UGL - UGL Limited

[Klogg]

@So_Cynical - Appreciate the feedback, but I'm only really interested in valuation techniques and how this fits in. I'm no good at picking the bottom and will leave that to those who are.

Klogg, FWIW, I don't really value this using "Relative multiples" (Ie. EV/EBIT, P/E) but mainly on my own assumptions as to the future economics of the business wrapped into a DCF valuation.

And really, this is only long term thinking, and you can think of it what you will.... that group EBIT will roughly double over the period to 2025. I'm valuing the engineering business and the property services businesses separately and then subtracting corporate corporate level costs. Probably need to do that to be ball park.

This is the way I normally work. I usually look at a form of peer analysis, but not to get a relative valuation. Rather, this feeds me some info at a macro level and what the competitive landscape is for the company.

I guess this really answers my question though. The relative valuation alone seems to be a fairly weak bit of information, but I should be using it to backup any absolute valuation.

When I did my DCF calcs, I did use a similar technique to the one you mentioned. I don't have the figures next to me, so I don't know if my calculations were near yours, but the business definitely fell into the value bucket.

Thanks again Ves and skc. You guys have answered my last few questions.
Appreciate it.


Edit: Ves - in your calculations, did you make any assumptions about the immediate (1-2year) future of the engineering business, especially around the cyclical nature of mining services?

 

[Klogg]

Edit: Ves - in your calculations, did you make any assumptions about the immediate (1-2year) future of the engineering business, especially around the cyclical nature of mining services?

To be more specific, did you assume a worst case scenario involving any further revenue loss in this area? I'm at a loss on how to actually model this... (although after a certain point in the valuation, it becomes somewhat negligible from what I'm seeing)

Apologies for the poor wording - just woke up! (and with a nasty hangover)

 

[craft]

However, the question I can't seem to answer is, how much comfort does a relative valuation really give?

Hi Klogg

For me the valuation that gives the most comfort is expected cash flows from the business - obviously to make that calculation I have to make assumptions. For anything to be a buy it has to pass that valuation test. If it does I will look at relative valuations to fill in a bit more of the picture and get a wider industry perspective, and hopefully assist in entry decisions, which in this case has not been the greatest and I’m currently underwater. I'm inclined to be a bit early on entries but the luxury of averaging in often helps. Way back in the NVT thread somewhere I posted something more extensive about how I see the risks of entry and basically I'm happier to be too early than miss getting set as long as my absolute calculation indicates I will make my desired return long term.

In reviewing things the property valuation multiples seem pretty stable - the engineering service multiples are still getting squeezed and UGL has had contract blowout issues of their own so they certainly won’t be immune to that. Nervous about more possible hand grenades on the engineering side but still like the property – separation time line looks like its pushing out though.

 

[Klogg]

In reviewing things the property valuation multiples seem pretty stable - the engineering service multiples are still getting squeezed and UGL has had contract blowout issues of their own so they certainly won’t be immune to that. Nervous about more possible hand grenades on the engineering side but still like the property – separation time line looks like its pushing out though.

It is the short-term engineering issues that I don't know how to accommodate (how much room for error do I allow). However, should there be no major cost blowouts, then there's very little uncertainty for me.

That does answer my questions though, and also tells me that I should consider historical valuation multiples of more than a few years...

Thanks again for the help - especially since you don't actually get anything from it.


And for those that are interested, here is the section on entry points posted by Craft within the NVT thread:

Once an opportunity is identified, there are two risks in relation to timing, one is buying too early, the other is missing out on the price that gives rise to the opportunity.

Buying too early means I suffer a few % points of opportunity cost over my envisaged time frame but I have at least locked in acceptable actual return. (so long as my assumptions were correct).

The ramifications of ‘could have, would have, should have’ are potentially unlimited opportunity costs and missing the opportunity to lock in an acceptable actual return.

Buying too early is a mistake of commission that sucks. ‘Could have, would have, should have’ is a mistake of omission that whilst probably easier to bear, can ultimately be a lot more detrimental to wealth creation.

