Somero: have the foundations been laid for growth?

Somero Enterprises is an American company based in Fort Meyers, Florida. It is engaged in the production and sale of concrete levelling technologies, primarily laser screeds, which ensure recently poured concrete is flat and level for further development and is typically used in the upwards build of warehouses, skyscrapers and offices. Somero is a unique business in that it is incorporated and does the vast majority of its business in America, however, it is listed on London’s junior AIM market — seemingly the reverse of pretty much every company looking to go public in current times who flock to the NYSE or the Nasdaq. Anyway, it is quite rare that British small-cap investors get the opportunity to buy a small US firm on the London market. Let’s dig a little deeper and see what foundations Somero has laid for itself in recent years.

US Infrastructure Package and its Potential Effects

First and foremost, before we dive into Somero’s background and recent results, let’s take a look at the overall marketplace and reasoning behind writing this particular article. Somero operates within the US infrastructure industry, which has recently been provided with stimulation due to the potential unleashing of a $2 trillion-plus infrastructure spending plan put together by Joe Biden. Those of you who read my monthly newsletters will have been informed of this package recently and the implications the wider market and economy is drawing from current US stimulus plans. However, there is a more direct scenario playing out as a result of this pending infrastructure package. The following stocks are all tied to the infrastructure thesis, and I have added their performance since the lows of March 2020. For reference, the S&P500 has done 77.7% from March 2020 to date.

  • United Rentals (356%) — the world’s largest heavy equipment rental service.

  • Ashtead (210%) — a British equipment rental company with a large US presence.

  • Caterpillar (141%) — a heavy equipment supplier to the raw materials and construction industry.

  • Vulcan Materials (83.15%) — a US construction materials and aggregates company.

  • Somero Enterprises (118%) — a US concrete levelling company.

Caterpillar Stock Price

All of the companies listed above have reclaimed all-time highs in their stock prices. Looking at long term charts for United Rentals and Caterpillar, these stocks have pretty much gone vertical since the March 2020 lows. However, Somero has underperformed this basket of peers by a fair margin and has not yet broken its pre-Covid all-time highs.

Somero's Business Structure

A Boom Screed

Somero’s revenues can be roughly divided into three categories. Firstly, Screeds, the largest segment, at roughly 60% of revenues, for which Somero offers Boom Screeds (as seen in the image above) and Ride-on Screeds. These are laser-guided machines that are able to drag concrete back and forth to ensure the poured concrete dries in a level solid form. The second-largest segment ‘Other services’ accounts for roughly 30% of revenues and includes parts, servicing and training revenues, which all provide a complementary revenue stream for Somero. Lastly, at around 10% of revenues, Somero has a 3-D profiler system, that enables the digital management and oversight of levelling projects.

So why do we need laser screeds in our industrial construction process?

Well, Somero’s strapline goes some way to explaining their product need with ‘Faster, Flatter and with Fewer people’. Somero is the modern-day replacement for the manual and labour intensive screeding with many workers to a particular job. Manual screeding isn’t going to derive the laser precision of Somero’s screeds either, and flatness matters. In the construction of a warehouse where shelving racks are piled tens of metres high to the ceiling, having a flat surface makes a large difference to the final angle of a tall object. Thus, to get the job done efficiently and correctly, laser screeds are increasingly used in these types of projects.

Somero's Revenues and Performance

Recent full-year results show that Somero had a very resilient year in the face of global lockdowns. Despite many construction sites being forced to close, Somero delivered revenues of $88.6m, 1% shy of the 2019 result, driven by a strong North American second half of the year. Somero ended with a record level of year-end cash, driven by the operating result and very good cash conversion whilst also introducing three new products during the year.

Somero is a cyclical business. As seen in the 2008/9 financial crisis, where the construction industry was arguably at the epicentre of a wider global crisis, Somero’s revenues fell significantly. So significant was the initial drop that it took Somero until 2015 to reach pre-financial crisis revenue levels, owing to the lasting damage in Somero’s end markets from the crisis. Fast forward to 2020 and Somero has performed much more resiliently. The epicentre of this crisis has averted construction and mainly focused itself on wreaking devastation on the Travel and Leisure industries, which are reliant on social interaction. I wanted to display this revenue picture to explain that I would not advocate holding onto Somero in any likelihood of an industrial contraction. Somero is the sort of company I would buy during an upturn in industrial activity, but keep an eye on for signs of trouble on the horizon. Looking at the current macro picture, where we have PMI manufacturing indexes globally up-trending, Copper and Steel commodities rapidly rising (a sign of industrial purchasing activity) and Joe Biden looking to unleash his stimulus, it looks like the story for the infrastructure industry is positive.

I also wanted to show you the long term revenues of infrastructure-heavy goods company Caterpillar, to explain how well Somero has done to grow revenues consistently emerging from the 2008 financial crisis.

Caterpillar, which sells large loading vehicles to mining companies, diggers and various other heavy goods to the construction industry, bounced back much faster than Somero after the financial crisis, with pre-crisis topping revenues in 2011. However, revenues have since proved volatile, likely due to the commodity crisis in 2014/15 which led to large declines in the values of metals such as copper and iron. This led to less revenue for Caterpillar, under the constraints of poor end markets, and therefore induced volatility. However, looking to 2020 paints an interesting story. Caterpillar revenues fell roughly 22% vs a decline of 1% for Somero. Yes, the two companies are involved in different end markets and are of very different sizes, so this makes comparison quite difficult, however, it does help to show the resilience of the market Somero operates in. Somero has likely aided itself with the increased focus on service revenues to its already large installed base, and software services such as the 3-D profiler system, which help provide some buffer in times where customers are less likely to be purchasing new equipment.

Somero Financial Table - Source: Annual Reports

Looking at the financials, Somero seems to excel. The key metric for me here is the steady hold of operating margins above 25%. In recent years, operating margins touched 30%, which shows Somero’s significant pricing power and efficiency to turn revenue into profits, an exceptional feat for a small company producing heavy machinery. Somero has achieved much of its growth organically and has a well-managed balance sheet, shown by the low debt to equity ratio of 0.24. Lastly, Somero’s return on capital employed (ROCE) figures are very good, typically in the 40-50% range, showing Somero is an efficient and productive allocator of resources. These results are in line with some of the best businesses I have analysed in recent times, and if Somero were able to deliver these results year after year, I would expect the company’s shares to trade at a significant premium to the wider market. However, as we know from history, Somero’s revenues are linked to the industrial cycle, and a bad year can spell significant trouble for Somero’s P&L.

Somero trades on roughly 15 times estimated earnings in 2021, and I think there is a strong likelihood Somero will beat this estimation, vs 30 times estimated 2021 earnings for Caterpillar. With various macroeconomic indicators pointing to a more than healthy construction market in the short term, I think there is still value to be had in Somero’s shares currently. As Somero is typically very efficient at turning top-line (revenues) into profits, our focus as investors can remain on the top line, and ensuring Somero is operating in a construction market that is growing.

The Twenties Trader does not (yet) own shares in Somero Enterprises, but may look to initiate a position within the next 72 hours.

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