Skanska: A Good 2023 But Continued, High Valuation (OTCMKTS:SKSBF)

Dear readers/followers,

In this article, I mean to provide you with an update on Skanska (OTCPK:SKSBF) (OTCPK:SKBSY). My last update on the ticker in question was back in early December of last year, and I shifted my rating to “HOLD” at that time, from a “BUY”. In this article, I will update what I expect for 2024, and as we move into the Q1, we’ll see what sort of potential RoR we can forecast and see for Skanska. You can find the last article on the company here.

Skanska, like many infrastructure companies, is at its heart of a very cyclical business – but the company has a very strong operating performance to lean back on for the 4Q of 2023. The company has moved roughly in lock-step with the market over the past 4 months, returning around 8.5% compared to the market at 11%, but around 11% if we include dividends. Not a clear outperformance, and not at any level that I would consider appealing. Also, the company has moved up and down quite a bit.

When I last reviewed the company, we had 3Q – so now I will cover 4Q, as well as the forecast for 1Q and for the remainder of the overall year.

Skanska – Upside and potentials for the coming year

I’ve been covering Skanska fairly consistently for as long as I have been on Seeking Alpha. In fact, I’m probably one of the contributors who keeps the closest eye, based on the number of published articles, on this company and where it’s going.

So I want to be clear and say that Skanska is, in fact, a very good company fundamentally. It’s a cyclical construction company that has provided double-digit returns in the past, making it an attractive investment opportunity. Yes, the segments are inherently cyclical – this is especially true of its property segment, which has seen significant ups and downs in line with what we’ve seen in the past 2 years or so – but over the longer time, the trajectory for this company, if you buy it at a good valuation, tends to be good.

That’s why I have very strict pricing targets for this company. As soon as it drops below 140 SEK for the native, I’m “in” and either write some very attractive options or buy some shares.

However, if the company goes above 180-190, I’m “out”, and this is where I tend to write call options or sell my shares at a good profit. Anywhere between those valuations, I hold my ground, collect dividends, and am happy to own Skanska.

So where are we now?

Skanska had a “decent” 4Q. The company ended the year with a top-line sales revenue of 6%, with operating income decreasing 65% for the full year. This, however, includes significant impairment charges and changes in fair values. EPS was down significantly, which also led to a much lower dividend proposal of 5.5 SEK/share, down from 7.5 SEK in the last year.

Operating margins were under pressure. The company is still very much profitable, but dropped 100 bps in operating margin for its core segment, construction, but with a continued strong order backlog of almost 230B SEK.

The problems come from re-evaluations in the property market, which necessitated writedowns, resulting in a decline of 2B SEK in values. Also, ROCE in the project development segment saw declines moving from 8.1% to negative 3.7%, which is some of the worst we’ve seen from the segment. Also, RoE for the quarter was down to 5.8% from 15.8%.

At the same time, the company maintains an incredibly robust financial position, which enables the continued payment of a shareholder dividend well in excess of earnings.

On a granular level, I am not worried in the least about the construction segment despite a decline in revenue. A strong US construction market and a slowly recovering European market are likely to continue to contribute to a very strong trend over the long term here. This is also confirmed by the company’s backlog.

In residential development, the positive trend that at the very least can be mentioned is the fact that the company is actually selling more homes – up from 155 to 384 for the quarter. However, home starts are down almost 50%, which continues to show us that the Swedish home market is under significant pressure, and will likely continue to be there for as long as interest rates persist at a high level.

Things are even worse in Swedish CRE and CRE property development. Operating income turned negative to almost 1B SEK here, with significant impairments, low ROCE, bad finances, and so-so trends in pre-leasing and leasing. Skanska is divesting what it can.

The company’s book-to-build rates are declining, and overall bookings and backlogs are declining as well from the peak. All of these are natural developments, but they do have their impacts on the company’s share price and valuations – and also why I consider Skanska in fact to be relatively inflated at this point in time. Construction remains at a good level, but home/residential and CRE is where the issues currently are.

Pictures speak louder than words here, and here is what we have for Skanska at this time.

