SXE: About to flick the switch?

Founded in 1978 and listed on the ASX in 2007, Southern Cross Electrical Engineering (ASX:SXE) are a leading national electrical, instrumentation, communications and maintenance services group of companies. They offer their services to the mining/resource, infrastructure, defence, commercial, and construction industries/sectors.

The stock often appears in many client screens. Testimony to this, the company is one of the most viewed by members within the Stockopedia platform despite its size (it’s in the All Ordinaries index, but not in the ASX300).

Revenue is principally derived by the group from the provision of electrical, instrumentation and communications services through construction and services contracts. SXE report their revenue via three operating segments: commercial, resources, and infrastructure. Over the years SXE have made acquisitions to grow and diversify their business and since 2016 they have acquired Datatel, Heyday, and Trivantage Group. This resulted in record EBITDA earnings and reported profit after tax of $38.2m, and $20.1m respectively in FY23. Also, of note was that 35% of FY23 revenue ($465m) was recurring revenue which SXE has expressed a desire to increase by continuing to target maintenance and recurring earnings services contracts. SXE sees the decarbonisation and electrification of the Australian economy as a major growth area, particular points of interest specified by the company in their investor presentation September 2023:

“Australia is undergoing an energy transition to achieve net zero emissions by 2050.”

“Reduction in fossil fuel consumption will require a high degree of electrification in the road transport and industrial sectors”.

“Electrification is also expected to occur across a range of applications in industry, mining and manufacturing, as well as gas use in buildings”.

“Introduce a national plan to phase out fossil gas in existing buildings and appliances” Recommendation 2.2 –EVERY BUILDING COUNTS REPORT –Green Building Council of Australia 2023.

SXE also have a number of blue-chip clients on their books, including BHP, RIO, Woolworths, Coles, and Multiplex, with revenue from blue chip customers accounting for 46% of FY23 revenue. To date, SXE has managed to execute their strategy of acquiring business to grow and diversify their business and continue to be on the lookout for more acquisitions.

StockRank:

As to be expected after reporting record earnings and profit in FY23, things are looking pretty good at SXE. With their overall stockrank sitting at 99, Quality 94, Value 92, Momentum 96. This is what you would expect from a company that has no net debt, and has increased, revenue, earnings, profits, cash flow, dividends, and margins since 2018.

SXE’s F-Score is a healthy 7 with their only two blemishes being they issued shares to help fund their acquisitions and they were less productive than last year, due to asset turnover falling from 1.6 to 1.5.

This can be seen in FY23 revenue of $465m being lower than FY22’s $553m. Their Z2-score is a safe to cautious, and with good liquidity ratios and a record $77m cash on hand, there is not much to worry about here.

Financials:

As noted above, SXE are in a great position financially with record earnings and profits being reported for FY23 and has no net debt, record cash on hand, and continues to increase free cash flow and operating cash flow per share. With this going some way to explain the recent share price rise and subsequent momentum score increase.

Management looks to be on the same side as shareholders as they have maintained a prudent dividend cover. Since 2018 it has not fallen below 1.3, indicating they have retained some of the profits generated within the company to help fund acquisitions and capex, and have not issued excessive amounts of shares to help fund their acquisition spree, with average shares only increasing from 212m to 261m, since 2018.

Now, for me, the thing to remember with engineering/mining services companies, is they are only one bad contract away from a poor financial performance, as among other things, costs can blow out due to delays, technical difficulties, labour shortages, weather events, or the contract can be pulled altogether, leaving a hole in revenue and earnings; and as we can see from their operating margin of 6.3%, which ranks 7th out of 30 other construction and engineering companies, this sub-sector operates on low margins and therefore it does not take a large hit to revenue or earnings to have a material impact on margins and profits. Often stocks in this sub-sector can trade at a discount due to this reason.

Liquidity and Ownership:

With a market cap of $222.2m and only 261m share on issue of which the largest shareholder accounts for 17.9%, top shareholders hold 48.7% and 74% is classified as free float and can be traded; SXE are in the small end of town and have a small cap-size classification for this reason. For small parcels of shares most DIY investors should not have any issues getting in or out but if a large order is placed or top shareholder decides to get active then there could be liquidity issues getting in and out and the share price will fluctuate as a result.

Outlook:

SXE have a record $610m of work in the pipeline and are targeting revenue of around $500m for FY24 and have forecast FY24 EBITDA earnings to be at similar levels as FY23 with growth anticipated in FY25 and beyond. Consensus estimates have profit for FY24 and FY25 remaining flat at $20.3m and 20.7m respectively, with revenue estimated to increase to $587m and $604m for FY24 and FY25.

But as often is the case when with small stocks coverage is thin with only one broker covering the stock, who has a strong buy recommendation. Furthermore, with little to no debt on the balance sheet, record cash holding of $77m and a stated desire to keep acquiring business SXE has significant room to leverage their balance sheet and more acquisitions are likely, which could significantly increase earnings and profits.

https://wcsecure.weblink.com.au/pdf/SXE/02709855.pdf

Conclusion:

SXE to date have proven they can execute their strategy of acquiring business to grow and diversify their business and have positioned themselves well with a strong balance sheet to continue this and capture an ever-increasing market share of the decarbonisation and electrification of our economy.

For me, SXE is not without its risks, but represents an opportunity for investors to get in at ground level on what appears to be a significant growth area for some time to come.

---

Important Information: Stockopedia Ltd ABN 39 757 874 670 UK business registration number 0637267 (“Stockopedia”) is an Authorised Representative of Daylight Financial Group Pty Ltd ABN 77 633 984 773 (“DFGPL”) which is the holder of an Australian Financial Services Licence (AFS Licence No. 521404).

Information in this commentary is current as at date prepared unless otherwise stated. However, please bear in mind that investments can go up or down in value, and that past performance is not a reliable indicator of future performance. For more Important Information please refer to the Disclaimer section of this website.

This communication may contain general financial product advice. It has been prepared without taking into account your personal circumstances, and you should therefore consider its appropriateness in light of your objectives, financial circumstances and needs before acting on it.

If our advice relates to the acquisition or possible acquisition of a particular financial product, you should obtain a copy of and consider the Product Disclosure Statement (PDS) before making any decision.