Obrascon Huarte Lain SA (XMAD:OHL, Financial) was one of the best companies on the Spanish stock exchange due to the excellent profitability offered by its motorway subsidiaries in Brazil and Mexico until 2013. The company, which is also known as OHL, sold its Brazilian subsidiary just before the economic crisis began.
Its problems accelerated in 2015, when it was accused of receiving favorable treatment in the procurement of its exploitation contracts for Mexican highways. Eventually, the CEO of Mexican operations was dismissed.
Subsequently, other scandals emerged in Spain that linked OHL to the payment of commissions in Operation Lezo, which involved the deviation of public funds to private individuals in Canal Isabel II, leading to the dismissal of CEO Javier Lopez Madrid in 2017. In addition, Chairman Juan Miguel Villar Mir had to answer for the alleged payment of commissions.
OHL's image was badly damaged by these criminal proceedings. The market capitalization plummeted from more than 3 billion euros ($3.39 billion) and was subsequently removed from the selective Spanish IBEX 35 index in 2016.
In addition, from 2016 onward, OHL's profit and loss account deteriorated sharply, requiring a significant capital increase of 1 billion euros, which multiplied the number of shares in circulation by a factor of 3. From that moment on, the company focused on the reduction of excessive debt and, at the end of 2017, it decided to sell its motorway subsidiary in Mexico for 2 billion euros, eliminating its bank debt and leaving in circulation only a bond issue for just over 600 million.
After the sale of its motorway subsidiary, it appeared that its excessive debt load had been resolved, but the presentation of extraordinary losses of up to 1.3 billion euros in the first nine months generated panic among shareholders and the share has plummeted once again.
Basic company data
Number of shares: 286,200,000
Capitalization: 206 million euros
Net cash and short-term investments: 380 million euros
Enterprise value: -180 million euros
Adjusted net losses: -526 million euros (first nine months 2018)
Businesses evolution and financial strengths
Shareholders have been disappointed many times in recent years and the company's Sept. 30 earnings caused panic. Now we wonder if there is any reason to regain confidence in this security. Although there is some uncertainty, we think there could be a reasonably better outlook in the coming quarters.
OHL's management team has been completely reformed. It was this management team, along with its president, who decided to carry out the current strategy of making liquid investments, surface extraordinary losses and design an action plan to establish a starting point for building a new project.
The management team established the last quarter of 2018 as the starting point for initiating a future project seeking greater visibility in the medium term, recognizing as losses all those projects that do not guarantee profitability.
Of the current portfolio of 5.1 billion euros, it has been determined that 20% of its projects do not guarantee profitability and losses have been assumed on them, establishing a gross margin of 0% for these projects and 6.5% for the remaining portfolio. Future profit margins will not be affected by past losses and there will be better visibility of the business' profitability.
In addition, strong cost-control measures have been implemented that will enable the company to reduce its structural costs below 160 million, which will result in cost savings of 30% from 2019 onward.
The company's objective will be to preserve its cash levels (currently the cash is more than 1 billion euros) and to control its debt in order to obtain new sources of financing for its future projects.
This strategy of provisioning losses and trying to generate liquidity in projects we think is quite prudent and consistent since the new management team is trying to invest in a business that is viable. The management has a 2020 sales target of between 2.5 billion and 3 billion euros, with a gross margin of 8% (6.5% by 2019), structure costs of 4% (cost reduction of over 30% with respect to 2018) and an earnings before interest, taxes, depreciation and amortization margin of 5%.
The company has lost a lot of credibility over the last four years and its shares are very volatile, but anything that comes close to the new business plan will be recognized very positively because it is currently valued at just over 200 million euros, has more than 1 billion euros in cash, has guided for potential losses, has no significant bond maturities until 2022 and has an order book of more than 5.1 billion with more than 4 billion that will generate a margin of between 6.5% and 8% of gross profit.
The market is suspicious of the viability of the project right now, but the solvency of the business seems sufficiently backed up and the chances of it executing its strategy are relatively high.
The shares are currently in freefall after presenting accounts with 1.3 billion euros in losses and having provided for all those projects in which there is no practically full guarantee that they will generate gross profit.
Management and shareholders
OHL's largest shareholder is its 87-year-old chairman, Villar Mir, who was Spain's finance minister in 1975 and economic vice president of Real Madrid until 1995. In June, he reduced his stake in OHL from 50.1% to 37%, just before the last share price collapsed.
Some of the main international investment fund managers have almost 25% of OHL's capital. AzValor and Magallanes, two value-focused funds with a fantastic track record, have accumulated shares in the last quarter.
In June, José Antonio Fernández Gallar was named the company's new CEO. He is the fourth CEO to be appointed in the last two years, reflecting the uncertainty the company has suffered.
Valuation
To assess OHL, we have to determine if the company has any uncertainty as to solvency and profitability. If we clear up these two doubts, we can determine if the investment can be safe and profitable in the medium and long term.
OHL has gone from having a complex financial structure with a high level of debt to having net cash of 350 million euros, 1.05 billion in cash and 670 million in bonds and only 73 million maturing before 2022. In addition, its debt over equity is only 0.5 times, so it should not be a problem.
The company has made adjustments to all of its projects where there were doubts about profitability, provisioning millions of dollars and outcropping extraordinary losses. It has also generated skepticism due to the lack of credibility, but we do not think there are any solvency problems. As a result, we think that it could be the starting point for profitability.
We think that the company seems solvent (as also attested by the rating given by Fitch) its failed projects have been adequately provisioned, now the rest of OHL's investment projects will be profitable.
The management's objectives for 2020 of achieving sales between 2.5 billion and 3 billion euros, a gross margin of 8% and an EBITDA margin of 5% would value OHL at between 1 and 2 times EBITDA. It would also have a wide margin of safety. We have doubts about the company's projections, but we think OHL is a good value play to add to the portfolio.
Risks
As we have said, OHL has been involved in some scandals in Latin America and Spain, has deteriorated its accounts and has presented multimillion-dollar losses. The new management team hopes to turn a new page next quarter, but the big question is whether it will disappoint shareholders or actually improve this time.Ă‚
The company has lost credibility in the markets and nobody believes it can change course, but OHL has sold assets, eliminated debt, has positive net cash and has provided for all projects where there is doubt about their profitability. Is this enough? It seems so, but only time will tell.
If in the coming quarters there are additional losses, that would be very bad news. The company has drawn up its new business plan to seek financing for new projects and it would be complicated if it did not reach an agreement with the banks to access these new loans.
OHL will look for new projects in highway concessions, but hopefully it will not be immersed in new scandals.Ă‚
Outlook
The next several quarters will be key to determining whether OHL's new project is credible or not. The good thing is that on this occasion, "Mr. Market" does not believe anything the company says and is absolutely depressed about it, offering it to us for only 200 million euros.
If OHL is able to prove itself with its new projects, the stock has significant upside potential. We will be patient and observe how the company evolves over the next year. In my opinion, the risk-reward ratio seems favorable.