That being said, I do believe that we can clearly communicate a “trough” at this time. Rates have started dropping in Sweden. As I am writing this article, one of the larger mortgage banks just announced a 10 bps cut on the longer-term interest rates. The signs are clear for anyone who seeks them – these trends are coming down, and as a consequence, we’ll likely have a potential increase during 2024 for this company, perhaps as early as 1Q. Some of the capital-located (Stockholm) companies such as JM (No symbol) have reported the first indicators of a positive reversal, with increased sales and more market interest.

Thankfully, Skanska is moving very firmly out of CRE – and levels at this time cannot be compared to where the company was even just a few years ago. It’s in line to where I would hope that Skanska would go.

When it comes to Swedish CRE, I’m mostly staying firmly out of it, as I believe values are still inflated and the future prospects do not look good.

For Skanska on the other hand, prospects going forward are quite positive. For the coming year, a reversal to 15-16 SEK in adjusted EPS is expected, and even if there’s a degree of negative uncertainty to this forecast, this is actually rather slim.

Beyond that, the company is even expected to grow further in both 2025 and 2026, ending at a 17-18 SEK EPS in 2026, which would mean that the company’s current blended P/E at a price of 194, despite being expensive as I see it, is still rather low.

Let’s look at what this would mean for valuation and where we should and would estimate the company here – after we look at a bit at the risks.

Risks & Upside

The main risk to Skanska continues to be fairly simple – it’s macro, which is completely outside of the company’s control. In order for fundamental improvements in the company’s earnings, we need lower interest rates and higher buying activity, as I have pointed out before.

I continue to expect interest rate cuts this year, and I expect them to seriously begin in June to August of this year – though it’s of course that some over-eager Swedish Fed might try to cut while inflation is still above 5%. However, for as long as we lack clarity in 50% of the company’s segments, which we at this time still do, I’m continuing to impair the company’s targets based on this, which I view as a significant risk.

The upside for the company is obvious to me. You’re buying Scandinavia’s largest construction and residential building business.

Skanska – Looking at the valuation potential

So, let me be clear that I do not consider Skanska to be a “BUY” yet. Trading at over 190 SEK on a per-share basis, the company is still expensive, even with what I consider to be solid forecasts for higher earnings.

I would forecast Skanska at the historical double-digit 12-14x P/E – and given that the company currently trades at 19x, and a 12-13x P/E forecast puts us in the double-digit RoR, in terms of annualized rates of return, this just isn’t something that I am all that interested in – even with the company’s fundamentals. The new dividend puts the company’s yield well below 3% at this time, and that means that any savings account provides a better yield at this time as well.

Given the company’s inherent cyclicality added to this, I do not consider this to be an appealing potential at a conservative estimate – the company needs to go down.

Can the company go down as much as I would consider it attractive, given what we’re looking at in terms of growth? If the company starts to report quarterlies this year with what seems like good expectations, should that not support valuation growth, rather than decline?

It depends – the company rarely moves above this valuation on a historical basis – and you can see that the current valuation clearly is an anomaly. Given historical valuation levels and continued volatility, I would not estimate the company higher.

It also doesn’t help that over the long term, Skanska isn’t really a significant outperformer here. The company has managed below 9% annualized RoR if invested during 2003, with plenty of negative years. It’s more volatile than its quality would suggest, which means, to me, that you really want to make sure about your investment valuation level here, which over time has been clearly stated (using these historical valuations), to be below 13x P/E.

Based on this, which in fact has been clear about before, I would say that Skanska is not in a great position to invest here, and therefore I say the following as my thesis.

Thesis

• Skanska is a very solid construction company with plenty of upside at the right price. The company moves in clear cycles that are macro, not micro/company-based.
• At this time, we’re down because construction is working well, but everything having to with property or leasing is in a tight spot, despite an overall tight leasing market due to low supply in some of its core areas.
• The overall stance on Skanska is no longer positive and still a “HOLD” here. Before you invest, you should make sure that you’re not exposing yourself to unfavorable risk/reward situations – and in this case, I believe you may be doing so.
• I believe Skanska may drop down this year to 160-150 SEK/share, which would enable us to slowly start allocating in the business once again.

Remember, I’m all about:

1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansions/reversion.

I view the company as a “HOLD” rating here, because it does not fulfill my valuation-related criteria at the time of publishing.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.