SKE - Skilled Group

Having spent the last 3 months drifting downwards to about $1.20, Skilled has risen strongly for the last 2 weeks, closing at $1.61 today.

I hold SKE and have been offered additional shares under their "non-renounceable entitlement offer".
This happens to be a stock where I am presently in profit. The current SP is $1.95 and the offer, closing 18 March, is at $1.68.
I'm tempted but the present volatility is an issue of course.
Any general thoughts on this?
Regards
Rick

Up 83% since the last post so I hope you did take up that entitlement, Rick.

With all the doom & gloom about the impending reversal in mining services stocks and half of SKE's business being in the mining and oil & gas sectors, SKE is concentrating on growing the non-mining part of the business and management is confident of further growth.

The price seems to be travelling well with maybe an impending breakout in the offering by the looks of the charts. However, I noticed that after the reasonable rise during the day, the market sentiment seems to have dissipated, so we can only wait to see whether it improves again tomorrow.

Cheers
Country Lad

Could be right. But it looks a little messy for mine.

SKE, its been a pleasure doing business over the last four months but today you left me no choice, we may meet again though

A follow up to my post above and an example of why I use stops, especially when a stock starts to hesitate.

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I wonder if the heavy volume is just CBA selling... I admit I was semi-interested in this the last time it was in the $2.30s. I missed a spectacular run, and an even more spectacular fall by the looks of it.

Perhaps the market is considering that SKE also supplies heavily to car manufacturing as well as to mining, I think.

It seems to me to be a well-run company but a point of buying in contractors, from the pov of the purchasing company, is easy divestment so I see SKE as basically a playground for traders rather than somewhere I would go.

SKC or someone else... did you notice any announcements in this sector that would explain the heavy volume and price decline in SKE over the past few days? It is starting to look pretty attractive now. Fantastic cashflow generation, low capex and volume based (meaning asset utilisation is not as big a deal, and also provides some insulation against commodities prices) and very high ROIC. Also it does not rely on high margins for profitability, like a lot of companies in related sectors have over the boom part of the cycle. The balance sheet is pretty clean too.

There is either an announcement or a speeding ticket coming... or someone wants out really badly. Fairly certain there has been no earnings downgrades from SKE management to date.

Job numbers today showed a drop in participation rate, drop in full time jobs (over compensated for part time jobs - hence the increase)...
This is the only news I've heard that is relevant to the company...

Ves said:

SKC or someone else... did you notice any announcements in this sector that would explain the heavy volume and price decline in SKE over the past few days? It is starting to look pretty attractive now. Fantastic cashflow generation, low capex and volume based (meaning asset utilisation is not as big a deal, and also provides some insulation against commodities prices) and very high ROIC. Also it does not rely on high margins for profitability, like a lot of companies in related sectors have over the boom part of the cycle. The balance sheet is pretty clean too.

There is either an announcement or a speeding ticket coming... or someone wants out really badly. Fairly certain there has been no earnings downgrades from SKE management to date.

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I don't know this stock well, but if I was to guess, then either they were trading at PE that's too high (like recent weakness in SEK, CRZ, MTU, TPM etc), earning growth assumptions being too generous, or that placement in the engineering / resource sector is a meaningful part of their business. Or some combination of all three...

I will let you find out the real answer and share with us here.

skc said:

I don't know this stock well, but if I was to guess, then either they were trading at PE that's too high (like recent weakness in SEK, CRZ, MTU, TPM etc), earning growth assumptions being too generous, or that placement in the engineering / resource sector is a meaningful part of their business. Or some combination of all three...

I will let you find out the real answer and share with us here.

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Trailing P/E is about 9.5 after today. Before the drop it was between 10-11. Forward P/E, which is based on analysts estimates, and should be taken with a grain of salt is for 25c EPS in 2013, 27.7c EPS in 2014. That would put it on a P/E of 8.5 for 2013 and 7.5 for 2014. Again to be taken with a grain of salt.

I don't think it was the jobs data (although that no doubt wouldn't have helped with sentiment with these kinds of stocks). It was already about 7% down before that was released and has been consistently down most of the last week (and indeed it was $3.75 at some point this year before all of the engineering / mining services companies got slammed).

I think this company's earnings has held up pretty well over the last few years. Indeed, I believe their model has more resilience than the firms that have all the big cranes and equipment pieces on their balance sheets. There are more variable costs to cut, if need be. It's a pretty flexible business model, as seen by the steady margins over the last 10 years; they can adapt pretty quickly if the **** hits the fan. They made some acquisitions before and during the GFC and messed their balance sheet a bit, had to raise some capital... and have since paid the rest off whilst raising the dividend back to it's previous level. That cash is still coming in - and the payout ratio expressed in cash earnings is much lower than the dividends / NPAT, so it looks fairly maintainable.

