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Opus – fundamentals justify large upside

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The share has been a real dog throughout 2015. We’ll have a closer look whether this was justified or if it is time for a comeback during 2016.

There have been two major events that put Swedish vehicle inspection specialist Opus Group in the focus of the media; one with a negative read across for the company and one with a positive. For some peculiar reason, the stock market seems to have focused only on the negative one, which we believe offers a great entry point for the long-term investor.

Opus Remote Sensing revealed Volkswagen’s wrongdoing already 2014

Already during 2014, Opus identified unusually high emission levels from Volkswagen and Audi diesel cars in the USA with the help of its Remote Sensing – technology. The results of the tests were presented in the USA several months before the VW-scandal was actually revealed. On September 3o th 2015, New York Times published an article about how Remote Sensing, by testing on the road in real-life conditions rather in the laboratory, can be an effective tool to measure emission levels for polluting vehicles. In the following days, Opus could report that the interest for its patented Remote Sensing – technology has increased substantially following the VW scandal. Furthermore, the US Environmental Protection Agency (EPA) announced at the beginning of October 2015, that stricter guidelines for ozone standards will be introduced. The establishment of mandatory vehicle inspection programs for environmental control is one way for the states to actually enforce the new standards and this could potentially be very positive for Opus.

Swedish “Transportstyrelsen” wants to lengthen inspection intervals in Sweden

In its home market Sweden, Opus was in October confronted with a proposal by the Swedish transport agency “Transportstyrelsen”, that is aiming to actually reduce the number of vehicle inspections conducted in Sweden by lengthening the inspection intervals to a rhythm of 4-2-2 years. If the Swedish government was to accept the proposal, the potential changes could become gradually effective during 2018 and 2022. However, there are several independent studies that show that the proposed changes would lead to worsened traffic safety and higher pollution levels. It seems at least questionable that the current Swedish socialist government, which is in a coalition with the environmental party, really wants to jeopardise the good Swedish standard when it comes to traffic safety and pollution. Opus is currently examining the potential effects of the proposal and the necessary adaptions it would need to make in order to minimise the potential impact of a worst-case scenario. The day Swedish media started to report of the Transportstyrelsen’s examination, Opus’ share got hammered from SEK 8,70 to SEK 5,4; an astonishing punishment of 40% for a proposal that:

  1. is not adopted by the government yet
  2. would start to impact operations several years in the future
  3. most likely will have only limited effects on Opus’s bottom line.

In an initial statement following the proposal, Opus noted that the economic effects for itself will be limited. The negative effect on Opus Bilprovning is estimated to be around 23% once the new rules are effective and given the prices would be unchanged. Supported of cost savings by some SEK 100m, EBITDA would decline by around SEK 30m compared to current levels, also assuming unchanged prices. Opus’s management believes that it is likely that the industry will compensate for the proposal by increasing prices which could eliminate the negative EBITDA effect all-together.

Global expansion in focus

Opus Group was founded in 1990 and is today one of the leading vehicle inspection players worldwide. In the US, the company is market leader with some 44% of the market while in Sweden the company is number 2 with around 28%. The company has grown its sales by an impressing 46% CAGR the last five years and sales reached almost SEK 1.5bn in 2014 with strong cash operating cash flows and good profitability. Following the divestment of its Equipment business during 2015, operations are divided into two divisions: Vehicle inspection international (ca. 67% of sales) and vehicle inspection Sweden (ca 33% of sales). The company conducts more than 25 million vehicle inspections per year and it is committed to continue to grow. With eight successful acquisitions since 2008, management’s track record of integrating new businesses is impressive.

The business as service provided within vehicle inspection is stable and non-cyclical with good cashflows. In the USA, Opus is growing strongly and the company is focusing on further organic growth by winning new contracts both in North America and in new markets internationally. The market for environmental and safety controls has existed for many years in developed countries but is now spreading to the rest of the world. Several developing countries are yet to introduce vehicle inspection programs, at the same time as their vehicle fleet is growing by 5-25% per year. There are obvious driving forces internationally with ever-increasing demands on safety and environmental compliance, and an increasing number of vehicles. In early 2015, Opus won a 20-year concession for public service for a province in Pakistan. In Chile, Opus won its third concession in the region around the capital Santiago with a 8-year duration.

International vehicle inspection the main driver

Opus recently reported its Q3 2015 numbers which showed a sales of SEK 386m (+6.8% y-o-y) and an EBITDA, excluding non-recurring items of SEK 77.8m. This implied an adjusted EBITDA margin of more than 20%. Within International Vehicle inspection there are several interesting projects. Besides the already mentioned concessions in Pakistan and Chile, Opus launched a new Remote Sensing program in Virginia, USA during Q4 2015 and an additional so-called “Equipment as a Service (EaaS)” program has been launched in California. Opus believes that it can launch the EaaS modell in several states in the USA going forward. Furthermore, the company is actively seeking to increase its number of services around the actual inspection. Management believes that the international inspection segment will be the driving force to reach the company’s growth target of 10% (CAGR 5 years) with an EBITDA margin of 15%.

At the end of Q3, Opus had SEK 296m in cash and a net debt / equity ratio of 0.77x. This despite the large acquisition of US company Drew Technologies in early 2015. As a target, Opus does not want its net debt to exceed EBITDA by more than 3x. At the end of Q3, net debt /EBITDA was at 2.4x.

Large upside in the share

A share price of SEK 6 implies a market cap of SEK 1.7bn and an enterprise value of SEK 2.4bn. Consensus according to Thomson Reuters is currently looking for sales of SEK 1.7bn in 2016 and SEK 1.79bn in 2017.  As a consequence, Opus is currently trading at a EV/Sales multiple of 1.4x for 2016 and 1.35x for 2017. Due to its many acquisition, Opus has a high level of depreciation which is the reason why we think it is most reasonable to look at EBITDA and there is usually a good correlation between the EBITDA margin of a company and the EV/Sales multiple the market is willing to pay for it. In the case of Opus,  consensus expects an EBITDA margin of 21% for 2016 and 22% for 2017.

Looking at the Swedish capital goods sector, there are eight companies which are expected to report an EBITDA margin between 18 and 24% for 2016. Those companies are trading a EV/Sales between 1.6x and 3.1x, with an average of 2.4x. The same group is expected to report an EBITDA margin of 17% and 24% for 2017. The corresponding EV/Sales multiples are between 1.5x and 2.8x, with an average of 2.2x.  It is interesting to note that the expected EBITDA margins for Opus are above the averages for those eight company, both for 2016 and 2017. This is one of the reasons, why we think that Opus deserves a valuation of closer to EV/Sales 2x to begin with. Using an EV/Sales multiple of 2x on the 2016-2017 estimates implies a reasonable share price between SEK 9.4 and SEK 10. This implies an upside of some 60% compared to current levels.

Nordic Investor

This article was originally published on www.vafinans.se

Disclaimer: Nordic Investor holds shares in Opus

 

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