Obviously I would like to buy at the absolute low – but I’m not that good, given my fallibility I err on the side of buying too early rather than missing out. But I’m not oblivious to the charts or the short term momentum of the business – they guide how aggressively I accumulate. Specifically I bought NVT this time round because; the market had had a chance to factor in the 2nd half forecast; and from an EW perspective there are some possibilities that a low is in place (I genuinely hope not) – ie a fairly symmetrical ABC correction terminating at the 61.8% Fib. Now I don’t really trust that analysis but it seems as good a reason as any to fire off another shot – and I still have a few more rounds left. I may run out of ammo before the price stops falling and that is a situation that really frustrates me but as I have hopefully explained, ultimately I would rather be a premature accumulator then the guy who sees the possibility but never takes the chance due to performance anxiety.

skc - I was almost tempted to quote your joke as well.


Anyway, time for me do a little more homework.

 

[craft]

It is the short-term engineering issues that I don't know how to accommodate (how much room for error do I allow). However, should there be no major cost blowouts, then there's very little uncertainty for me.

The crux of the matter and what is undoubtedly driving the market at the moment.

When we last heard from UGL, the first two paragraphs were:

The 2013 financial year saw difficult trading conditions adversely impact UGL’s financial performance
following the escalation in the capital investment slowdown across the Australian resources and
infrastructure sectors and a rigorous focus on cost management by the major miners.

UGL’s financial performance in the 2013 financial year was also disappointingly impacted by
underperformance across several power projects.

Since then FGE has gapped to the tune of 90% odd because of Power station contracts which I guess has helped push UGL price to within a whisker of 8+ year lows and posturing for a break of that support – perhaps massively on news.

Currently without a CEO for the engineering division because the last one had to step down due to alleged bribery whilst at Leightons.

The Macro scene is being described as a Mining Investment Cliff.

Soooo Is it time to lean harder against the herd or turn and run with them?

 

[odds-on]

The crux of the matter and what is undoubtedly driving the market at the moment.

When we last heard from UGL, the first two paragraphs were:



Since then FGE has gapped to the tune of 90% odd because of Power station contracts which I guess has helped push UGL price to within a whisker of 8+ year lows and posturing for a break of that support – perhaps massively on news.

Currently without a CEO for the engineering division because the last one had to step down due to alleged bribery whilst at Leightons.

The Macro scene is being described as a Mining Investment Cliff.

Soooo Is it time to lean harder against the herd or turn and run with them?

Hi Craft,

How do you see the demerger working out? It is planned for FY2015 and is subject to approvals (refer recent AGM presentation). I get the impression recent posters are keen to own the DTZ business but not the Engineering business. Surely it is best to wait for the demerger to happen, then purchase DTZ shares (assuming they are trading at an attractive valuation). There must be a risk that the demerger gets delayed, wrong management team gets appointed, corporate cost overruns and so on....

Cheers

 

[Klogg]

The Macro scene is being described as a Mining Investment Cliff.

Soooo Is it time to lean harder against the herd or turn and run with them?

I'd argue it's only partly contrary to the mainstream view... Going by recently reported earnings, if you adjust DTZ earnings for the one-off re-branding (all to DTZ), then you've got a situation where Engineering is a significantly smaller portion of overall earnings.

That being said, there's still the chance of short-term pain from Engineering - but all it has to do is have maintain flat-ish cash flow (through reduced Capex and cost reduction) over the next few years... by then DTZ will be an overwhelming portion of earnings and Engineering will be something on the size - should the macro trend in the property services space continue.

Probably worth mentioning that a reduction in debt and some cost reduction within Engineering is management's focus at the moment, so they're working toward that goal.

Surely it is best to wait for the demerger to happen, then purchase DTZ shares (assuming they are trading at an attractive valuation)

@Oddson - I know you shot this question to Craft, but just to generate some discussion on the matter, here's my view:

If you were to wait for the demerger, by then you'll have two different sets of financials, forecasts, earnings, etc. and more importantly, you won't have a property services company masquerading as a Mining Services company, thus affecting the perception of the market. From what I can tell, the value of DTZ is hidden in the fact that it is attached to, and associated with, a company that has a very poor macro outlook.

And yes, there is a risk that the de-merger is delayed, but how does this change your part ownership in DTZ?

