@Karmast i will be the first to admit to not having done the detailed work on DUR or MAD but i have an aversion to these types of companies. the reason why, which may or may not be the case here, is that it is a tough business with no real barriers or protection and relies on the continued good judgement of the management. That is fine up to a point. that point comes when the low-risk/high-value work is exhausted and the companies still have a desire to grow. as the book of biz grows internal controls become harder to maintain etc as does the mounting pressure to build ever greater loads of work. at some point, which could be years away, the chickens come home to roost. I ve seen similar companies hit the wall over the decades and that's the best answer i can come up with as to why they fall over. as you would expect no management ever says it is taking on poor biz so its up to you to work that out. of course, good luck with it.

Some fantastic analysis in this thread but realistically it could have been summed up much quicker; just ignore all those buffoons on Ausbiz, most of them just love the sound of their own voice!

There’s a few worth listening to @Wini. that’s why I like to tune in on Fridays! ;)

@Solvetheriddle I’d agree in general however you could also make that argument about most businesses. If mgt change or mess up or if the company exhausts all the safer growth options then things get tough. They only have a percent or two of the total market at present so there is very likely still years of low risk growth.

Where DUR have a moat I think is a mgt team that have been together for over a decade and have built an excellent track record. Coupled with the MEnD technology that no other player has and they state significantly minimises the chance they mess up a project and lose money. They are saying no to the projects that others take on and lose with.

@Karmast if what you write above turns out to be true there will be a long run way. I am a bit sceptical of some TAM measures that various management teams through up, sometimes the "real" TAM is a niche of the overall market. Maybe no one knows what the real market is until it is reached then the big decisions have to be made, by investors and management. Management saying they are better than the rest, well they are until they aren't. a strategy of holding DUR until the results start to wobble is a reasonable strategy, remembering it is a tough competitive biz.

Agreed

Yes I agree with this @Solvetheriddle .

I do wish Ausbiz would time stamp The Call on their podcast so you could do less chewing to get to the wheat.

Some of it is not even entertaining but some are gold like Claude, Luke, Gaurav, Michael Wayne, Joshua Barker, Ben Clark!

Whenever I hear, "We have a price target of ..." I feel dismayed.

Thanks @mikebrisy. I’ve learned more from your short reply than I did from “the Call”.

No, I haven’t done an analysis of the contract sizes, lumpiness and risk. It makes sense to understand this.

How did you get access to the broker reports. I just registered my interest for the ASX broker reports. Does that work?

I’d really appreciate your analysis of the business @mikebrisy. I think it would be worth a carton of your favourite brew next time we head to Brisy! :)

Cheers,

Rick

Thanks @Rick I’ll look forward to that.

Just Google “Moelis ASX analyst report November 2023” and you’ll get the link to the pdf on the ASX website. If you add $1.50 and $1.62 into the search it will help narrow it.

I also put the links in my reply to your straw.

By registering for the ASX service you get a weekly email with links to the latest reports.

I’ll write up my thoughts over the next few days.

Thanks @mikebrisy. Much appreciated.

I'm trying to get my head around Henry's remark on lumpiness of contracts and, more importantly, that with the low margins that all contractors have (c. 8% EBITDA and 4% NPAT - which is typical of the sector) it only takes one poor contract to set you back.

The big unknown in all these contracting businesses is you don't know how well they are pricing the contracts until they drop a writedown on your head. Last cycle 10 or so years ago there were small mining services contractors that popped out of nowhere and suddenly had billions in contracted work and a balance sheet that looked more like a corner shop. It turned out most of them were just feeding the top line by taking on uneconomic contracts to appease the market Gods. I don't think we are at that stage of the cycle and tbh, given the cost inflation over the last few years it's likely anyone who was doing that has already been taken to the cleaners – like every second home builder appears to have been.

One of the highest profile companies from back then that went bust was FGE. It was a bit of a market darling. Here is FGE's FY13 P&L.

Revenue and NPAT all going in the right direction...

