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Should you buy Seven Group?

At its half year results announced in February, Seven Group Holdings (SVW) reported a massive 392% increase in earnings, on the back of strong results from its mining equipment business, WesTrac. But it’s unlikely to reproduce that result anytime soon.

WesTrac Australia is by far the largest contributor to Seven’s results, contributing 88% of revenues ($2.4 billion), and 71% of earnings before interest and tax (EBIT). WesTrac holds the exclusive licence for Caterpillar equipment, including 400 ton mining trucks, loaders and excavators in Western Australia, New South Wales, the ACT and north-east China.

News that famed hedge fund manager James Chanos is shorting Caterpillar could have serious consequences for Seven Group’s earnings going forward. Caterpillar is the largest producer of construction and mining equipment, with 30% of its revenues and half its operating profit coming from global mining capital expenditure.

Mr Chanos says that one third of global mining capital expenditure is equipment, and growth of that spending over the last decade is waning. Mr Chanos says Caterpillar “is tied to the wrong products at the wrong time in the cycle”, and expects the giant company’s earnings to fall. That suggests that Westrac is likely to report disappointing earnings for the 2013 financial year, while the outlook for 2014 is likely to be disappointing – at best.

Seven Group also recently announced that after a six-month strategic review, it was keeping its 46% of Australia’s largest equipment hire company, Coates Hire. It seems that Seven and The Carlyle Group, another majority shareholder in Coates, were unable to offload the business due to a lack of interest.

Seven, which also has a major stake in Seven West Media (ASX:SWM), reported in June that it expected underlying net profit after tax for the year ending June 30 2013 to be at the low end of previous guidance (10 to 20% above 2012’s result). Write-downs and one-off extraordinary expenses could see reported profits materially below the underlying result.

WesTrac is making 350 workers redundant across its NSW/ACT business, at an estimated cost of $10 million. With another 3,500 employees, more cuts could be coming as the mining boom tapers off. We’ve already seen the effects of that on mining services companies like Boart Longyear (ASX:BLY) and Emeco Holdings (ASX:EHL).

Foolish takeaway

Seven Group looks like a strong contender to disappoint the market when the company reports its full year results in August. A cut to the dividend is also on the cards, which could upset yield investors. With a current P/E ratio of 6.5 and a dividend yield of 5.6%, Seven Group looks more like a value trap than good value.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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