Posting my July 2012 update for EEI Corporation on this thread as my analysis corner ran out of space after the HI summary.
Before reading this, you may want to see my April 2011 Deep Scan of EEI Corporation on my thread, pages 2 and 3. You can find a link to it in my signature.
July 2012 Update
Rationale behind investment thesis:
- solvency ratios still don't look well, and are mixed as a whole.
- ARCC-adjusted OCFBWC is still really good versus the low amount unadjusted, so the company seems solvent enough.
- EEI is still asset-liquid and current assets exceed current liabilities by a decent margin.
- Fixed charges coverage is good for OCFBWC, EBIT and EBITDA (over 2x), but horrible for NOPAT and Net OCF. Adjusting for ARCC consolidation, these numbers shoot past 2.0.
- Over/underbillings very low.
- Full value of contracts went down by only 6B, with 53% of the contracts complete.
- Average remaining life has fallen from 6.5 years to 4.0 years, so EEI had a somewhat harder time getting more contracts for its business in 2011. IF THIS PLUMMETS BY 2012, EXIT 50%.
- Estimated Project Gross Profit went up from 13.8% to 14.6%.
- CCC went down from 144 to 109 and it is a far cry from the average of 172.
> Comes from quicker turnover of inventory. Sales rate is still above 70%. However, this is attributable not to movements in actual inventory, but in decreases in sales figures.
- Asset turnover ratios still in line with long-term average.
- Gross margins went down for the year, mostly due to 25% increase in construction costs (personnel, equipment, materials).
- OPEX Controls worsened, but only because of large one-time items (without which they would've improved to 56%, leading to 7% OPM!)
- Depreciation in line with history, with hree PPE classes following a different useful life than what had been stated. Effect on reported would've decreased net income.
- Nonoperating items still mostly positive. Nothing has changed. Shows ARCC has tremendous impact on the business results, even though consolidation of its operations worsen it.
- Interest expenses went down. They will be minimal unless EEI takes in more LT debt. Liquidity is what's key now as the bank loans EEI possesses dwarf LT Debt.
- Effective taxes still at 30%. No big deal.
- Bottom line has fallen to 8.4% and RNOA has fallen to 7%. ARCC-adjusted RNOA is 11%, and is dangerously lower than the cost of capital at MEDIUM risk.
- Nothing has changed significantly for EEI's inherent stability except for changes in its backlogs, which have more in tandem with growth than with stability itself.
- SAUDI ARABIA
> "Kingdom construction sector most buoyant globally" (Saudi Gazette, May 24 2012)
:: Deloitte Middle East's report says "massive construction projects in the GCC, particularly around social and transport infrastructure", will offer tremendous opportunities valued at up to $500bn for contractors.
:: Growth is coming from "grand investments [by the] government", with plans nearing $400b in 5 years. These projects include schools, hospitals, universities, homes, airport expansions, railway, and road improvements.
:: Oil & Gas developments up-and-down stream support these opportunities.
:: Report indicates "vast opportunities across the Middle East" with "longer term infrastructure investment plans... estimated to [exceed] $1T".
> "Saudi Build 2012 galvanizes robust construction sector" (Saudi Gazette, July 5 2012)
:: Projected growth of 4.5% til '17
:: Public sector expenditures are aggre, awarding construction with $71.2B in contracts for 2011 alone.
:: Spokesperson for Nov 2012 Saudi Build conference said KSA needs to "urgently...expand its infrastructure... and social amenities to satisfy the evolving requirements of its fast-growing population."
> "Construction boom increases demand n water, MEP sectors" (Saudi Gazette, Mar 10 2012)
:: Construction boom will present numerous opportunities in water, plumbing, power, mechanical, and electrical sectors.
:: This is good for EEI's electromechanical expertise.
> "KSA investments in real estate and non-oil infrastructure drives demand for construction material and machinery" (Asia Today, Apr 17 2012)
:: Confirms expansion of KSA sector. No other value.
- COMPANY SOURCES (AR 2011)
> EEI has invested in construction equipment and improvements in SCM, along w/ ICT to streamline efficiency and cost effectiveness.
> Domestic construction sector is going strong because of private expenditures (whereas public expenditures contracted!). Company says it is operating in Singapore and Caledonia, but there is no mention of Japan anywhere.
> With the government's aggressive stance for PPP's, They are expecting government infrastructure spending to pick up in later years and channel the money to power, transportation, and other developments. Private sector expected to contribute through commercial and residential real estate.
~~ All these can entail construction of power plants and water distribution facilities, along with mining facilities and the like.
> Company is still actively exploring opportunities within Asia.
It doesn't look like EEI Corporation has changed significantly. However, a couple of warning signs have popped up (Long-term RNOA, Projects' Remaining Life), so investors should still keep track of this.
Growth prospects are still going to be based on local development (PPP's) and the "construction boom" in Saudi Arabia. EEI's competitive advantages do not seem to have changed (80 years experience, diverse projects, reputation in Philippines and KSA, and effective management of personnel)
Risk rating remains at MEDIUM RISK due to concerns with solvency, backlog development, and perpetuation of excess returns.
Valuation still follows analysis made years ago, where reproduction value is higher than stagnation value due to EEI's interest-bearing debt, its labor-intensive operations, and the lack of significant competitive barriers other than experience (learning curve) and brand (reputation of quality that its peers can also attain).
The current market price of P6.85 represents a 22% discount to EEI's reproduction value, a high margin of safety given the risk rating.
However, I cannot bank completely on this because the lack of real competitive advantages can all too easily erode EEI's future profits and moreover, value-adding growth.
Investors are paying almost 90% in MARK-UPS for a rosy future, with stagnation value estimated at P3.6. This is very dangerous given EEI's choice of industry. However, should it surpass its competitive environment and partake of the construction booms in KSA and the Philippines without sacrificing its excess returns, the margin of safety is actually very high: 35% with a pessimistic scenarios (54% potential upside).
Fortunately, those who have entered EEI early have more than enough incentives to stay on in the game, as they have paid zero for EEI's future growth. Those who intend on purchasing more should take note of their average costs per share, which must not exceed P4.50 (25% mark-up, the highest premium I'm personally willing to pay).