TEKFEN HOLDING: Downgrade to Marketperform
Although Tekfen’s current valuation is not demanding possible delays in new contract awards, weak earnings momentum and uncertainty about utilization of current cash are likely to pressure the stock performance
We downgrade Tekfen from Outperform to Marketperform as we see deterioration in earnings outlook due to declining level of backlog in contracting business and lower fertilizer segment margins. We revise our TP from TL26.0 to TL21.5 per share, which implies 18% upside potential. Although Tekfen’s current valuation is not demanding (2020 P/E multiple of 7.3x with our estimate 30% below consensus), possible delays in new contract awards, weak earnings momentum and uncertainty about utilization of current cash are likely to pressure the stock performance.
Backlog level coming down
Tekfen’s contracting backlog is expected to come down to around $1.2bn levels by 2019-end down from $2.7bn at 2018-end (excluding JV in Azerbaijan which is not consolidated) since the company failed to secure sizable new contracts this year. As a result, we estimate revenue from contracting segment in 2020 to decline to around $900mn (more downside risk if there is now new contract award in 2020) which is about 55% lower than revenue in 2019E. We understand that lack of new projects was not related to market developments as tendering activity is strong. Tekfen’s bidding policy has been less aggressive to date (as they looked to keep high margins) but we think that the company could also become more aggressive to win new contracts (which may also lower margin outlook after 2020E). We therefore estimate EBITDA margin to decline to around 9% in medium term (vs. 10% in 2019E one-off adj).
2019 guidance revised downwards due to weak fertilizer business
Another headwind for Tekfen is normalization in agri segment margins, which were hovering at cyclical highs in 2017-2018, but started to deteriorate as seen in 3Q numbers. While average EBITDA margin of fertilizer business was around 11% (2010-2017), in 2018 the margin peaked at around 19% and revised guidance for 2019 sees a normalization in the segment margin towards 15%. As a result of this trend, note that the company also cut 2019 guidance for EBITDA/net income by 4% and 11% respectively. For 2020E, we expect fertilizer business margin to stay under pressure at around 14%, but thanks to a recovery in other operations under agri segment (port, agriculture production), we see the segment margin to be slightly higher at 16%.
New investment decisions also increase risks for outlook
Tekfen has a net cash balance of $609mn as of 3Q19, which is equal to 51% of current Mcap. The company recently announced that they started a feasibility study for a 500K tons polypropylene investment in Turkey. If BoD approves the project, it could cost $1.4bn and take 4-5 years to complete. We think a possible investment of this size in a non-core business area could limit upside potential during the investment period (as the company could turn into a net debt position with low visibility over the return on its investment). Another option for Tekfen would be taking a minority stake in the project (if they succeed in finding partners), which might be more reasonable for the company, in our view.
SERHAT KAYA, YF Invest research department