SRG Limited could it be a Leighton’s 2.0?

SRG Limited (SRG) is a diversified mining, services and construction business that is starting to feel the uptick in both the resources sector and the Australian government infrastructure build programme.

SRG is not unlike Tempo Australia, which also looks set to benefit from the current macro environment. Similar to Tempo the board and senior management of SRG are replete with experience at much larger businesses most notably in the case of SRG with Leighton’s in one guise or another before Leighton’s was subsumed into behemoth that is CIMIC Group.

The business

The company’s main commercial divisions are civil, mining and construction all about 30% of revenue. The bulk of its revenue is currently from Australia but part of core strategy is to grow international revenue which it has achieved some early success. It also has developed some of its own patented products and while only small part of revenue currently it is higher margin business compared to its traditional business.

The products business is very complimentary to the projects SRG works on, as SRG can mandate using their own products as part of the tender which is nice point of difference to have from its competitors. Products can also be sold into the industry more broadly which opens up a nice additional revenue stream when they might lose the construction tender but still get the products sale for example as part of the winning bidder completing the job.

A very interesting joint venture

However, the most interesting development with SRG is its 50/50 JV with Tralyor Brothers, its American JV partner. Tralyor Brothers is a very similar business to SRG with Traylor Brothers bringing the networks, contacts and licensing in the US market to the JV. SRG brings its specialist dam engineering IP and knowledge to the partnership.

America's crumbling infrastructure

Infrastructure in the USA is in a state of critical disrepair and in need of major maintenance and upgrading. Even as far back as 2 years ago John Oliver did a piece on infrastructure for his current affairs show Last Week Tonight. Since then we have the Flint water crisis which made international headlines and overall no real improvement in the situation.

So, the day of reckoning is getting closer and closer and government can’t just simply keep kicking the can down the road any more. Even if a full-blown crisis like Flint or indeed a specific major dam incident is needed to get or find the money to pay for what needs to be done. Dams are a particular niche area where the JV is seeking to focus and capitalize on.

The JV is only in its infancy and upfront costs are being incurred to get it setup as you would imagine. These setup costs should be by and large digested in the next 12 months. At that point, we should start see the benefits flow back to into profit line of SRG.

Price and outlook

SRG currently trades at around $1.66 giving it a market cap of circa $110mil and I estimate an FY18 NPAT of about $8m. It has net cash on the balance sheet of $15mil which gives you an ex cash P/E of roughly 12 times for FY18. SRG also paid out a fully franked dividend of 7c last year and if they do the same again this year it puts SRG on a yield of approximately 4%.

Based on recent research, only 14% of companies with a market cap under $250mil market cap actually pay a dividend. Thus, it is relatively difficult compared to say an ASX 200 portfolio to get income into a microcap portfolio. So, where we can take a dividend and franking we will, provided the investment case still stacks up overall, I don’t believe in investing purely for yield.

SRG may not be particularly cheap at this current juncture but the JV gives it a nice option to further increase its offshore revenue. The JV has the potential to be an excellent source of long term incremental work in which the JV is seeking to make a claim in the US market as the leader in dam infrastructure.

If we then align the US JV option with the backdrop of a broadly improving macro environment and the company guiding to improved revenue and margins for FY18 for its core business in Australia, a solid balance sheet and a healthy dividend one could say you are “getting paid to wait” on the JV option. Taking all of this in totality to me reflects a situation for SRG that appears interesting.