 

[craft]

Hi Craft,

How do you see the demerger working out? It is planned for FY2015 and is subject to approvals (refer recent AGM presentation). I get the impression recent posters are keen to own the DTZ business but not the Engineering business. Surely it is best to wait for the demerger to happen, then purchase DTZ shares (assuming they are trading at an attractive valuation). There must be a risk that the demerger gets delayed, wrong management team gets appointed, corporate cost overruns and so on....

Cheers

Hi Odds - on

As you would know with such a nick, the market is always doing its best to price the odds. If things turn out worse then the market expects then it will obviously be better to wait - If it turns out better then expected then waiting means forgoing the profit.

As investors we get paid for taking the risk that things turn out different to what they are currently priced for. I think UGL with DTZ tucked away inside is a risk priced attractively now. not sure how it will be priced when things become clearer.

The biggest risk to the timetable as I see it at the moment is that the engineering side of the business may need the property business strength and diversification for a bit longer then the timetable indicated.

 

[craft]

I'd argue it's only partly contrary to the mainstream view... Going by recently reported earnings, if you adjust DTZ earnings for the one-off re-branding (all to DTZ), then you've got a situation where Engineering is a significantly smaller portion of overall earnings.

That being said, there's still the chance of short-term pain from Engineering - but all it has to do is have maintain flat-ish cash flow (through reduced Capex and cost reduction) over the next few years... by then DTZ will be an overwhelming portion of earnings and Engineering will be something on the size - should the macro trend in the property services space continue.

Probably worth mentioning that a reduction in debt and some cost reduction within Engineering is management's focus at the moment, so they're working toward that goal.

Hi Klogg

Good to have your thoughts hopefully we will also get some other views.

Soooo Is it time to lean harder against the herd or turn and run with them?

My short answer to the question is that I'm happy to lean against the market at this point. More detailed reasoning later.

 

[skc]

As investors we get paid for taking the risk that things turn out different to what they are currently priced for. I think UGL with DTZ tucked away inside is a risk priced attractively now. not sure how it will be priced when things become clearer.

The biggest risk to the timetable as I see it at the moment is that the engineering side of the business may need the property business strength and diversification for a bit longer then the timetable indicated.

Here's a bunch of broker comments on UGL...

http://www.fnarena.com/dsp_recommendations.cfm?searchsymbol=ugl

I am not suggesting that these guys are correct (they are quite good at groupthink), but I think the probability is that they won't know how to value the property business immediately after the de-merger (or confirmation of such).

I am also not a fan a Trevor Rowe...

http://www.crikey.com.au/2009/08/05/trevor-rowe-meets-his-maker/

Hi Odds - on

I've always read Odd-Son. I am an idiot :bonk:

 

[Klogg]

Can I get anyone's thoughts on why Capex spend was so high last FY?

2013:
Eng + Ops/Maint ~52m
DTZ = ~48.5m

2012:
Eng + Ops/Maint ~45m
DTZ ~ 24m

I can understand the increase within Property Services, but why such a high capex spend within a business that is suffering cost blowouts? Is it due to the style of business they're winning within Engineering?

Unfortunately I can't provide my own opinion on this, but I can't find much within any recent announcements about it. Hoping someone has come across this in some form or another...

 

[Klogg]

Sorry, last line was meant to read:

Unfortunately I can't provide my own opinion on this, because I can't find much within any recent announcements about it. Hoping someone has come across this in some form or another...

 

[Ves]

@So_Cynical - Appreciate the feedback, but I'm only really interested in valuation techniques and how this fits in. I'm no good at picking the bottom and will leave that to those who are.



This is the way I normally work. I usually look at a form of peer analysis, but not to get a relative valuation. Rather, this feeds me some info at a macro level and what the competitive landscape is for the company.

I guess this really answers my question though. The relative valuation alone seems to be a fairly weak bit of information, but I should be using it to backup any absolute valuation.

When I did my DCF calcs, I did use a similar technique to the one you mentioned. I don't have the figures next to me, so I don't know if my calculations were near yours, but the business definitely fell into the value bucket.

Thanks again Ves and skc. You guys have answered my last few questions.
Appreciate it.


