Thursday, November 1st, 2018
Global market turbulence this month is a timely reminder of the importance of capital positioning to risk management for investors and companies alike. Excess capital in the hands of a skilful allocator isn’t a waste of capability, rather it enables them to exploit volatility.
For this reason, our research focus list tends to be not only leaders within a specific niche, but also amply resourced companies with strong net cash balance sheets.
One such portfolio holding we were watching with interest during the sell-off was engineering group Lycopodium (ASX:LYL). Recent weakness saw LYL falling close just off 52-week lows at $4.28 per share. Based on our estimates, at these levels LYL trades at a forward yield of nearly 8 per cent, fully franked.
This is particularly interesting to the income-oriented investor because dividends are well-supported by net cash of $73m, representing 43 per cent of LYL’s $170m market capitalisation.
LYL’s origins go back to 1992 when it initially focused on junior miners for engineering, procurement and construction management work. Over time LYL built a reputation for innovation, efficiency and quality in delivering projects on time and on budget, enabling the business to reinvest to expand its service offering and geographic reach, which now spans Australia, Asia, Africa and North America. It also attracted larger clients such as Rio Tinto and all levels of Government.
The company’s strengthening presence has seen revenues increase three-fold since its listing in 2004. During this time LYL experienced both sides of the mining boom, however, with revenues following wide swings in demand. Nevertheless, LYL stayed cash-flow positive throughout, owing to a relatively flexible and capital-light business model as a services provider.
LYL is emerging from a lean 5-year period in a much stronger position and is well -placed as a best of breed operator to benefit from a strengthening outlook for commodities and a substantial domestic infrastructure pipeline.
Fiscal year 2018 earnings came in at $18.2 million, well ahead management’s typically conservative guidance of $16.5 million. The outlook was moderately upbeat, with management guiding to a steady first half fiscal 2019, with an increase in activity over the second half based on the forecast pipeline of study and project work.
Net of cash, the enterprise trades at a touch over 5 times trailing earnings, which we think is undemanding for a high quality, albeit cyclical, business with an improving demand outlook.