The only hint that things were a miss was probably their mentioning of "well positioned to withstand difficult market conditions"

They had a $1.3b order book. Difficult market conditions + fixed price contracts + long feedback loops + a SP price (and management incentives to chase revenue) that required growing revenue and it was somewhat inevitable they were going to start chasing unprofitable work...Which they did.

For an order book that size where all the price risk falls on the contractor there wasn't that much fat on the balance sheet...

By November this happened...Whoops.

By January there were more issues with contracts...

And then in February it was all over...

The demise was rapid to say the least.

I own some contractors. They are amazing businesses to own because they have so much inherent operating leverage. But they are dangerous businesses because of that leverage and because so much of the contract price risk is on them (what's the old saying about never buying a house that where the builder signed a fixed price contract!). As long as you accept you're not swimming between the flags with these businesses they can provide great returns on a 1-3 year basis but you don't want to own them through the cycle, imo.

@UlladullaDave what a great case study, and gets to the heart of why I don't generally own these businesses.

I spent a good part of my career on the client side and have seen how these contracts can go, and also the behaviour of the industry at different stages of the cycle. It is often a wonder anyone makes any money, and unsurprising so many go to the wall!

However, I cam taking a closer look at $DUR for several reasons:

• A specialist, with focus on asset preservation and remediation, with a good and stable specialist engineering staff
• Self delivers most of its work - reinforcing the specialist nature
• Does most of its work direct with clients and not as a subcontractor
• Maintains relationships with many clients through the asset life cycle
• Stable management (founders are Non Exec, ex-MD and current MD) with good insider ownership (albeit some selling down at and after IPO)
• Signficant shareholding from a privately-held, family-led engineering contractor

The first four in the list above are significant differentiators from many in the contracting industry.

I am also looking at the distribution of contracts in terms of sector, client and size - it looks reasonably diversified. Although they recently appear to have taken on more larger contracts - hence exposure to the kind of risks you are referring to - there still appears to be a large base of smaller, services-type work.

As part of their portfolio, they appear to have a core and sustainable business with Defence.

Also, margins appear reasonably stable - albeit weaker since IPO. Am trying to understand whether this is cyclical, the result of acquisitions or change in mix.

Work in progress!

That’s a good synopsis of contracting businesses @UlladullaDave. I am also very familiar with Forge having followed Roger Montgomery into it and losing some money. You might think I would have learnt from that lesson, but as you say you can do very well in a strong cycle, and that’s why you back there. This is why the PE ratios always appear to be low for what looks like a solid business.

Given the Forge example, there are some lessons to be learnt. The balance sheet needs to be healthy. There should be zero net debt on equity, and some cash in the bank to boot. The margins need to be steady or improving, and there needs to be a solid pipeline of work ahead, and management needs to be top notch. Some skin in the game helps.

I think holding size is important. These types of businesses should be limited in your portfolio. I would feel comfortable with up to 2% in any one industrial contractor type business, and maybe up to 5% of these types of businesses in the total portfolio. Don’t fall in love with them, watch for falling margins and ROE, and get out quickly if things turn sour.

Mathan is right in saying, GET OUT on the first downgrade!

Excellent start @mikebrisy. Don’t be afraid to put up a solid bear case. I won’t be offended. You might save me some cash! :)

@UlladullaDave Forge Group is a blast from the past!

I remember speaking with the Forge CEO Peter Hutchinson (current chairman of VYS) at the time they allowed a cornerstone investment from Clough, a much larger engineering firm. The price for was at 5x P/E, Forge was growing quickly and highly profitable, and I was rather miffed and annoyed.

Peter explained to me that the projects they bid on were very high risk. A slight misstep, cost overrun or incorrect pricing, could see the company incur large losses. They wanted a large engineering partner with systems and processes to help them mitigate these risks and provide backing for projects.

It didn't really sink in at the time. I eventually exited my position for a tidy profit. It was not until later when the costs for all their power plant projects blew out, which eventually blew up the company, did it all sink in. I've not touched an engineering projects company since.

@mushroompanda Amazing that he could explain the risk to you, how they planned to mitigate that risk, but it still got them.