Edit: Ves - in your calculations, did you make any assumptions about the immediate (1-2year) future of the engineering business, especially around the cyclical nature of mining services?

Hi Klogg

Sorry to be slow in replying. I’ve been doing a bit of thinking and procrastinating and juggling a few other things on the weekend…. Head hasn’t been completely around investing lately.

If I’ve done my job correctly in a DCF valuation I’ve spent time making plenty of assumptions on the future of the business that are “best guesses” on my perception and analysis of the information currently at hand. I will use low-ball, super conservative figures on some companies as a rough guide. But in companies with a fairly good competitive position it’s pretty much a waste of time because this line of thinking is most likely going to be so divergent from the underlying reality that unless the market is missing something really obvious you will never see a price low enough to match.

Back to UGL - when I say that EBIT could double by 2025 obviously I have no idea how accurate this is, but what I’m really talking about is what I think is the latent earning power hidden within the group using my best whole of cycle assumptions (and most of this obviously resides within the property sector, but engineering is probably closer to the bottom of the cycle than the top in my opinion. I wouldn’t invest if I didn’t think there was much potential for them to employ incremental capital back into the business and increase cash flow over time.

I’ve found that with valuations near term cash flows have a higher impact on the bottom line calculation in companies where you’re not able to forecast out very far and especially when there isn’t much in the way of growth in forecasted cash flow over time. I find you are best when you just make the best assumptions possible (that sounds counter intuitive but if as investor I find that I need to make really conservative or low-ball assumptions about the future, and then I probably don’t have the confidence in the company’s prospects to hold it anyway). If you’re valuing UGL at $2B, and the near term earnings are $200m lower than your forecast then that’s only 10%.

Where I really am probably more conservative is in the very distant future – ie. the terminal value. I generally come up with a perpetuity calculation if there’s enough competitive advantage to warrant it. I never bake in any growth (that’s just a bonus if it happens). I also always find that I will play around the edges with the terminal value by multiplying it by a factor of less than 100% based on my confidence in whether or not they can maintain their competitive position and earnings power. Obviously if you think there’s no competitive advantage at all, then you’re just going to use a best estimate of the replacement cost of assets in the terminal value. How much you go above this really is your feeling on how strong and enduring you think any competitive advantage will be by the time you reach the terminal value period (whether it’s 5-10-20 years into the future).

I also generally ask for around 15%pa before tax return, so the discount rate is fairly high.

Margin of safety obviously comes in there somewhere too…

Whilst future earnings hits to engineering earnings are definitely possible the contracts are pretty well diversified on a sector basis and there is a high amount of recurring revenue. I also think there enough scale that it would take a big hit to a project to do a large amount of damage to earnings (or equity like Forge). There’s enough resilience built in for me to be able to hold my position with confidence through the current market down term and not be worried by the red figures on my screen.

I pretty much agree with you that the short and medium term earnings of engineering will most likely be flat, and that the property business will do most of the heavy lifting.

Re: the demerger, agree that it’s probably better to buy when you see value, than to wait until there is clarity and risk that the value is no longer there.

 

[Klogg]

Ves,
Thanks again for your reply, and please don't apologise. Procrastination is my favourite pass-time


Relating to a few points:

But in companies with a fairly good competitive position it’s pretty much a waste of time because this line of thinking is most likely going to be so divergent from the underlying reality that unless the market is missing something really obvious you will never see a price low enough to match.

And this was my problem when I was initially going through the valuation process with UGL. I was applying the worst case scenario, adding a 10% buffer, then demanding a 30% MOS at the end of it. By the time I was done, you'd have to buy the company at 7-8 * P/E to fit the criteria... Now my job is to ensure I don't over-do it the other way. Although I'm quite certain I haven't.

I pretty much agree with you that the short and medium term earnings of engineering will most likely be flat

In my calcs, I allowed for a decline in EBIT by 10% YoY for the next 3 years. Looking back, this doesn't really reflect reality, as there will either be a major blowout/contract loss, or nothing at all. Slowly losing business seems to me like it's the least likely scenario.
I'm thinking of factoring in a major cost blowout and seeing how it effects my valuation - Just a question of what is realistic...

