Hargreaves Services acquisition makes good sense for shareholders

Disclosure: I own shares in Hargreaves Services.

What should shareholders make of Hargreaves Services’ surprise £11.85m acquisition of earthworks and civil engineering firm C A Blackwell Group Ltd? As I’ll explain in a moment, I think this is another astute move from Hargreaves’ management, who I regard highly.

I last wrote about Hargreaves in December when I pointed out that the stock appears significantly undervalued at the moment, thanks to uncertainty about the firm’s future. The gist of my comments were that the shares were valued roughly at their net current asset value, without recognising a further 222p/share of net fixed assets such as land and plant.

What’s new?

Hargreaves needs to replace its coal mining and sales business with something new. The group already has considerable expertise in bulk logisitics, heavy plant operation and mining. Acquisition of a company that specialises in earthworks, civil engineering and mining and quarrying services seems logical, and that’s what Hargreaves has now done.

C A Blackwell appears big enough to make a material difference to Hargreaves’ results and the deal seems to have been cautiously structured.

Deal valuation

Hargreaves will make a net cash payment of £8.5m, of which £5.25m will be held in escrow pending the settlement of certain historic claims and the post-acquisition sale of two investment properties with a book value of £6.5m. Blackwell shareholders will also have transferred to them a £3.35m property at Earls Colne.

The total consideration will thus be up to £11.85m.

Blackwell currently has net debt of £13m and net assets of £13.5m (including the Earls Colne property). This suggests the group is quite heavily geared at present. However, by stripping out the apparently unecessary properties and using them to reduce debt Hargreaves has been able to reduce its cash outlay and de-risk the business.

Once the deal is completed, the underlying enterprise value paid by Hargreaves should be £15.0m, including around £3m of debt.

Blackwell sales and earnings

According to Hargreaves, Blackwell is expected to have generated an operating profit of £3.3m on revenues of £89.0m in 2015. Included within these totals are exceptional operating profit of £1.2m and revenue of £12.2m.

Stripping out these exceptionals, Blackwell appears likely to report an operating margin of 2.7% on revenue of £76.8m. To put this in context, Hargreaves is expected to report revenue of £477m and net profits of £4.6m for its current financial year.

Blackwell’s adjusted EBITDA for the year just ended is expected to be £4.1m, giving an underlying EV/EBITDA entry multiple for Hargreaves of only 3.7. This seems reasonable to me.

Big synergy

One of the biggest fixed assets on Hargreaves’ balance sheet is its fleet of heavy plant. This kind of equipment tends to be difficult to sell in bulk without marking it down. That could be a problem as the wind down of Hargreaves’ coal operations means that much of its plant fleet could become surplus to requirements. Trying to dispose of this quickly could result in big accounting writedowns and might be disappointing in cash terms, too.

Hargreaves’ management implicitly recognised this risk in yesterday’s statement (my emphasis in bold):

The operations of Blackwell are highly complementary to those of Hargreaves in terms of skills, experience and, critically, the equipment that they utilise. In the opinion of the Directors, the integration of Blackwell into Hargreaves creates new and exciting opportunities to deploy one of the largest heavy plant fleets in Europe within a large and well-funded Group.

After averaging down recently, I continue to hold.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.