SNC - SNC-Lavalin Group

[mcliu]

I've started a position at 17 1/2. A little outside my "good company, good management, good price" frame, more like "mediocre company, no management, dirt cheap". I think most, if not all, the bad news is finally priced in. Not quite done my work, but i'm somewhere in the $30/share IV range. It seems Caisse is finally applying pressure to get a new board to get this ship steered away from the rocks. Selling 10% of the crown jewel 407 is not my idea of smart, but I understand the need to stabilize the balance sheet and rebuild trust with investors. At this price your getting the concession/capital business for a discount the the E&C business for nothing - and a free dollop of headline risk. I'm not in the "the backlog is worthless and melting" camp. They still maintain street cred with industry. PPP is here to stay and they are a player. I can only speak to Lavalin's work in mining, where the mine engineers still regularly use Lavalin, and don't bat an eye at the many issue's swirling around SNC - which I believe are fading. I think it's a slow grind for a while, tax loss selling this fall will likely be brutal.

 

I'll continue to pick away...

 

Maybe Bruce Flatt will buy me out...

 

Thanks for your thoughts. I've been looking at this as well, they have some very profitable businesses like nuclear, but I'm having trouble understanding the extent of their potential losses.

 

Did you get a sense of how much more losses are in their fixed-price contracts?

 

From their recent call, it seems like the losses that they've booked are non-cash adjustments based on revised estimates, but actual cash outflows will occur later on, so there's at least $500M to $1B to add to EV, is that the right way to think about it?

[longlake95]

I agree, handicapping the future here is murky. I think the cash outlays in the future will be metered and manageable. I've basically accounted for that by using an overly conservative earnings power going forward, to absorb payments going forward for botched contracts.

I don't know if that's right, but if I can buy cheap enough there is a cushion there. I think it's a positive that SNC is stepping out the lump-sum business. That will be a headwind in the short-term, but better in the long run.

 

The back of the envelope #'s look like:

$5.3B -  for all the capital investments ( very cautious marking of the capital biz, 407 is worth 5B alone)

$3.5B - $700 @ 5X Pretax earnings a couple of years out

-$3.5B - recourse debt + a portion of the non - recourse debt (because nobody really likes to forgive on debt...ya maybe overly cautious)

 

=$5.3B = $30/per share

 

I don't normally handicap so severely, I try to be as realistic as possible. But the headline risk and the fact that this company's dealings have rattled the PMO's office and the Canadian public, it's hard to tell if something comes out of left field to impair SNC even more. I do think SNC is an important employer in Canada and part of the PPP solution, so I believe the government ends up being soft on SNC - in typical Canadian fashion. This is really important opportunity for Caisse to step-up and take leadership and restore SNC.

 

This is certainly a special situation investment for me. It will be small until some smoke clears.

 

 

 

 

[Cardboard]

I was really lucky to get out shortly after I got in or just prior to Q1 results being published for a loss of over $1/share. Something felt fishy.

 

I would think that by now and at that price that all bad news has been priced in. For a while it also felt uncertain if the 407 sale would close if at all? Now they have $3 billion of cash in hand.

 

It looks like this will take a while to restructure but, it will. I would expect layoffs and a shrinking business to end up with a better one.

 

So I think this could bounce from here as it is priced for bankruptcy but, until good results show up again it could take a couple years.

 

Cardboard

[absolutbrian]

Dear community,

Some of you might know me by my real name, Brian Langis, and this is my first CFB post. This is also a follow up on a presentation I gave at the 2019 Toronto Value Symposium (at the Fairfax AGM) in April. When I pitched SNC-Lavalin Group (SNC.to) it was trading at $34, down from its all-time high of $61. Then the stock fell to ~$25 on bad news and it’s now trading at $16.30 on more bad news.  Nobody wants to see a stock falls, especially one that I pitched to a group of smart investors. I believe I should address the current situation.

 

I posted an update of SNC on Seeking Alpha. Here's the link: https://seekingalpha.com/article/4275981-snc-lavalin-buy-highway-get-e-and-c-cheap

 

Here are some of the key points since the publication.

 

Where are we?

SNC is now trading at $16.30, the lowest in 15+ years and down 73% from its high. Despite the recurring issues with the Infrastructure & Construction segment, I still believe SNC is not a value trap. I believe shareholders will be rewarded in the long run for the risk they take. Keep in mind, as mentioned in the article, this is not an easy investment. It will take time to turnaround the ship.

