I realise the title of this article could be considered a bit of an oxymoron, noting our disdain for mining services companies at the moment- indeed, how could a company that we would normally just write-off as having no hope be considered a bargain?
Well, one must first realise that UGL has five operating divisions- rail and defence; asset services; technology systems; infrastructure engineering; and international. Importantly, analysts estimate that UGL's direct exposure to the mining and energy sector is 25%.
A Bargain in Disguise?
There are obviously investors that thought UGL Limited (ASX: UGL) was a bargain when it hit a 10-year low of just $1.31 in late March, capping a remarkable fall from over $7 in 2011 at the peak of the mining boom, and over $9 before the GFC. The share price has since (essentially) doubled to within reach of $2.60 on the back of some positive news flow and takeover speculation.
The rise started with the $120 million contract the company won at GLNG back in late March, gathered steam when The Australian reported that Transfield Services Limited (ASX: TSE) and Downer EDI Limited (ASX: DOW) were looking at takeover opportunities, and really surged when The Australian Financial Review reported that a "large private equity firm" and another engineering contractor have been sounding out shareholders about a takeover .
There Must Be More To It?
The appeal of UGL stems from its 2015-16 sales forecast of $3.1 billion and operations in some of the country's largest projects. This appeal was justified, much to my surprise, when UGL's management reported in early July that worst was over for the group. As my colleague Brendan Lau reported at the time, the five things investors need to know about the latest update are:
- Management is forecasting total revenue of $3.1 billion and underlying earnings before interest and tax (EBIT) of $75 million for the current year. This is ahead of consensus sales estimates of $2.7 billion. If the sale of its property business is excluded, UGL says revenue and EBIT is forecast to come in at $2.3 billion and $47 million, respectively.
- While revenue in 2015-16 is expected to be flat at around $2.3 billion, UGL is expecting "improved profitability" due to the benefits from its restructure and efficiency review. This means EBIT margin is expected to improve one percentage point to 3% next year with 70% of that year's revenue locked in.
- But its 2016-17 that is causing the most excitement as management is predicting "a substantial change in revenue of at least $300 million" because of its exposure to transport infrastructure and liquefied natural gas (LNG) plant maintenance.
- UGL's order book stands at $5.1 billion and management is targeting annual cost savings of $33 million from 2015-16 onwards due to a cut in 200 full time jobs.
- Management thinks that the $175 million provision for UGL's problem Ichthys project is "adequate" with 30% of the construction completed.
What now?
If you're sceptical about the above forecasts and upbeat commentary, you're not alone. Analysts all over the country acknowledged that while the plan was great, there's still a long way to go.
UGL's estimates are likely based on wining more work, especially maintenance work at large projects. The group's major rivals- Downer, Transfield, and Monadelphous Group Limited (ASX: MND) will be competing for the same jobs and all have capable management teams. In short – there's no reason to believe that UGL's bid will be any more likely to succeed than its rivals.
This is the crux of UGL's problem, while it may trade on a forward price to earnings ratio of just 11, it has an extremely small profit margin, exposure to high-risk projects, and no competitive advantage over peers.