EBIT in 2012 was about $84 million. Say they lost 30% of that to the reversing cycle. That's about $60 million EBIT. Which coincidently is close to the five year average. I haven't gone back much further yet... but I will have that data when I have finished plugging it into my financial model. Dividend still looks maintainable at those levels after maintenance capex IMO. EV at close today is $490 Equity + $70 debt = $560 million. That is an EBIT multiple of 9.33 times. Not exactly a massive stretch, especially for a company that can earn rates of return in excess of 50% on capital employed.

I'm hopeless at predicting price action over the short-term, and there is no doubt going to be lots of sellers lining up assuming that earnings will be downgraded as we approach 30 June 2013, but this is starting to look attractively priced at these levels.

Ves said:

I don't think it was the jobs data (although that no doubt wouldn't have helped with sentiment with these kinds of stocks). It was already about 7% down before that was released and has been consistently down most of the last week (and indeed it was $3.75 at some point this year before all of the engineering / mining services companies got slammed).

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Actually Credit Swiss downgraded them today so that would explain some of the fall. At $3.75 and EPS of 25c, forward PE of 15... so of course they should be smashed down from there given the market and the industry outlook.

Ves said:

I think this company's earnings has held up pretty well over the last few years. Indeed, I believe their model has more resilience than the firms that have all the big cranes and equipment pieces on their balance sheets. There are more variable costs to cut, if need be. It's a pretty flexible business model, as seen by the steady margins over the last 10 years; they can adapt pretty quickly if the **** hits the fan.

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Is it truely a flexible business model? How does the business work? Do they have heaps of labour on their books? How long and how much does it take to fire them if there's no work for them?

We had a boom in the last few years - so of course earnings held up well. But things have changed completely.
The mantra to every resource companies these days is "Cost out". Contract miners are sent home so the company can do it in-house. Expensive contractors are no longer required when the work dies down. Ugly tin-clad houses in resource towns are up for sale with no inspections for 3 months (AFR article today).

Everything about SKE spells cyclical. I think it is risky to think a cyclical business is resilient in the face of overwhelming industy trends.

Ves said:

EBIT in 2012 was about $84 million. Say they lost 30% of that to the reversing cycle. That's about $60 million EBIT. Which coincidently is close to the five year average. I haven't gone back much further yet... but I will have that data when I have finished plugging it into my financial model. Dividend still looks maintainable at those levels after maintenance capex IMO. EV at close today is $490 Equity + $70 debt = $560 million. That is an EBIT multiple of 9.33 times. Not exactly a massive stretch, especially for a company that can earn rates of return in excess of 50% on capital employed.

I'm hopeless at predicting price action over the short-term, and there is no doubt going to be lots of sellers lining up assuming that earnings will be downgraded as we approach 30 June 2013, but this is starting to look attractively priced at these levels.

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I think you should look harder about valuation rather than worrying about the price action. Taking 30% off EBIT may sound like a lot, but I think you need to work on the actual top and bottom line. As I said, I don't know how quickly they can cut costs (e.g. do they fire their own staff and cop one-off redundancies?) in the face of falling revenue. May be the EBIT will evaporate faster than you anticipate? I don't have the answer, but I'd assess the downside scenario a bit more. And after you work out a lower EBIT, don't forget a multiple contraction as well. NWH is trading at 3-4 times NPAT so 9x EBIT with falling E is probably a bit rich for the market.

Don't mean to sound all negative.... just being a devil's advocate. It may be a bargain for all I know.

skc said:

Don't mean to sound all negative.... just being a devil's advocate. It may be a bargain for all I know.

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That's all good. I'm still digging into it and once I have mapped out the financials for the whole cycle I can start answering some of your questions in more detail. You've provided a sound reasoning for your doubts, and I agree you would have to be comfortable that the company can handle the worst case scenarios before you can start valuing it in more detail. Thank you again for taking the time to reply.

Ves said:

That's all good. I'm still digging into it and once I have mapped out the financials for the whole cycle I can start answering some of your questions in more detail. You've provided a sound reasoning for your doubts, and I agree you would have to be comfortable that the company can handle the worst case scenarios before you can start valuing it in more detail. Thank you again for taking the time to reply.

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Actually bought some SKE on the open today. A we know nothing speeding ticket combined with a strong overnight lead and an upgrade by Wilsons... enough ingredients for a quick long trade.

skc said:

Actually bought some SKE on the open today. A we know nothing speeding ticket combined with a strong overnight lead and an upgrade by Wilsons... enough ingredients for a quick long trade.

