SRFT is a family-controlled construction company operating in Israel. It generated revenues constructing and selling residential buildings (69% of revenues), commercial buildings (22%), and land/others (9%).
The company engages in the purchase of land with either bank financing (secured by the underlying property) or ‘combination’ arrangements with the seller, banks, and apartment buyers that requires little capital of its own. In the latter case, the land rights are recognized as an asset with a corresponding liability for ‘construction service obligations’ – both of which are reduced as the project progresses.
Demand for apartments is currently under pressure due to rising mortgage interest rates. Further, cost inflation may not be matched by future apartment price increases – the law limits the proportion of contracts that can be tied to the inflation index. Another constraint is the availability of land for construction, which is mostly controlled by the Israel Land Authority.
The company did particularly well after the pandemic reporting FY22 revenues of ₪470mn (FY21: ₪560mn), ebit of ₪169mn (FY21: ₪194mn) and net profits of ₪114mn (FY21: ₪137mn). This is backed by strong overall cash conversion.
Borrowings are mostly comprised of fixed-rate bonds (trading close to par) along with floating-rate bank debt. It had net debt of ₪132mn, which is minimal at 0.8x FY22 ebitda and 27% of net tangible equity of ₪484mn.
Tangible equity mostly comprises of land (₪260mn), and buildings under construction (₪509mn).
Though FY22 inventories were higher relative to cost-of-sales vs. FY21, it’s at one-third the average of the last six years.
The equity is currently trading for ~₪355mn indicating an enterprise value of ₪487mn, which is 2.9x FY22 ebit, 3.8x trailing three-year average ebit, and 73% of net tangible equity.
Compared to eight listed Israeli construction companies, it trades under one-quarter of the median earnings multiple despite gross and operating profitability double that of its listed peers and respectable returns on invested capital (~14%).
Recent dividends of ₪14mn yielded ~4% at market.
It has a flexible operating structure using subcontractors and leasing equipment. Management indicated that they may engage in investment activities for rent considering its unencumbered equity. Such options are valuable in a downturn.
Though the near-term future is likely to generate reduced sales and profits, the company appears undervalued and the investor is getting a sufficient margin of safety in demonstrated earning power and tangible equity lodged in the hands of a seemingly capable management.