Finally, one last question. What's your reasoning behind not factoring in any growth? I do this in most cases, but given the nature/position of the DTZ business, it's extremely difficult to picture a no-growth situation.

 

[craft]

I am also not a fan a Trevor Rowe...

I hear you on this one.

Here's a bunch of broker comments on UGL...

This doesn't worry me so much - Normally have to be in disagreement with the broking consensus to get a price that is justifies my long term cash flow assumptions.

I've always read Odd-Son. I am an idiot :bonk:

Don't worry, me too - for a long time until he straightened me out.

......................


All dressed up in my finest chain mesh gloves but now where to go yet - does it look like it wants to break to you?

 

[skc]

This doesn't worry me so much - Normally have to be in disagreement with the broking consensus to get a price that is justifies my long term cash flow assumptions.

Not saying they are right, just saying their attitude will take time to change and I am willing to bet that they won't change fast enough to make the property business too dear overnight.

All dressed up in my finest chain mesh gloves but now where to go yet - does it look like it wants to break to you?

On the chart alone it sure looks like it wants to break down. They only held AGM on 29 Oct so you'd think that they will wait another few weeks before releasing any earth shattering left field news (if they exist). But if things get ugly then a cap raising will definitely be on.

Apart from potential nasties from the engineering side, the other issue with jumping in now would be the uncertainty around capital structure of the two businesses. DTZ may have good prospects but if they load it up with too much debt (to ease the burden of the engineering side) then it may not be that awesome either.

The fact that they said the demerger will take over a year... you have to ask why so long? None of the reasonable guesses are good imo.

If I was really keen on this I'd make sure I have a parcel to secure the chance to participate in any cap raising. But when to buy the rest would be quite an art...

 

[Ves]

Finally, one last question. What's your reasoning behind not factoring in any growth? I do this in most cases, but given the nature/position of the DTZ business, it's extremely difficult to picture a no-growth situation.

With the comment on factoring in no growth - this relates to the terminal value / perpetuity calculation only (unless of course it's a mature / no growth business with lousy prospects).

For the initial cash flow period, I will guesstimate the cashflows out for another cycle, and include any increase in earnings power / profitability in calculating how much these will increase over that period. Obviously you don't want to include any growth that is achieved at the cost of capital or below. There is most definitely profitable growth in this part of my valuation for DTZ. I'm usually loathe to go past then years in pretty much every case because it's just too far out for me to really feel comfortable in projecting future earnings power.

Then there's the terminal value. This is always no growth for me - the cash flows at this point are very long-dated, and as a conservative measure (read: admission by this point it's 10+ years and it's too hard) I refuse to pay a premium for carrying the risk that the company may not be able to pump excess capital into any form of competitive advantage by this point in time. More than happy to pay for the company maintaining earnings power if I believe they will have a sustainable competitive advantage of degree by the end of my cash flow period (see my comment above in relation to the confidence factor that reduces the terminal value calculation).

More than anything look at it as risk management.... better to be surprised by upside than to pay for upside that never happens, especially if it's 10+ years away.

 

[Klogg]

Ah, that makes sense now.

Thanks so much. You have no idea how helpful this exercise, and your help (craft, skc, Ves), has been.

I think I'm out of questions now... haha.

 

[VSntchr]

With the comment on factoring in no growth - this relates to the terminal value / perpetuity calculation only (unless of course it's a mature / no growth business with lousy prospects).


Then there's the terminal value. This is always no growth for me - the cash flows at this point are very long-dated, and as a conservative measure (read: admission by this point it's 10+ years and it's too hard) I refuse to pay a premium for carrying the risk that the company may not be able to pump excess capital into any form of competitive advantage by this point in time. More than happy to pay for the company maintaining earnings power if I believe they will have a sustainable competitive advantage of degree by the end of my cash flow period (see my comment above in relation to the confidence factor that reduces the terminal value calculation).

VES, when you talk about no growth and then talk about maintaining earnings power..I presume that you are referring to a business being able to maintain margins and increase revenue in-line with, but not above, inflation?
That is what I do in the large majority of the valuations I do..

 

[tech/a]

Another example of holding in hope that this or that may happen.
Technically its been and certainly looks to remain --- falling.