Sam Woo Construction Group Limited

Sam Woo (‘Group’) is in the construction business providing foundation works and ancillary services in Hong Kong and Macau.

It is a relatively small company with $170m in market capitalization and a handful of contracts. Therefore, it is greatly impacted by the vicissitudes of the construction business (and construction accounting).

Covid-19 and the social unrest in Hong Kong has impacted the approval of public infrastructure projects. It currently has contracts in hand aggregating only $214m, which will be completed in the next two years.

Management expects severe operating headwinds in the near future. Fortunately, the group’s balance sheet as at September 30^th reveals a net cash position of $73m. Its net current asset value was only $23m but net tangible assets were $621m, which largely includes $541m of machinery and equipment. (The machinery and equipment were subject to strict impairment tests in the auditors’ report.)

Since we can’t hang our hat on net current asset value, let’s examine the past earnings and cash generation ability of the group.

TTM sales were $760m but this has ranged as high as $1.1b in 2015 and as low as $452m in 2018. Ebitda has averaged $80m and net profits have averaged $48m in the last five years. Free cash flows have been even better averaging $68m/year.

Against these multiples of 2x ebitda, 3.5x earnings, and 2.5x free cash flows, the stock appears to be a cheap call option on the business.

Businesses aren’t static, however, and it’s important to ensure the ship isn’t sinking. Though the group reported losses of $51m before tax credit (and included $9m in government grants) in the last six months, it generated cash from operations of $27m, which was used to shore up the balance sheet.

As a bonus, management paid out $34m as final dividend in the midst of this misery. Payouts haven’t been consistent though with an aggregate of only $80m paid in the last five years.

The Hong Kong government has committed to $100b in public infrastructure projects, and the group can expect to participate in this over time.

Even after considering the lumpy nature of the business, it’s hard to argue that the stock isn’t cheap relative to the group’s earning power – given the steady financial position. The bounty is unlikely to be immediate, however, and much patience is likely required for a restoration (and perhaps improvement) of past earnings.