A resilient British small cap with a global opportunity

Severfield is the biggest structural steel specialist in the UK. Last year, its revenue of £492mn was almost double that of the second-biggest player, privately-owned William Hare.

It has provided the frames for some of the country’s best-known buildings, including the Shard in London, and is currently working on Everton Football Club’s new stadium and the Envision electric vehicle battery plant in Sunderland.

Although the end markets it serves are cyclical, its track record demonstrates its resilience – particularly over the past decade.

It has generated positive free cash flow for 22 of its past 30 years of trading, with four of the eight negative periods immediately following the global financial crisis. It only declared a pre-tax loss in two of those.

Its worst year as a listed company came in 2013, when it was forced to tap shareholders for around £48mn through a rights issue to shore up its balance sheet after booking losses on a series of projects. The most painful of these was a £10mn provision on 122 Leadenhall Street – the London skyscraper better known as the Cheesegrater.

Reduced risk 

A restructuring followed, with a keener focus on risk management. The group turned down work that it deemed not profitable enough, or where there was “insufficient allowance for risk”.

This approach has been reflected in its numbers. Its adjusted operating margin grew from 3.3 per cent in 2014 to as high as 8.5 per cent pre-pandemic, although it has settled below 6 per cent per cent over the past two years. This has partly been the result of much higher steel prices, which have boosted revenue but – because the higher costs are passed straight through to clients – have diluted margins.

Other profitability metrics, such as return on invested capital (net operating profit after tax, divided by fixed assets plus net working capital), have also shown a marked improvement over the decade.

Severfield’s strength partly lies in the variety of its projects. Last year, 37 per cent of orders came from the industrial market – think big sheds and factories. A further 19 per cent comprised stadia and leisure builds, and 14 per cent were commercial offices. Transport projects and nuclear schemes each made up 12 per cent, with the remainder split between data centres and energy work.

Its share price came under pressure last year as higher interest rates meant clients were wary of pushing ahead with new schemes that had become more expensive to finance.

When it announced interim results in November, for instance, it had to remove a £50mn order from its book because Sunset Studios had halted work on a £700mn film production base in Hertfordshire.

However, a trading update last month showed that things are looking up. Its order book increased by £29mn in the six months to April to £511mn, and the company said it was continuing “to see large project opportunities” both in the commercial and industrial spaces and in nuclear and infrastructure.

Moreover, a joint venture (JV) in India with the country’s biggest steel producer, JSW Steel, which had previously been a drag on performance, “is expected to deliver another step-up in profitability” for the year that ended in March, after nearly doubling pre-tax profit in the prior year to £3.6mn.

Strong cash generation also meant Severfield finished the year with net debt of around £10mn, which was well below analysts’ estimates; Peel Hunt had forecast net debt of £30mn, and house broker Liberum had predicted £25mn. The company attributed the difference to an improvement in underlying working capital, as well as an increase in advanced payments from clients.

The latter is worth noting, as one of the gripes that many investors have with the construction industry is the lumpiness of cash flows. Payments are generally only made as projects hit certain milestones, so for companies in the supply chain there is a risk of their cash being tied up for some time, or even lost if a client defaults.

Severfield, however, benefits from the fact steel frames are usually installed at the start of construction projects, so there is less time for things to go wrong. And many customers make advanced payments to secure the steel they need to protect themselves against fluctuations in commodity prices. As a result, the company aims to convert at least 85 per cent of profits into cash.

The much lower debt level and a better-than-expected bout of trading gave Severfield the freedom to announce a £10mn buyback last month, which caused shares to jump by 20 per cent.

Having already moved above their 50-day moving average in March, Severfield’s shares promptly shot past their 200-day moving average.

The shares have continued to climb since, eliminating a 25 per cent discount to their net asset value within a couple of weeks. They now trade at around 7.5 times earnings per share, compared with just six times a few weeks ago, which raises the question of whether investors have missed the boat.

Home truths

Looking at Severfield’s prospects from a purely domestic viewpoint, this may appear to be the case. Severfield made over 80 per cent of its revenue from the UK in the first half of last year and the outlook for its home market looks uninspiring.

Structural steelwork consumption plateaued at 893,000 tonnes last year, and is set to dwindle to 873,000 tonnes by 2026, according to the British Constructional Steelwork Association. Over the next 12 months, an increase in spending on infrastructure projects seems likely to be offset by weaker demand for offices and warehouses.

Yet Severfield is well placed in the infrastructure sphere and its recent growth demonstrates its ability to win a greater share of what is still a fragmented market, house broker Liberum has argued. Although Severfield has a 50-60 per cent share of the stadia and leisure market, in most other sectors its share is typically below 20 per cent.

It is outside the UK where the greatest potential lies, however. The company bought Dutch competitor Voortman Steel Construction for €24mn (£20.5mn) in March last year and it is this deal that has underpinned its recent strength. The proportion of Severfield’s order book deriving from continental Europe and Ireland rose from 13 per cent on 1 November 2023 to 32 per cent on 1 April 2024, according to its latest trading update.

The Indian JV also continues to flourish, with total output for the latest financial year set to top 100,000 tonnes for the second year running. Steel frames are only used in 10 per cent of building projects in India, compared with over 70 per cent in the UK, but adoption is growing. India’s construction and infrastructure sectors consumed 83mn tonnes of steel last year – a figure set to grow to 153mn tonnes by 2031, according to Deloitte.

Severfield’s JV operates from Karnataka in the south of India, but recently secured a site in the northern state of Gujarat for a second plant that could double capacity to 200,000 tonnes a year. Liberum analysts say that if the JV hits a goal of producing 250,000-300,000 tonnes within five years, it could generate pre-tax profit of £25mn a year, with Severfield’s post-tax share equating to around £10mn.

Of course, this will mean some capital outlay in the short term and analysts only expect cash profits for the current financial year to rise by 3 per cent to £46.3mn. A step-up of 6 per cent is expected from next year, though, and – given Severfield’s strong order book and a credible track record of cash generation – other opportunities for overseas expansion could well emerge. If not, Severfield can keep returning cash through dividends and buybacks.

Last IC view: Buy, 65p, 21 Nov 2023