 

So what’s happened?

SNC is in a difficult situation. Since Q3-2019, the company has been hit with massive cost-overrun in their fixed-price project.

The Company is also the subject of a political scandal in Ottawa with the Liberal party, which could have been avoided, but yet here we are.

 

In the article I said that I wouldn’t be surprised that the new CEO takes the quarter as an opportunity to ditch guidance and dump more bad news and that’s exactly what happened. SNC took a $1.9b impairment charge link to its oil and gas division, Kentz. They already took a $1.2b impairment charge back in February. SNC bought Kentz for $2.1b back in 2014. The CDPQ, the largest shareholder with 19.9%, publicly came out against the deterioration of SNC performance. Back in the spring the CDPQ said they will “be a rock” for SNC, I guess they are losing patience like everyone else.

 

SNC is facing many headwinds, operationally, financially, politically, reputationally…let’s quickly address them:

 

1) SNC has been having operational issues. SNC some good assets and bad assets. The recent restructure announced will have SNC focus on its strong points. SNC is still in business. They are still winning contracts.  SNC is walking away from Turnkey lump sump projects, the key source of its problems. Exit: O&G, mining, and construction which are its least profitable activities. They will focus on design, nuclear, engineering services “EDPM”.  They will be less risky and more cash-flow predictable. More details on the new strategy is expected in the fall. The future SNC might look like more of a WSP Global or Stantec.

 

2) Finance: SNC took on a lot of debt for its WS Atkins acquisition of $3.6b in 2017. Despite paying a big price for Atkins, it’s one of the strong points of SNC today. To deal with the debt SNC sold part of their private highway, cut the dividend, and is engaged on a cost cutting program. SNC also has $13.87 (post-H407 sale) of net assets in their Capital Investment Portfolio (CIP).

 

3) Politics: Unfortunately SNC is in the middle of a political scandal for the Trudeau’s Liberal government.  SNC was also a victim of a diplomatic spat between Saudi Arabia and Canada. There’s not much in SNC’s control at the moment. Hopefully after the election the government will finally find a solution to SNC’s legal problems.

 

4) Reputation: SNC didn’t murder anybody but you would think they did. Their reputation is not good. It’s affecting employee morale and departures. The public perception of the company is toxic. SNC is managing a PR crisis. SNC, a 100+ year old company, has its brand; a once valued intangible asset is now in the garbage bin. You can change a reputation. Merck’s Vioxx is responsible for the death of 38,000 people and the company is still around. With SNC it will take time. I don’t expect anything before the Canadian Federal election in October. Plus they have to Libya bribery court case they have to deal with. It will take a lot of time, a string of good news/quarters, and communications to deal its reputation.

 

So what is SNC doing?

The new CEO as a clear mandate: Turn the company around. He said he wants to “de-risk” the company. So he decided to drop fixed-cost projects and constructions (read above). They will focus on high margin areas like consulting, EDPM…They might sell off divisions like Resources which is more cyclical.

 

However, SNC still has to honor their previous contracts and this is very where the market is very sour on. Instead of seeing the backlog has a positive, it’s considered a liability. The market is saying: “We expect more cost-overrun from your construction projects, this will put SNC on the brink.” However, out of the $3.4b in infrastructure & construction backlog, $2.5b is considered “low-risk”. It’s not for the faint of the heart and potential surprises are still possible. A 30% cost overrun on $1b is a $300m lost…

 

Other thoughts

The intrinsic value of SNC is much higher, but investors don’t want to hear any of that. There’s too much volatility linked to fixed-cost contracts even though SNC is leaving the segment. Also most of the proceeds from the Highway sale will go to de-leveraging. I don’t expect much to go to share buybacks, if any, since the situation is worse than expected. The money should be used to stabilized the company. But imagine the buyback at these prices... I expect clarification this fall with where management is going from here.

 

The core thesis of my investment thesis is still relevant. SNC is a high-conviction contrarian investment opportunity. It’s definitely not for everyone. The sentiment around the stock is extremely negative, which is reflected in the share price.