I think that sums up the challenge of these contracting businesses. It's always at the peak that the pricing starts to go a bit silly. When all you need is a Bobcat and a pulse to tender for contracts.

@Rick no credible bear case from me, as yet. (Although I'll put some hypotheses on the table below, just to be devil's advocate).

I read the IPO prospectus this morning and the investment note just posted by @Karmast draws heavily on that. I think the key insight I've drawn so far (and the Sohra Peak note brings this out very clearly and independently of my research, so thanks for sharing!) is that the market seems to be pricing $DUR like a typical engineering construction company, when it is far from it.

By focusing on asset remediation and life extension, and following a differentiated business model from the sector, the risk profile of its work is fundamentally different from sector peers. Clearly, by sticking to projects within their core capability area, management understand project risk and therefore how to price work. That is key.

I haven't yet looked at the transcript from 1H FY24, and I don't understand the reasons behind the recent sell-off. One hypothesis is that a lot of shareholders who got on at IPO of $0.50 have done extremely well in a short period of time. Perhaps, some have decided to take profits, and that's triggered something of a profit-taking trend?

Having spent much of my career working in capital project management, I know that one of the key factors for long terms success is project leadership - not only in selecting the right projects, with the right commercial construct, and pricing risk appropriately, but then also having the right people driving execution. (It is amazing the difference a few key roles on a project leadership team can make - you would not believe some of the turnarounds I have witnessed first hand.)

So, I am going to fabricate a Bear thesis drawing on these elements. To be clear, I don't hold this view (yet), but I am trying to identify why $DUR might be fairly priced.

So, in order to synthesis a Bear Case, I am going to draw on three elements.

1. Leadership - a changing of the guard

The founder-owners of $DUR have done decades of hard work building this business (including their formative years working together at Savcor) . Taking it public is primarily a vehicle to monetise that investment. We are also about to see a changing of the guard. Phil Harcourt is the first to move, having stepped into Non-Exec Director from MD, with co-founder Chris Oates taking up the reins. Executive Manager Deane Diprose will likely be next, already having 45 years industry experience. That leaves Chris Oates, current MD, with only 30 years, experience as the leader who will need to refresh the leadership bench. Another key stakeholder is Jim Giumelli, and his successor (son?) James of Ertech (which holds c. 20% of shares). What are their long term plans regarding their investment? I note also that Gavin Miller is the Chairmand of both Ertech and Duratec.

The 3 founders each monetised only c. 10% of their holdings at IPO or $1.5 million each. Ertech cashed out $24m at IPO.

We've recently seen some further insider selling: with Phil and Chris each selling a further 10% of their holdings (perhaps Deane did too?).

While all founders and Ertech collectively still have a significant holding, this is something to watch.

2. People - the key to sustainability - is going to be harder to deliver

Continuing to deliver and grow requires Duratec to attract, develop and retain talent, particularly in the key engineering and project management roles. As they grow this may become more of a challenge. In fact, engineering and project management recruitment is a nationwide issue, and there is ample coverage in the press of the problems it is causing. For example, the Federal Government is seeking to scale back the Government-backed infrastructure programme due to project cost escalations arising from resource constraints. I also hear anecdotal stories from my network of projects in QLD that are struggling to mobilise workers to site to meet contracted works.

While $DUR isn't directly competing for the major infastructure builds, it is competing for the same talent pool - engineers and project professionals.

It is unclear whether $DUR has a distinctive employee value proposition.

I'm going to flesh out this second leg of the bear hypothesis by doing some trawling on LinkedIn, to identify the key roles, and assess how stable the workforce appears. There are a few hints on GlassDoor that $DUR might not have a compelling employee value proposition - however, the data is patchy and not compelling.

3. Risk Profile Evolves over Time

As $DUR grows it will be increasingly likely to take on larger projects. With major project selection decision-making concentrated in the depleting Founder-Executive team, this will increase the chances that $DUR makes errors in selecting and pricing these larger project. Should this occur, returns will be eroded and start to look more like the industry.

