Seven Group Holdings Placement - Good Track Record but Still a Large Deal to Digest

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Equity Bottom-Up

<p>At AUD 15.50, <a href="https://www.smartkarma.com/entities/803" target="_blank" data-smartkarma-citation="entities:803:1">Seven Group Holdings (SVW AU)</a> shares screen as somewhat overvalued, though our quibble is with the price not the business. The company has a strong track record of management and is now easier for the average person to understand than in many years and is therefore investable to wider audience. It is somewhat of a pity it is overvalued—on tangible elements—because there are reasons to see in it another <a href="https://www.smartkarma.com/entities/1104" target="_blank" data-smartkarma-citation="entities:1104:1">Wesfarmers Ltd (WES AU)</a> in its infancy, that is, an Australian conglomerate whose diversified and changing portfolio delivered nearly 20-fold share price appreciation excluding dividends over three decades and a market capitalisation of AUD 52.9 billion. But we cannot clutch at such straws. Any fair value estimate for Seven Group must be based on solid fundamentals, not blue sky. Trying to buy what is unquantifiable requires a steady and disciplined hand. And the right price, offering a margin of safety, helps too.</p><h2>Key Takeaways</h2><ul>
<li>Seven Group has delivered excellent returns for shareholders over the long run. While the past is not necessarily a great predictor of future returns, positive behaviours within a reliably persistent management culture can be. Seven Group's consistent payment of dividends, for example, is a good sign. For the quarter century to fiscal 2018, an ordinary shareholder enjoyed combined dividend and share price appreciation of 10.3% CAGR, well ahead of the S&amp;P/ASX 200 Accumulation's 7.5% CAGR. Average returns on invested capital of 14.5% comfortably exceeded the weighted average cost of capital. We forecast a sharp 29% increase in fiscal 2019 dividend to AUD 54 cents from AUD 42 cents, anticipating recovery in the payout ratio to 50% from 36%, and a 12% increase in underlying EPS to AUD 1.09 from AUD 0.97. At the current AUD 15.50 share price, our fiscal 2019 dividend forecast translates to a useful 3.3% fully franked yield.</li>
<li>Earnings visibility is improving for Seven Group, with asset purchases increasing the proportion of earnings consolidated on book increasing investment appeal. We view this as sufficiently important to soften our fair value uncertainty to high from very high, with a contemporaneous 7.0% lift in fair value estimate to AUD 15.00 per share from AUD 14.00. Key fair value influencers include a reduced 9.0% cost of equity assumption from 11.0% prior, and downgrade in credit risk to moderate from above-average. Examples of recent clarity-improving changes include purchase of the balance of equipment rental business Coates Hire and buyback of the TELYS4 preference shares.</li>
</ul><p><em>Analyst: Mark Taylor</em></p>

At AUD 15.50, Seven Group Holdings (SVW AU) shares screen as somewhat overvalued, though our quibble is with the price not the business. The company has a strong track record of management and is now easier for the average person to understand than in many years and is therefore investable to wider audience. It is somewhat of a pity it is overvalued—on tangible elements—because there are reasons to see in it another Wesfarmers Ltd (WES AU) in its infancy, that is, an Australian conglomerate whose diversified and changing portfolio delivered nearly 20-fold share price appreciation excluding dividends over three decades and a market capitalisation of AUD 52.9 billion. But we cannot clutch at such straws. Any fair value estimate for Seven Group must be based on solid fundamentals, not blue sky. Trying to buy what is unquantifiable requires a steady and disciplined hand. And the right price, offering a margin of safety, helps too.Key Takeaways
Seven Group has delivered excellent returns for shareholders over the long run. While the past is not necessarily a great predictor of future returns, positive behaviours within a reliably persistent management culture can be. Seven Group's consistent payment of dividends, for example, is a good sign. For the quarter century to fiscal 2018, an ordinary shareholder enjoyed combined dividend and share price appreciation of 10.3% CAGR, well ahead of the S&amp;P/ASX 200 Accumulation's 7.5% CAGR. Average returns on invested capital of 14.5% comfortably exceeded the weighted average cost of capital. We forecast a sharp 29% increase in fiscal 2019 dividend to AUD 54 cents from AUD 42 cents, anticipating recovery in the payout ratio to 50% from 36%, and a 12% increase in underlying EPS to AUD 1.09 from AUD 0.97. At the current AUD 15.50 share price, our fiscal 2019 dividend forecast translates to a useful 3.3% fully franked yield.
Earnings visibility is improving for Seven Group, with asset purchases increasing the proportion of earnings consolidated on book increasing investment appeal. We view this as sufficiently important to soften our fair value uncertainty to high from very high, with a contemporaneous 7.0% lift in fair value estimate to AUD 15.00 per share from AUD 14.00. Key fair value influencers include a reduced 9.0% cost of equity assumption from 11.0% prior, and downgrade in credit risk to moderate from above-average. Examples of recent clarity-improving changes include purchase of the balance of equipment rental business Coates Hire and buyback of the TELYS4 preference shares.
Analyst: Mark Taylor

Seven Group: Potentially a New Wesfarmers in the Making