 

I hope this update helps. I don't know how active I will be on the forum but some of you have my personal email address and number. You can follow me on Twitter:

or on my blog where I post occassionaly about investing and other randomness. http://brianlangis.com/

 

Thanks,

 

Brian

 

[Cardboard]

Well Brian, I certainly hope that you will continue posting as this is a great post!

 

There is already a small thread on SNC but, there is little discussion going on. As I mentioned, I got in at around $34 and luckily got out at a small loss just before Q1 was released as something didn't feel right.

 

Then there was really bad results, serious doubt about 407 sale closing, CEO out, dividend cut, Caisse unhappy ,etc. Finally, the 407 deal closed or a major cash inflow and stock still heading down...

 

I think this will turnaround and be a smaller more efficient engineering company which should trade at 15+ times earnings like Stantec and others. It will take time.

 

Moreover right now, we are in a world trying to price in the next 3 recessions, so anything seen as cyclical or in trouble is avoided like plague. Where does this stop or this never ending vicious fear cycle is a mystery?

 

Cardboard

[longlake95]

Hi Brian,

 

Great post. Thanks for your analysis. As Card mentioned there is an SNC thread, maybe you could repost there and continue to check-in once and a while. Im a new owner of SNC (August) and agree this company has a lot of hair on it - but there is value there, perhaps significant value. The political cloud hanging over SNC is a benefit to long term buyers buying now. I think in 3 years nobody in Ottawa or the general public remembers the SNC issues.

 

longlake

[absolutbrian]

Longlake95 and Cardboard,

Thank you for the replies.

 

I didn't see the previous SNC thread. I even searched for it. Link?

[longlake95]

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/snc-lavalin/msg379033/#msg379033

[absolutbrian]

SNC won a "major" engineering contract. Contract amount is not disclosed but the contract sounds significant. This is part of SNC's strategy to increase their service division. This is a multi-year contract reimbursable contract, the future of SNC. This also displays Atkins' competences. The market doesn't care. Stock down anyway to $15.80.

 

SNC-Lavalin appointed on major PMO contract on Australia's largest rail programme

https://web.tmxmoney.com/article.php?newsid=8236459111169865&qm_symbol=SNC

[longlake95]

https://www.newswire.ca/news-releases/snc-lavalin-appointed-on-major-pmo-contract-on-australia-s-largest-rail-programme-888761233.html

[Spekulatius]

Fixed price contracts for large construction projects are a disaster for the industry, just look at FLR.

[Cardboard]

I am back in with a smallish position. I was waiting for a bottom and think that we have it now along with lots of value to support.

 

Reacted positively to good news today or contract extension while equity market was down.

 

Cardboard

[absolutbrian]

We should expect an update and a "plan" from the new CEO this fall. Hopefully it would clarify a lot of uncertainties and give investors a sense of direction. When he got the job in June he said he would take 60 days to meet with key shareholders.

 

I hope we get clarity on:

* How much debt has been paid back? How much leverage is left?

* What's the story with the share buybacks? Sounds attractive at these prices but is there money enough money for that?

* Can we get a the picture of what's going with the Infrastructure & Construction segment? This has been a major source of problems/losses. And how much of it in that's left in the backlog can be "de-risk"?

* An update on the Resource segment. Can anything be sold?

 

As for their legal issues, I don't expect anything new. The elections are in October, so their file is a definite "don't-touch". They are expected to face trial an anything can happen.

[Cardboard]

Train leaving the station?

 

CIBC resumed coverage today with an outperform-speculative rating and target dropped from $49 to $25. Seems to be the only explanation for the pop other than a decently good looking bottom on the chart.

 

[Cardboard]

Can't find an english article on this but, Jarislowsky after telling people that this would be about worthless with a sale of 407 (wanted a shareholder vote) has now bought back over 10% of SNC shares: scare the little guy then scoop shares at bargain prices in August...

 

Likely helps to explain the increase of yesterday as word got out on the Street.

 

https://www.lapresse.ca/affaires/201909/10/01-5240687-jarislowsky-revient-en-force-dans-le-titre-de-snc-lavalin.php

 

With 47% now held by 3 large institutions with deep pockets and all looking bad since they bought at much higher prices except for Jarislowski latest average down. 2 making noise: Caisse and Jarislowski. I am thinking that a privatization may not be far behind. It would be the best way for these guys to restructure the whole thing and make a really good return.