(More work to do on looking at the portfolio evolution. This part of the thesis does not look fact-based, as if anything $DUR appears to continue to be very well diversified).

Conclusion and Further Thoughts

On all the fundamentals, $DUR appears attractively price (I'll not regurgitate the analysis and arguments put forward by others), it has a differentiated strategy and business model in its sector, is founder-led, with strong insider ownership.

It also appears not to be on the radar screen of institutional investors and has very limited analyst coverage. The top 4 shareholders are Ertech and the three founders, account for around 50% of shares. There don't appear to be any institutional investors with a signfiicant holding.

A block sale to institutional investors is a clear means for the founder and Ertech to further monetise their holdings if they wish to. There seems a be a good degree of coordination in share sales by Ertech and the founders, so this could allow for an orderly transition of the register over coming years.

$DUR in the Context of it Sector "Peers"

Figures below shows P/E vs. 3-Year Revenue CAGR and P/E vs. 3-Year EBITDA CAGR (where available, otherwise 2-year). Not all companies plotted on both graphs due to data availability at source used. (marketscreener.com). Due to the source, I'm not confident all the individual data points are right, but the overall picture tells the story.

I've also plotted where $DUR would be if it was trading at "Consensus" where is where it was briefly a few months ago. (Note: I am unaware of the relationship of the 2 analysts to $DUR, e.g., role in IPO or paid research etc. etc. so as always, beware.)

My Next Steps

I am going to keep $DUR on my watch list for now, monitoing the SP action. If IPO holders are taking profits, then this potentially has further to run. Equally, the downstrend could turn quite quickly if someone quietly steps in and starts to build a position, as the volumes over recent days are getting quite low. (Maybe not Mathan or Henry J or Claude W!)

I'm going to look further into the project portoflio and the people in key positions.

But this is looking promising so far.

Disc: Not held

Thank you again @mikebrisy. This is absolute gold! The scatter plots showing CAGR v PE (including consensus) are very interesting. Lycopodium is a stand out for EBITDA CAGR v PE. I already have a large holding in LYL. That’s a very useful comparison.

Another risk I see is the recent growth in the mining portfolio which might come under pressure in future (and not just for DUR). DUR grew mining revenue 163% in the past year. With the downward pressure on commodity prices (except for gold) the miners are likely to trim their budgets over the next year. We could see mining revenue pull back.

We could also see a sell off from of Duratec from tomorrow, now the stock has gone ex-div (1.5 cps fully franked, or 2.14 cps gross). A normal market reaction would be a 2% fall tomorrow. In the case of Duratec there could be a number of keen sellers who have been hanging out for the dividend before offloading. Sometimes you can buy much better ex-dividend because it can perpetuate a falling share price, but that’s not always the case.

I envy your work Mike. You have an incredible skill set for analysis! I’m learning from it. Thanks.

Cheers,

Rick

Thanks @Rick , glad it’s helpful. Agree with your remarks about mining, even though asset sustenance is more resilient than growth capex - everything gets screwed down when prices dip.

I also noticed the standout of $LYL and have read some of the straws on it by distinguished StrawPeople incl. @Bear77.

@Rick - yes you were right about the continuing sell off today, although how much is due to ex-Div vs. broader market - ... fundamentally you expect c. -2% due to Div.

Your earlier observation about increased exposure to resources and the observation about $LYL got me thinking as to whether the sell-off over the last three months has been driven by the softening metals complex.

So I have plotted SP (not adjusted for dividends) over the last three months of ASX Materials Index, $DUR, $LYL and $WOR Indexed to 15/12/23.

I chose $LYL as a small cap peer with higher exposure to mining and mineral processing and $WOR as a diversified large cap exposed to the sector.

I make the following observations - purely on macro/sector considerations and not considering underlying performance:

• Materials is off about -10% from its peak (driven by Li and Fe,... and perhaps minor contribution from Ni)
• $WOR is flat with any metals impact offset by energy which remains strong, globally
• $LYL has outperformed by +15%, presumably driven by its exposure to Au?
• $DUR has under-performed by c. 30%

Given $DUR's relatively minor exposure to resources in this comparative analysis, I can't see softening sentiment in the sector being a factor.

