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Hill & Smith set to cash in on US infrastructure boom
As president Biden’s team begins what are likely to be weeks of horse-trading with their Republican peers over the shape and size of the new infrastructure plan, one firm which is set to benefit is FTSE 250 road safety equipment supplier Hill & Smith (HILS).
A new chief executive has the ability to drive earnings growth and a loftier valuation, providing a double win for investors.
SPEND, SPEND, SPEND
Whether the Biden team try to go it alone with their $2.25 trillion plan, which needs significant tax rises, or there is a compromise with the Republicans – who have opened negotiations with an offer of $800 billion to $900 billion and no tax rises – the one area both parties agree is in dire need of increased investment is America’s physical infrastructure.
According to Goldman Sachs’s senior investment strategist Abby Joseph Cohen: ‘The US has really fallen behind in terms of its infrastructure spend. The federal budget used to be 5% of GDP, now it’s half that. And at a state and local level, budgets are strained so they cut back on things voters tend not to notice, like spending on roads and pipelines.’
Total engineering and construction spending in the US only fell 1% last year, according to FMI Corp’s 2021 Engineering and Construction Industry Overview. However, this figure was severely skewed by residential construction which saw an 8% rise in building single-family homes and a 10% rise in spending on renovations, while some non-residential sectors saw a fall of up to 17% in spending.
The American Society of Civil Engineers recently scored the level of US critical infrastructure at C minus, noting that ‘across the country a water main break occurs every two minutes, 43% of public roadways are in poor or mediocre condition, and 10,000 miles of levees remain unaccounted for and unchecked’.
According to Joseph Cohen, just to fix the existing road, rail and pipeline infrastructure in the US would cost $2.5 trillion. Rural infrastructure in particular is a problem, especially with the shift to remote working putting more strain on local facilities.
FASTER GROWTH, HIGHER MARGINS
For Hill & Smith, the opportunities are huge. Analysts at Jefferies estimate ‘structural and stimulus-driven investment in highways, and broader infrastructure in the UK & US could drive a period of organic growth that is double the historic trend’.
Jefferies believes organic revenues could grow at 6% per year from this year to the end of the 2024-25 financial year due to the UK’s £27 billion Road Investment Strategy 2 and $135 billion of proposed US spending.
As well as road and rail, US power utilities need an infrastructure upgrade as the unexpected freeze in Texas and widespread blackouts earlier this year demonstrated.
A higher volume of US orders would also benefit group margins, with Jefferies suggesting a strategic acquisition in the high-margin galvanizing business in the US could add even more upside to its forecasts.
The firm disappointed investors back in March when it released its results for 2020, as Covid-related shutdowns in the UK, France and India hit spending.
However, much of the work has simply been delayed or ‘shifted to the right’, while the company was quick to respond by cutting discretionary spending and driving local efficiency plans.
New chief executive Paul Simmons, who joined in September 2020 from UK engineering firm Halma (HLMA), is a strong believer in the decentralised, autonomous operating model and has already laid out a strategy to build on the firm’s growth potential in the UK and US, including targeted acquisitions.
‘First and foremost, we will continue to focus on accelerating organic growth by increasing the rate of innovation and identifying new niche markets. Second, we will place greater emphasis on higher margins and long-term growth, and we have already fine-tuned our portfolio management criteria to that effect.’
Investors who back Simmons’ pedigree include Richard Penny, seasoned manager of the TM Crux UK Special Situations Fund (BG5Q5X2).
‘At Halma, Mr Simmons was part of a strong shareholder friendly culture with multiple acquisitions, culminating with the shares becoming some of the most highly valued UK stock market shares,’ he says.
‘Initial signs are promising that if Mr Simmons can transfer some of the “Halma magic” to Hill & Smith, and with shares at a significantly lower valuation, it will provide scope for strong share price performance over the medium term.’
On current forecasts, Jefferies believes the valuation of Hill & Smith – at 18.7 times current year earnings and 16.7 times two-year forward earnings – offers a 20% discount to the UK industrials sector, whereas it sees a 5% discount as more appropriate.
Certainly compared with another big US infrastructure beneficiary, equipment hire firm Ashtead (AHT) – which trades on 35 times current year earnings and 29 times two-year forward forecasts – there is plenty of room for Hill & Smith to re-rate if the new chief executive can execute on his plan. [IC]