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Bought some too by the way - but not at open as my order did not get filled (which reminds me I'm a long-term investor, and a small fish, and should buy at market - it usually costs me few extra cents per share when I start counting the pennies I may save...). A minor position (which I often do for good prospects) whilst I finish the research. I don't think my conclusions will change. Reading back this morning I tried to answer some of your questions in my first two posts, however, probably did not communicate them very clearly. Might add some extra answers to your posts over the weekend.

skc said:

Is it truely a flexible business model? How does the business work? Do they have heaps of labour on their books? How long and how much does it take to fire them if there's no work for them?

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I thought these guys were just a labour hire outfit? Sort of like a temp agency, you only go on their books once they contract you. They are pretty exposed to mining and oil and gas. Of there three divisions (they sold their call centre division) the least resource exposed has been flat/down over the last few years while the Engineering and Technical services segments have put in solid growth.

Maybe Ves has some insight into that breakdown?

Ves said:

Bought some too by the way - but not at open as my order did not get filled (which reminds me I'm a long-term investor, and a small fish, and should buy at market - it usually costs me few extra cents per share when I start counting the pennies I may save...). A minor position (which I often do for good prospects) whilst I finish the research. I don't think my conclusions will change. Reading back this morning I tried to answer some of your questions in my first two posts, however, probably did not communicate them very clearly. Might add some extra answers to your posts over the weekend.

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You do what you need to do to satisfy yourself... happy either way if you wish to share your finding or keep it to yourself. Although I always find that articulating the answer in writing helps you structure your thinking and potentially reach a more logical conslusion.

McLovin said:

I thought these guys were just a labour hire outfit? Sort of like a temp agency, you only go on their books once they contract you. They are pretty exposed to mining and oil and gas. Of there three divisions (they sold their call centre division) the least resource exposed has been flat/down over the last few years while the Engineering and Technical services segments have put in solid growth.

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You are probably right. I'd imagine they would have some fraction of core staff on the books. Mining labour was so tight that calling around last minute might not get them the right staff on short notice.

Just some more thoughts about earnings resilience in a down-turn.

As McLovin said SKE is generally thought of as a labour hire outfit providing labour solutions to a wide range of industries. They are the market leader in the segment with our 11% market share. Their brand-name comes with a good reputation for safety and flexible solutions. PRG is also in a similar space if you know them.

From the 2013 half-year presentation revenue is split as follows:

Mining 28%
Oil & Gas 26%

The rest is spread across infrastructure, telecommunicaitons, government, auto & defence, transport, health and a few other industries.

Skilled Group generally focusses on longer-term infrastructure contracts (with allows it to maintain relationships with both its workforce and its clients). In the mining sector they generally focus on operational contracts (ie. the main driver of their business is commodity volume which is still ramping up in Australia), as long as the mines are still digging up materials then they need to run. 50% of clients have 2-5 year contracts, 18% have 5+ years.

This is a low margin business which relies on volume of employees rather than premium pricing. As I remarked previously this is a low-fixed cost business with high operational leverage (asset turnover is consistently over 5 times) and very low capital intensity (ROIC averaging 50%+). It's very scalable and can be tuned to the economic conditions fairly quickly. Their biggest expense is employee / labour costs. These generally come in very close to 87% and have gone no higher than 88.5% over the last few years. As this company has had a capital structure transformation over the past few years it is best to look at its operating margins rather than its EBIT margins (interest expenses and indeed tax rate has fluctuated wildly and distorts the picture). SKE's operating margin 5% over the past 10 years (give or take a few fractions of a percentage point). This mirrors from what we should expect from a business with high variable cost control.

They have been in the midst of a capital and cost base structure transformation since the strategy reviews of 2010. They're trimming the fat after years of acquisition binges by the previous management. Debt has reduced significantly and internal costings have decreased and still are. Without any top-line growth since 2008 the bottom line growth has increased significantly. The company has and continues to control most of their profitability growth through astute cost management and debt reduction despite the prevailing softness in the labour markets to which they are exposed.

If I am correct about SKE's competitive position and their cost controls I would forsee that in a major downturn some of their lessor competitors may find the going tough and there will be a large potential for the bigger fish like SKE (who have strong balance sheets to weather the downturn) to grow organically by gaining market share. There is nothing stronger than a competitive advantage in weak market conditions.

skc said:

You do what you need to do to satisfy yourself... happy either way if you wish to share your finding or keep it to yourself. Although I always find that articulating the answer in writing helps you structure your thinking and potentially reach a more logical conslusion.

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Yep, completely agree with the benefits of articulating your thoughts in writing - especially to others.

Great post

Will be doing some research for myself after having read this.

Interesting Fact: Skilled sponsors "Skilled Stadium" home of the Gold Coast Titans