2023-08-31 05:41:32 ET
Summary
- AF Gruppen is a construction and engineering company in Norway with a good market position and impressive dividend yield.
- Despite weakness in 2023, the company is still considered one of the more interesting companies in Scandinavia.
- The company has a diverse range of business areas, with some segments performing well and others experiencing challenges.
Dear readers/followers,
I'm a fairly prolific investor in engineering and construction companies in Scandinavia - when these are cheap. I've been working with options and common share investments on Skanska ( OTCPK:SKBSY ) and NCC AB. I've also been looking at PEAB. And recently, about 2 years ago, I included the Norwegian company AF Gruppen ( OTCPK:AGRUF ) in my spectrum of coverage for the sector.
AF Gruppen is an engineering, construction, and industrial business in Norway. It has a good market position, it has an impressive dividend yield, and it works out of Oslo.
In this article, I'll show you why despite 2023E weakness, I'm adding and I recently added to this company in my portfolio. This company is one of the more interesting construction and engineering companies in Scandinavia, despite what may seem initially like a "mess" of segments.
What is AF Gruppen and what does it do?
AF Gruppen, as you might have guessed, translates to the AF Group. It's a company that has been around since the mid-80s and initially was in oil/gas and energy as well as major construction/infrastructure projects. It built the Troll Field Tunnel in the early 1990s, and from an early day worked in a number of different specialties.
However, the real change came in the late 90s when the company merged with Oslo's largest contractor at the time, Ragnar Eversen. This effectively doubled the company's revenues. It also went into the property sector when it acquired Odin, and seeing where society was going, AF also built up a business in recycling as well as a business in demolition, all of which became profitable business areas. For its quickly gained expertise, the company was awarded Norway's largest demo project, the demolition project of an entire refinery back in 2000.
What about today?
AF Gruppen today represents over 30B NOK in annual revenues from 3,000 employees around Norway and Sweden. It has businesses mostly in Norway, but it also has some business areas in Sweden. The mix of its business areas makes it almost certain that when one business area is up, another one is bound to be down.
Despite its cyclical sectors, AF Gruppen is rated very high in terms of safety and profitability. Benchmarking and analytical services, such as GuruFocus or Morningstar give the company higher points than you might expect. GuruFocus is at 93/100 in total, showcasing high profitability with an absolutely stellar RoE of almost 32%.
While the income statement for FY22 wasn't as impressive, the company still showcased a working business model with an appealing split and a decent net profit.
Like most construction companies, AF has cyclicality to its earnings. The 4Q's tend to be the strongest, with 3Q and 1Q tending to be the weakest quarters, at least as of late. The company's share price has seen a very interesting sort of decline over the past few months, to where it now trades natively at 124-125 NOK, which for the current company dividend pushes it to a yield of around 8%.
The company is in the midst of exactly the trends we see in the remaining sector here - meaning negative trends in property and residential which are impacting profitability. As you can see from the company's income statement and revenue split, the company is active in a number of attractive segments. On a company-reporting basis, these are categorized into Civil Engineering, Construction, Betonmast, Property, Sweden, Energy/Environment, and Offshore.
All of these segments had good recent quarterly results , with the one exception of Property, and in some parts Sweden - though Sweden was more a variance within the segment itself, not a poor result.
Property delivered weak results, with sales contracts for only 16 homes with almost no share for AF at all. The sales ratio in commenced projects is at 75% but the entire industry here is very sluggish.
The other segments all show some positive indicators. Order intake and revenues were very solid across the board. Norwegian Construction, unlike other nations, continues to see a very high level of activity. Five new contracts were announced, with attractive projects such as wastewater treatment plants, museums, and other buildings with an order backlog of well over 10B NOK as of the 2Q23 quarter. Even this does not compare to the civil engineering segment, which has an ATH backlog of just over 20B NOK, and with the segment getting new orders in the form of airport constructions , new tunnels, and other major projects. Norway remains a very wealthy nation, and one that's active in terms of major infrastructure pushes - and AF Gruppen is a net beneficiary of such trends.
Here also comes one of the few risks to the company - overall concentration. Unlike Skanska, which has a clear international profile, this is not the case with AF Gruppen. This is mostly a Norwegian company, so the correlation to Norwegian trends is higher than you might want.
Still, as a "group", the company has exposure to every sort of construction or infrastructure trend you might want to be looking for. The company's Energy and Environment segment continues to work well, with a Backlog of almost 1.5B and good overall orders.
Even the Offshore segment, typically not a darling for this or any company, is seeing significant revenue growth and profitability. Norway is seeing building activity, of this there is no doubt.
