LogiCamms is an engineering consultancy to the hydrocarbons, mining and infrastructure industries in Australia and New Zealand. According to management, the nature of the services they provide seek to support their clients to solve some of their more complex problems. For example they provide solutions that address complex process and system requirements, such as identifying efficiency gains on existing facilities. The large majority of the services they provide are in support of enhancing the efficiency, safety and profitability of existing facilities.
There is a significant ongoing reduction in capital expenditure and new investment in the oil & gas and mining sectors due to the decline in commodity prices. In Australia total new capital expenditure as of Q3 2015 decreased by 20% y-o-y. In addition, a number of commodity producers are in the process of restructuring their businesses which often delays the award of new work for the likes of LogiCamms. Consequently, the markets in which LogiCamms operates are very competitive and challenging right now leading to declining margins and volume in the service sector.
Notably, in contrast to most of its peers LogiCamms was able to grow revenue and earnings in financial year 2015 (ending in June 2015) over the previous year. More importantly, as of November 2015 management expects operations to remain relatively resilient. EBITDA for the first half of financial year 2016 (ending in December 2015) is expected to be in the order of AUD 4.0 m. On a full year look ahead, they expect revenue to reach AUD 120 m for FY16 (10% y-o-y decline). In addition, the Company aims to maintain its EBITDA margin in the lower end of its target range of 8% to 10%. Hence, EBITDA might reach AUD 9.6 m.
To put this into perspective, the company has a market cap of AUD 38 m, no debt outstanding, and cash as of YE 2015 (according to management) of at least AUD 10 m. Based on management’s projections, LogiCamms is valued at less than 3 times enterprise value to EBITDA multiple. Given (1) the company’s asset light business, (2) the company does not have to serve interest payments and (3) receives substantial tax credits from research and development incentives, free cash flow conversion has been close to 75% over the last eight years.
What are the reasons for the company being cheap?
1) Threat of future cost and volume pressure
The major question is whether current revenues and profitability will be sustainable in 2017 and beyond. The current valuation implies a sharp drop in business activity. From my perspective there is no doubt that the company will be more and more affected by the ongoing spending reductions of Australian commodity businesses with contracts running out and not being renewed leading to lower profits for LogiCamm.
(i) Relatively diversified client base
However, unlike many competitors in the service industry LogiCamms contract risk seems to be less concentrated. The company completes more than 1,200 projects per annum with the 20 largest customers contributing around 60% of revenue. In 2015, there were two customers where revenue amounted to greater than 10% of the Group’s total revenues. One customer in the hydrocarbons sector amounted to AUD 19.7 m (14.7% of revenues) and one customer in the mining sector amounted to AUD 13.5 m (10.0%). In contrast to many mining/oil&gas services companies who rely on a very small number of large contracts, LogiCamms is less dependent on key customers and might therefore have more influence on contract terms.
(ii) Focus on brownfield operations
In addition to that, LogiCamms tries to manage market pressures through a strong focus on ongoing and sustaining operating expenditure. The company earns 80% of its revenue from existing facilities (brownfield operations), rather than through new (greenfield) projects. Moreover, most of their exposure relates to production assets that require ongoing service support to ensure continued safe and efficient operation. According to management, this focus on adding value to their customers’ existing assets allows LogiCamms the opportunity to continue to win work in this challenged market.
(iii) Asset light business model
Furthermore, Logicamms business is asset light. Unlike many servicers with large property plant & equipment on their balance sheet or large amounts of uncancellable operating leases off balance sheet, intangibles dominate Logicamms assets (see below) with relatively low working capital requirements (roughly 10% of revenues) at the same time. With regard to the income statement, operating leverage seems to be relatively low with personal costs and contractor expenses making up roughly 65% of revenues. A quick adjustment of administrative costs and so called business development costs comprising together 32% of revenues should be manageable as well. At the same time, depreciation & amortization are less than 2% of revenues.
(iv) Major revenue contribution from Hydrocarbons (LNG and coal seam gas)
Mining services as a total percentage of revenues have been reduced over the last years being currently at 29%. The oil & gas industry has become more important with roughly 65% of revenues coming from this industry. The shift towards oil & gas has been pronounced due to the acquisition of ITL in 2013. In the oil & gas sector Logicamms is mostly servicing LNG / coal seam gas facilities and gas pipeline projects.
