Severfield — Poised for expansion

Declining revenue due to lower steel prices and the unusual cancellation of a single project in FY24 obscure the real growth story developing for Severfield. Its Core Construction Operations produced a record underlying operating profit and the smaller Modular Solutions division turned a small loss in FY23, into a profit. Underlying demand trends are positive and the order books for the core business and India remain at elevated levels, with solid fundamentals and robust pipelines. Furthermore, the company’s balance sheet is modestly geared, allowing it to reward shareholders with dividends and a share buyback, while retaining the headroom to make value-enhancing acquisitions as and when opportunities appear.

Severfield reported a 6% decline in revenue to £463.5m as lower steel prices and lower activity reduced revenue by £87.1m, which was offset by the inclusion of £59.5m in revenue from the acquisition of VSCH. However, operational delivery overcame the impact of weaker market conditions and underlying operating profit was up 14% to £37.7m, which implied that the underlying operating margin increased 140bp to 8.1%, the highest margin since 2020. Excluding operating profit from VSCH, underlying profitability was broadly unchanged.

Underlying PBT increased 12% to £36.5m, with underlying EPS rising 5% to 8.9p, from which the company anticipates paying a total dividend for the year of 3.7p, up 9%. Net debt came in at £9.4m on a pre-IFRS 16 basis, benefiting from a £10m customer advance and a £10m working capital improvement in FY24.

Revenue from the C&I division declined by 5.3% to £361.8m due to the cancellation of the Sunset Studios project and softer market conditions, notably in the distribution sector. Lost revenue was partly offset by the inclusion of VSCH. In the year, Severfield progressed work on several large projects including the new Everton FC stadium, the Envision Battery Plant in Sunderland, a BAE manufacturing facility in Scotland, and the LHR 11 data centre, 81 Newgate and the Excel Area, all located in London. Furthermore, it progressed work on the SeAH Wind monopile facility, which highlights Severfield’s exposure to the alternative energy sector.

Severfield’s N&I division saw revenue reduce by 7.7% to £87.4m, again affected by softer market conditions that were offset by normal revenue timing differences inherent within the nuclear operations. Despite the cancellation of the northern phase of HS2, Severfield continues to work on a number of bridge packages for the Balfour Beattie Vinci and Effage Kier consortia and other HS2 packages, including the Silvertown Tunnel and Old Oak Common. On the nuclear side, work continued at Hinkley Point, Sellafield and in Berkshire for AWE.

The small but important Modular Solutions division saw revenue decline 5.7% to £21.5m, but due to an improved mix of business, notably higher-margin Severstor products, the division converted a £0.6m operating loss in the previous year into a £0.3m operating profit in FY24. The division also includes a profit contribution from the joint venture, CMF, at the PBT level. This contribution fell from £0.5m to £0.1m as softer market conditions in distribution and some overhead under-recovery was experienced as it ramped up its expanded production facilities in Wales.

JSSL, Severfield’s Indian joint venture, had another good year, producing more than 100,000 tonnes of steelwork for the second year in a row, driven by robust underlying demand. Despite the solid demand, reported revenue declined 5% to £130.8m, largely due to FX fluctuations, but EBITDA grew 15% to a record level of £13.2m. Severfield’s post-tax share of profit was £1.9m, up 46% (see Exhibit 1 above). The strong profit performance was the result of an improved mix of business and good contract execution, and the implied operating margin improved from 6.5% in FY23 to 8.0% in FY24.

The outlook for JSSL is very encouraging as the Indian economy is forecast to more than double between 2023 and 2030, and the substitution of concrete for steel in construction is set to see the volume of steel in construction triple, from 5mt in 2020, to 14–15mt by 2028. In order to capture some of this growth, JSSL has acquired additional land in Gujarat in northwest India, which it expects to begin work on in H2. This expanding facility will also give the JV the opportunity to address some of the opportunities that are appearing in other markets, such as Saudi Arabia. The capital cost of expansion is expected to be funded by the JV and will not affect the group balance sheet.

At the headline level, the total UK and Europe orderbook is largely unchanged at £478m as at 1 June 2024. However, the composition altered dramatically in the period. Although the absolute contribution from N&I and Modular both grew modestly, the contribution from C&I UK fell more than £100m, from £271m to £162m, with the loss of the £50m Sunset Studios contract being a major contributor to the decline. However, this reduction was almost completely offset by an increase in the C&I Europe and Ireland orderbook from £55m to £150m, highlighting both the contribution from VSCH and the momentum being generated as Severfield increases its presence on the European continent.

We anticipate that Severfield is likely to build on the momentum in Europe and Ireland, but also rebuild the C&I UK orderbook over time, as the pipeline appears to be expanding as client demand and enquiries are building. In particular, the green energy transition, which spans many different categories such as energy transition, battery plants, factories for renewables and offshore as well as onshore substations, gathers pace. This is being largely driven by the UK government’s 10-year, £755bn Infrastructure and Investment plan, of which more than 80% is targeted at sectors such as energy, electricity and gas transmission and transport, all of which are core to Severfield’s sphere of activity.

In India, the orderbook is also gathering momentum, growing from £139m in June 2023, to £181m at the same point this year. Growth is being driven in particular by the commercial sector, which includes offices, data centres and distribution. Demand for steel rather than concrete structures is pushing demand in all sectors, whereas AI and digital data demand, and physical storage facilities, are driving demand in data centres and distribution. There are also solid prospects in the pipeline that are not yet in the orderbook that give Severfield confidence in the outlook for India and the planned expansion. Other opportunities outside India are also surfacing, with projects in Saudi Arabia beginning to emerge as potential prospects, and these could be material indeed.

In 2023, Severfield announced an initiative called Project Horizon, which was designed to digitise many aspects of the business and improve efficiency and traceability. There were 100 workflows that were classified as either short, medium or long term. So far, 22 of the 57 short- to medium-term projects have been completed, with another 22 currently ongoing. To date, the project has been self-funded and further benefits are likely to be captured over the life of the overall project.

Severfield has a strong balance sheet, with a net debt to EBITDA ratio of c 0.25x at the end of March 2024. With this in mind, and with an eye on operational requirements, potential M&A and shareholders returns, the company announced a £10m share buyback in April, which by the announcement of the FY24 results had seen the company buying back c 1.4m shares for a cost of £1.0m. Our forecasts, which we revised in our update note published on 21 June, assume this exercise is completed in the current year, which implies a net debt to EBITDA ratio of 0.5x at the end of March 2025. We estimate that in FY26 the share buyback adds c 4% to EPS.

Severfield retains material balance sheet capacity despite the share buyback. Although it has c £20m of outstanding term loans, it also has an undrawn revolving credit facility of £60m, which could be used to fund any targeted acquisitions. In the last five years, the company has executed three deals, the largest being Harry Peers for £24m, and in total has invested c £62m, suggesting that any deal is likely to be somewhat smaller than the current available credit. Given the limited opportunity in the UK, with the exception of some niche fabricators, and the success of the VSCH deal, we believe any acquisition is more likely to be on the European mainland, rather than in the UK.