Despite some less-than-ideal profit trends simply due to the fact that inflation is up, costs are up overall and the macro is difficult with a rising interest rate environment, the company is actually seeing very high activity. Yes, the latest quarterly results were below the expectations set by the company itself - but the company's financial position is nonetheless solid, and with over 10B NOK in orders in a single quarter, there is really very little to fundamentally dislike here.
Accepting that construction and engineering are cyclical, you are able to see valuation trends over time and when this company could be a good investment for your portfolio, provided that it meets your targets.
I started buying when the company dipped below the 140 NOK level for the native share. Fundamentals for the business are "too good" to ignore. The company has a debt/equity of less than 0.95x, an interest coverage of 25x, and overall positive fundamentals speak in favor of this company on the short-term side, we're seeing declining overall gross margins and operating margins. This is nothing surprising - all companies in the sector are seeing these trends. The company lacks meaningful S&P global credit, but at LT debt/cap of less than 15% does, as I see it, not need this. We're looking at a yield of 10.5 NOK per year, paid bi-annually, and with a tradition of two years.
However, be certain in understanding that even if this trend is on the positive side, I don't think the company is tied to this dividend. If earnings are at a level where the payout ratio no longer makes sense, the company will abandon its dividend. Overall, adjusted EPS has long been higher than the dividend payout, so GAAP/EPS is not necessarily indicative of a near-term cut, but I would say that the sort of decline we're seeing probable for the 2023E fiscal, it's likely that we may see some reduction in the dividend for the next year - though not by much.
Let me clarify this in the valuation section.
Valuation for AF Gruppen - we're easily seeing 15%+ annualized on a long-term basis.
The valuation for AF Gruppen is definitely getting more interesting. Take a look at the 20-year trends.
The correlation to the company's 17-19x premium overtime is high for this business. That's why the break from these trends, no matter how justified they may be (and they are in this macro), is of interest to me.
Because of the forecast that AF Gruppen's earnings are going down in the near term - that's a pretty safe call. Everything is pointing to around a 20%+ EPS drop for this year, much in line with the company's expectations, potentially even worse.
However, this does not make the company unattractive to me. It only poses the question at what level the company would reverse. While we're not yet at a 15x P/E for the 2023 results, on a normalized level we're certainly at that price here, normalized being around 8.5-9.5 NOK/share for the past few years - and also what the company is expected to reach again.
Likelihood?
Based on a 2-year accuracy of over 90% with either beats or hits, I do consider it "Not unlikely" to see such outperformance going forward. Also, a reversal to below 10 NOK/share is in no way out of the company's wheelhouse - and here are the S&P Global estimates for GAAP for the following years.
Stabilization is really all we need. A 15.5x P/E upside from this would be around 15.1% annualized, based on the EPS reversal rate, around 25% in 2024, and another 2% in 2025E. However, AF Gruppen does usually trade at higher multiples, so a more realistic long-term target would be something along these lines.
We have different ways of outperforming the market. Some use options and derivatives, some focus strictly on buy-and-hold with dividend-paying stocks. Some use ETF's. I personally combine strategic buying of dividend-paying stocks when their common shares are attractive for such a strategy, complemented by writing of attractive options when this is a better choice.
For AF Gruppen, because options availability is low, this is a common share investment play to me. If options were more widely available at good prices, I might consider this as an attractive entry.
For this situation, however, the company is attractive enough as a common share investment with a double-digit 15%+ annualized realistic upside to where I would consider this a viable sort of entry.
I expect AF Gruppen to outperform slightly over time. This is not a triple-digit investment, with portfolio-beating RoR potential. I view it more as a mixed income/reversal investment where I take advantage of sector weakness and good longer-term trends. I am frankly surprised that the construction sector in Sweden has held up as well as it has for now, and that companies here are still trading at share prices as high as we're seeing.
As I am writing this article, AF Gruppen is actually up almost 2% on the market - but there is still a solid upside despite now trading at around 127 NOK.
Here is my initiating thesis for the company.
Thesis
- AF Gruppen is a company that combines attractive overall yield with an attractive overall reversal upside, now that the share price is down from over 180 NOK/share, and touches upon levels of 125 NOK. This implies a yield of over 8% and an upside of over 15% per year even on a very conservative 15x P/E forward basis.
- I recently added more AF Gruppen to my portfolio and will continue to add as the company experiences weakness in terms of share price. The company trades on the native ticker AFG on the Oslo exchange, and analysts give the company a conservative PT of around 140 NOK/share.
- I give the company a rating of "BUY" here" and consider a fair target for this company at least 165 NOK/share on the long term based both on reversal and growth.
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
This means that the company fulfills every single one of my criteria, making it relatively clear why I view it as a "BUY" here.
For further details see:
AF Gruppen - Long-Term Upside In Construction/Engineering