Large amounts of LNG capacity have been added and more capacity is expected to be added going forward. Hence, LogiCamms should be one of the companies who will benefit from the increasing demand for project and maintenance work in this sector.
Over the last ten years Australian LNG exports grew by 9.1% per annum. The following graph as of March 2015 shows an estimation of the expected development of the Australian liquefaction capacity until 2020:
According to this study, in a few years Australia is expected to surpass Qatar as the world’s largest exporter of LNG with Japan, China and South Korea being the major target markets. They expect Australia to have a total nameplate capacity of around 86 million tonnes per annum (mtpa) by 2020 and LNG exports are forecast to rise from 23.2 mtpa in 2013–14 to 76.6 mtpa in 2019–20.
According to this study, there have been a number of difficulties to overcome even before the severe decline in commodity prices started. Moreover, with demand from Asia for LNG now most likely being lower than originally anticipated, projects might be delayed or cancelled.
Still, a large part of the capacity is already under construction making it less probable that the projects will not be completed. The table below shows facilities completed versus facilities under construction (please click on the picture to enlarge):
2) Acquisition spree over the last years might lead to imminent impairments
As already mentioned intangibles mostly consisting of goodwill dominate LogiCamms assets. Over the last years the company made the following acquisitions:
I believe it is likely that management will make impairments in the future given that acquisitions were made under assumptions which were based on a different market environment than what LogiCamms is facing today. Obviously, any write down will not have an effect on cash earnings.
3) Uncertainty about capital allocation
According to management, the company is currently looking for additional takeover candidates to participate in industry consolidation. They are also referring to options in relation to LogiCamms capital structure which might include the addition of debt to the balance sheet to finance acquisitions.
At the same time, the company itself might become an acquisition target. Recently, Tetra Tech made an offer for Coffey one of LogiCamms peers, which values Coffey at AUD 170 m or a LTM EV/EBITDA multiple of 8.1 times.
The company currently expects to maintain its previously stated dividend payout ratio of 40% to 60% of net profit after tax, but is also saying that it might target a lower payout ratio in case of other capital requirement. Overall, we can expect the dividend to be cut from last year’s AUD
0.08 (12% yield) 0.07 (10% yield) which will might put short term pressure on the share price.
4) Management change and no skin in the game
Steve Banning was re-appointed as managing director (CEO) in March 2015, having formerly been managing director from November 2011 until May 2014. Prior, he was Managing Director of Epic Energy from 2007 until 2011, which is currently one of Logicamms more important clients. Hence, the appointment of Matthew Andamo who followed Mr. Banning was not successful as he only stayed for less than twelve months. This exercise of Mr. Banning leaving, then Mr. Andamo leaving and then Mr. Banning re-joining the company cost shareholders roughly AUD 1.0 m in termination benefits.
Management’s variable remuneration is based on short term growth measures like EBITDA but also long term strategic goals like for instance “expansion of hydrocarbon presence” or “M&A acquisition programme” which might be difficult to define. In addition, for an asset light business EBITDA is acceptable. However, a better metric would simply be return on capital employed.
In addition, while the company provides the management with a generous option scheme it seems that the management does not own a noteworthy holding in the company’s equity.
5) Recent increase in provisions on onerous leases
Since 2014, the company has been booking provisions for onerous leases where sub-lease inflows will fall below contractual outflows. The provision on onerous leases increased from AUD 0 in 2013 to AUD 1.9 m in 2014 and AUD 2.4 m in 2015. So, that is something I will keep in mind.
Conclusion / Valuation
In a challenging environment LogiCamms tries to position itself in the seemingly resilient parts of its industry. Whether the company will be successful with this strategy is hard to tell. The current market value implies a significant downturn in profitability. For this type of business I am willing to pay a mid cycle 8 times EBITDA multiple. I think that this is appropriate due to the high earnings quality of the business. At the current enterprise value this implies an EBITDA of at least AUD 3.5 m or 29% / 36% of 2015 EBITDA / projected 2016 EBITDA. Of course, this approach implies that overcapacities in LogiCamms operations can be adjusted relatively fast and that management will allocate net cash to the benefit of shareholders.
From today on I will build a 2% position with a limit of AUD 0.6 per share.
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