Will Servcorp make a successful long-term investment?
Paul from WA asks to value ServCorp. Don’t get excited, I am not going to make a habit of doing this.
Management have delivered returns on equity in excess of 20% over the past five years. This is desirable given the amount of profits being retained to organically grow equity and fund its expansion plans. The balance sheet is strong with plenty of net cash and the business is generating high quality cash flows.
Because of the recent capital raising of circa $80m to fund an expansion program of around 100 floors, any valuation must contain a caveat that it is subject to the rate of return the company manages to achieve on the incremental equity.
So, watch the capital raising development closely. Up until recently, management has been content to slowly and organically growing the business via the reinvestment of profits to fund the roll out of new floors. I like this and the model appears to have worked, with around 67 floors being opened to date.
The capital raising signals a departure from SRV’s original approach. Management plan on opening ‘at least’ 100 new floors – that’s more than double the current level over the next three to four years.
As with any aggressive growth plan, scalable systems must exist particularly when growth of circa 150% in such a short period of time, needs to be managed. Always a challenge.
Management believe that they will be able to enter into leases within A-grade properties and new markets at attractive rates, taking advantage of any recovery in economic activity.
If they can deliver returns commensurate with recently reported ROE levels, on a materially expanded equity base, investors should be handsomely rewarded. All bets are off if green shoots fail to germinate. Remember Servcorp is a cyclical business.
So what is the value? Without taking into account the profitability of the recent capital raising, the value is $2.39. I wouldn’t pay much attention to this valuation because if the company can employ the capital it recently raised at previously recorded rates of return, the value is closer to the current price.
By Roger Montgomery, 22 October 2009
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