 

Cardboard

[longlake95]

SNC would be a great fit for BAM. They must use a ton of engineering services, especially in BIP not to mention BAM's connections around the world. He probably loves the concession side of the business too. This seems right up Flatt's alley...unloved asset....long runway of growth/business....no one else competing to buy SNC....and a distressed price.

 

LL

[Cardboard]

Ferrovial/Cintra is now adding some uncertainty to the 407 sale:

 

https://www.stockwatch.com/News/Item.aspx?bid=Z-C%3aSNC-2808534&symbol=SNC&region=C

 

What is curious is that this was known before the open yet, the stock still rallied almost to $20 before pulling back?

 

I am also surprised that CPPIB did cut the cheque before the period to appeal had lapsed.

[longlake95]

Add to SNC today on the news of JF buying 11%. With JF now on board, along with Caisse, I think they now  can assert enough pressure on SNC to do the right things to right the ship.

 

LL

[absolutbrian]

This is definitely a vote of confidence. Jarislowsky Fraser's firm now owns 10% of SNC. It's also notable that he's a former board member and used to own over 10% in the past before selling and buying again.

https://business.financialpost.com/pmn/business-pmn/canadas-jarislowsky-fraser-raises-stake-in-snc-lavalin-shares-rise

[Cardboard]

Taking off big time! This is really good as this will attract funds + technical folks.

 

I am probably going to trim in the $24-26 range as then it becomes more of a longer term turnaround.

 

Cardboard

[longlake95]

It's a 4% position for me - I'm hanging on till we see a few quarter roll by. Ya, I think it's partly a relief rally and partly coat-tailing off of JF. Either way its good. Now we just need Bruce Flatt to buy this thing, cancel the 407 sale, keep the crown jewel, and sink capital to stabilize the balance sheet. I do worry about a convent breach if earning don't march higher soon. However, with 48% or so of the stock in strong hands I think that worry has diminished some as they will force the right levers to be pulled.

 

 

[absolutbrian]

SNC's legal case returns to court on September 20. It's trial by judge alone. SNC plead not guilt and said it intended to vigorously challenge the charges. Maybe, I'm saying this with the smallest probabilities, that the judge will throw out the whole thing.

 

Longlake:

• I don't think BAM will buy it. Unless the price is really good. RBC and certainly not the CPDQ will probably not sell at a capital loss. I'm a big BAM investor and I like Bruce Flatt, but I doubt he will pay up unless he sees a good bargain. But hypothetically speaking, I agree, BAM's playbook could do good work with SNC. However many obstacle in the way.
  

• SNC sold the 407 and they maintain 6.7%. There's no going back on the sale. The news of Ferrovial/Cintra is immateriel because the sale is completed. Cintra and CPPIB had all agreed that even if the court’s decision were to be reversed on appeal, the sale would proceed and CPPIB and Cintra would adjust the number of shares of Highway 407 they own.

 

Jarislowky's buy sends a big vote of confidence for SNC as the stock as past the $20 mark.

[longlake95]

Nice Q3, even ex 407 sale. Nice to see resource backlog rolling off and what remains is mostly light rail projects. It's time to carve off resource E&C, and just provide engineering services...

 

https://www.snclavalin.com/en/media/press-releases/2019/31-10-2019

[absolutbrian]

I guess SNC didn't celebrate Halloween today with one of their freak show horror quarter. From what we have seen in the last year, this is refreshing. The stock has responded well, up 13% this morning. Ian Campbell has been nominated as CEO. They didn't delever has much as I expected but now maintain some cash, close to a $1b. They will need it for future infrastructure projects in the backlog and potentiel cost overruns. Now they need to execute.

[no_free_lunch]

I am in on this one.

 

I don't have an advanced understanding of SNC but I will put out my quick thesis. The sale of a portion of 407 was for top dollar and the proceeds have allowed the company to basically clear out their long term debt.  Engineering services are doing something like a billion in operating cash flow a year.  Despite the scandal engineering services has a huge backlog.  Earnings should be well over $2 per share next year and on top of that with a deleveraged balance sheet the company will eventually have opportunities to grow via acquisition. There are additional catalysts available including sale of O&G.

 

It is not without some risk but seems cheap and a nice alternative to the overpriced market.