Tuesday, December 4, 2012

Coffey International Limited

I recently tweeted that I am examining 3 shares which I believe are undervalued.

The second of these is Coffey International Limited (COF).

COF is an engineering consultancy company with a history going back to 1959. It listed on the ASX in 1990. The company went on a diworsefication spree from 2003 to 2008, acquiring more than 30 businesses from a combination of cashflow, capital raisings and debt, until the GFC stopped this stupidity. Faced with heavy losses from write-offs, coupled with heavy staff turnover, management changed hands in March 2011. Since then, current management has restructured the business by selling and discontinuing non profitable businesses, cutting down debt, and improving operational efficiencies. 

In a nutshell, the core businesses of COF are quite stable.  This arises from its entrenched relationships, embedded expertise and geographical reach, aided by a very fragmented customer base. Not unlike the story of GEICO, management is engaging in cancer surgery, stripping away the useless parts and retaining the good businesses at its core.  Management’s efforts are starting to gain traction- costs are coming down, margins are being maintained or improved, staff turnover is reduced.

Due to disappointing results in the last few years, and an anticipated slowdown in mining investments, I believe that the market is now overdiscounting near term uncertainties for COF, and overlooking the underlying trend improvements in COF’s businesses.

COF has 256 m shares on issue.  At AUD$0.32 cents, market cap is AUD$82m.   Operating cashflow is AUD$21m per annum, giving P/Cashflow multiple of 4.  If I add $66m of net debt, the enterprise value/ cashflow multiple is 7. Given COF’s long operating history and stability of its revenues, a reasonable valuation is about 10 times multiple.  Hence current market price is a 30% discount, assuming no costs improvements and no revenue or margin growth.  Recent update by management on 4 December 2012 appears to indicate that revenues are holding whilst costs are still being removed, although the outlook for the second half is still uncertain.

Trailing PE is 11 based on NPAT of $7m derived by adding back $37m worth of write-offs.  At this stage, due to write-offs and restructuring, earnings multiple is not a reliable indicator of the value for COF.  In the long run, we expect the earnings to match the cashflow, which will bring earnings multiple into the low single digit figures. 

Balance Sheet
As at June 2012, COF has net debt of $66m.  There are $9m in franking credits.  

Disclosure: The author owns shares in COF.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

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