY10).

	2007	2008	2009	2010
Intangibles as % of equity	54.1%	42.0%	36.9%	31.3%

Figure 8. Intangibles as a % of equity
Source: GCS Financials

A quick glance at the balance sheet does reveal a strong cash position at $11.63M or 15% of equity (30 June 2010). We suspect a portion of this is to support performance guarantees for contracted work. The group has the capacity to acquire more businesses and to utilise some of this cash and debt facilities as opposed to raising equity. We await the 1H11 results to re-analyse this cash position.

Net operating cash flow has outpaced NPAT in all years since listing except for 2008 which is positive. It is desirable to see such figures and it provides confidence that the business is running well. It should always be remembered that in companies financial statements, NPAT figures can easily be manipulated and particularly so by contracting companies through recognition of income.

The declining NROE is noted and needs reviewing. Annual growth in both revenue and NPAT since listing has been at a declining rate. As the group retains equity, the slowing growth has affected profitability.

	2008	2009	2010
Revenue	104.1%	23.0%	7.2%
NPAT	98.9%	10.6%	5.4%

Figure 9. % Change on previous year
Source: GCS Financials

 

Concurrently, the businesses cost of good sold (COGS) figure has risen consistently as a % of sales revenue and this factor also is affecting profitability. Higher capital employed, as a company grows and which generate lower margins is indicative of diseconomies of scale. These exist in most small companies.

Figure 5. COGS as a % of sales revenue
Source: GCS Financials

Further, when we consider the number of acquisitions made over the past few years we can begin to develop an understanding as to the context of the declining NROE. By acquiring these businesses, the consolidated GCS entity has increased its equity base by taking on goodwill and large amounts of new plant and equipment to its balance sheet.

Whilst EBIT margins are quite high at 18.8% of revenue, these have declined as the company has grown and acquired businesses.

The falling NROE highlights the fact that these additional businesses have not as yet enhanced the value of the group. Earnings have risen but not profitability. Rising year on year revenues and NPAT are excellent selling points for management, but these should not necessarily impress a value based investor. Thus, whilst GCS has managed to consistently increase profits, profitability is declining.

Figure 10. Earnings & Dividends Per Share

The payout ratio is forecast to be 50% over the next two years and both EPS and DPS, (based on company guidance) are forecast to rise.

We have selected 25% as our Normalised Return on Equity (NROE). We have derived a Required Return (RR) of 15.8% which takes into consideration the risks of investing in this business.

RR	15.8%
NROE	25.0%

Using the above inputs and the equity per share, MyClime produces the following values:

	2009	2010	2011E	2012E
Value	$1.60	$1.77	$1.95	$2.14
Value Change (%)		10.6%	10.1%	9.7%

The following valuations are based on analysts’ forecasts and are subject to change.

 

Figure 10. GCS: Value & Price

Global Construction Services appears attractive as its price is well below our MyClime valuation. It is pursuing growth with board members who have successfully grown a similar business internationally. The business has focused its operations within the growing West Australian economy. With exposure to the states buoyant mining industry being only a small percentage of the groups’ revenue, there is the possibility for growth in the area.

However, of concern is the declining NROE which is a result of its growth strategies. The increased levels of plant and equipment which the company has acquired has boosted equity but has not resulted in a proportionate growth in profitability. However, these acquisitions have been made as part of a strategy to increase the groups geographical exposure and product range in order to better service its clients. One would hope that eventually some synergies flow through and lead to an improving NROE.

It will thus be critical for us to monitor this businesses performance in the next few reporting seasons to ascertain as to whether NROE stabilises and develops a base at the current levels (a good value opportunity) or continues to fall and therefore seek opportunities elsewhere.