Forge Group Limited: One fast-growing & cheap play on the mining boom

Forge Group Limited (ASX:FGE) today announced its first half results for FY2012, with revenues up 12% to $227.8m and a …

Mike King

Mike King is a Fool.com.au Investment Analyst and Writer. He caught the investing bug more than a decade ago, at a time when the U.S. had invaded Iraq and fear reigned in the markets. His initial success as the markets took off encouraged his passion and thirst for knowledge. With 13 years behind him at one of Australia's largest domestic banks, Mike's passion for stocks led him to join a boutique funds management firm, where he stayed for four years. A seven-year stint in equity research at one of the largest investment banks in the world followed that, giving Mike a thirst to pursue his passion further. Mike holds a Diploma in Applied Finance and Investment and a Graduate Certificate in Financial Planning. His passion is to help retail investors invest better, and that passion was one of his primary reasons for joining The Motley Fool Australia in late 2011. Mike has written thousands of articles since joining, including for Fairfax Media, Yahoo!7, Ninemsn and has also appeared on ABC's The Business. You can see all of Mikes' holdings here

Published February 16, 2012 1:42 pm AEDT

Forge Group Limited (ASX:FGE) today announced its first half results for FY2012, with revenues up 12% to $227.8m and a net profit of $21.3m after tax. The company's order book has increased by 336% to $1.2Bn over the prior corresponding period.

It was also pleasing to see increases in both the EBIT and net profit margins to 9.4% and 13.5% respectively, over FY2011's full year results.

Forge – the company

Forge is engaged in construction, commercial building, engineering, maintenance and workshop fabrication. The company operates through four subsidiaries.

Cimeco, which provides construction services
CTEC (which was acquired in January 2012), provides engineering, procurement and construction (EPC), operations and maintenance solutions to the energy and utilities sectors
Abesque Engineering which provides EPC services to the resources, oil and gas sectors
Webb Construction which provides construction, structural, mechanical, piping, electrical and instrumentation services, mainly in West Africa.

The company also has a joint venture with Clough Limited (ASX: CLO) which was formed to service Australian EPC projects. Clough also happens to be a majority shareholder in Forge, holding 31% of the company.

Acquisition of CTEC

Whilst the results only confirm that Forge is an emerging EPC provider to the resources, oils, gas and utilities sector, the acquisition of CTEC appears to be an important step in Forge's growth strategy. As Forge state in their results announcement "we see significant upside potential for Forge subsidiaries Abesque and Cimeco in being able to undertake engineering and civil, mechanical and E&I services to CTEC which on CTEC's current contracts could amount to additional internally generated revenue of well over $100m."

CTEC is expected to generate additional revenues in the range of $200 to $250m in the first full year of ownership. In comparison, this is roughly equivalent to the total revenues Forge made during the first half of 2012.

High ROE and margins and little debt

Forge generates a return on equity of around 35%, and its margins are consistently higher than other construction and EPC providers such as AJ Lucas Group Limited (ASX: AJL), Ausenco Limited (ASX: AAX), United Group Limited (ASX: UGL) Leighton Holdings Limited (ASX: LEI), Watpac Limited (ASX: WTP) and even higher margins than Monadelphous Group Limited (ASX: MND).

In fact, many commentators have suggested that Forge is the "next Monadelphous", which shows how highly Forge is regarded.

The company has very little debt, with $93.1m in cash and cash equivalents, compared to borrowings of just $11.3m. Capital expenditure (capex) is forecast to be over $30m for FY2012 and debt levels expected to rise slightly. The capex spend is to position Forge to operate in a space normally reserved for Tier 1 construction contractors, and to participate in future large scale construction projects.

Risks

As principally a mining services company, Forge is dependent on the demand for commodities. The diversification into servicing the oils, gas and utilities sectors should mitigate some this risk.

The other risk I see is overspending on capex, and then not capturing the big project contracts that Forge is positioning itself to service. Substantial increases in debt would be one warning sign.

The Foolish bottom line

Forge has stated that it's likely to achieve substantial growth in the second half of FY2012 and beyond, through its CTEC acquisition and organic growth in its order book. Trading on an undemanding forecast P/E of 11.6, Forge is definitely worthy of a closer look.

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Motley Fool contributor Mike King owns shares in Forge Group. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool's disclosure policy

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