And although there was a sharp leg down on the 1H FY24 result, the downtrend was established and is re-asserting itself.

So far, I can see only three factors:

• Reduced Order Book
• Margins lower than historical
• IPO participants taking profits

As a further comment on yesterday's comparative P/E analysis post, you could argue that $DUR's relatively minor (albeit increasing) exposure to mining and energy means that it should command a higher P/E on average than those companies serving the mining and energy sectors....all other things being equal, particularly given the stable, solid contribution from defense and the growing proportion of MSA income.

The case for value is continuing to build.

And just to close out the week, I've mapped the trends in the pipeline for $DUR.

While Pipeline and Tenders are healthy, the Orderbook has fallen to the lowest level in 4 years, although it should be pointed out that the figures for 2021, 2022 and 2023 are the values reported at the FY results, whereas the figures reported for FY24 are at the 1H results. (I'm not aware of seasonality in these measures). I've used a FY24 Revenue forecast of $588m in the calculation.

My recollection from the industry is that >100% is considered strong, 50-100% is considered healthy, and <%50% might be a cause for concern, but this depends on the track record at the tender stage, the procurement cycle, and the project life cycle.

On its own, this might not be a cause for concern, particularly given the strength of tenders and pipeline. However, there is a wider narrative of a potential slowdown in resources and commercial property. I don't have a good enough view on these sectors to judge the macro drivers. Furthermore, the 1H FY24 Results release called out delays in project awards in the all important Defence sector.

So, this is possibly the key leg in the Bear thesis: that $DUR hasn't been winning as much work as is needed to sustainably drive growth, and I think this less robust potential outlook might have caused some IPO shareholders to call time and cash in some gains.

Putting everything together that I've learned this week, I am minded to continue to watch the SP action, and will perhaps hold off to see what the FY looks like. No need to rush into anything, as I can't see any near term catalysts. A strengthened Order Book at the FY might counter the Bear thesis.

I think $DUR is a quality business with a lot to like about it. The question I haven't asked is "at what price would I be unable to say no"? That's for next week!

@mikebrisy I think you have nailed the bear case for Duratec. A weaker November 2023 order book ($388 million) will likely flow through to create an air pocket in revenue and profits sometime over the next year or two. However, the order book could surprise to the upside in future reports. At 24th November 2023, the pipeline and tenders were the highest ever at $3.74 billion and $1.02 billion respectively. Duratec have historically won about half the tenders they submit (on average, with high variability). This could lift the order book back up to $500 million.

I agree, there’s probably no hurry to buy the stock right now and it might be safer to check the order book in the FY24 report. Ideally we’d be looking for an order book approaching or above $500 million for revenue growth to continue.

Held

@Rick, yes, that's true, I was thinking that an order book back at $420m at FY24 would be enough to move me to a "Buy".

Such a result would demonstrate strong conversion of tenders. it is worth doing some simple maths.

$420m (my target order book for FY24) - $388m (1H FY24 Order Book) + $295m (est. H2 Revenue) = +$327m orders added in H2 which is +$654m on an annualised basis.

Assuming 10% revenue growth from FY24 gives FY25 revenue of $647m. So, such an order book gets us back above 100% coverage.

If the result is more in the range of $400-$420m - then that is still a significant improvement. I would consider buying it, depending on a) the SP at the time and b) the management guidance commentary, as well as c) the level of tenders and pipeline, but these last two measures are only meaningful given the rate of conversion to orders.

I see the SP continues to slide this morning. This is testing my capital discipline - I want a great company at a fair price, and not a mediocre company at a cheap price. Delivery of pipeline conversion to orders in the tougher macro is part of the "great company" proof.

Well said @Rick and @mikebrisy . Historically they have given updates to guidance in between reports when there have been meaninginful new contracts won, so you may not need to wait till the Annual report for an update if they do convert a good chunk of the tenders. I'll be watching for the same thing and share the question mark.