Lesico (TLV: LSCO) Investment Thesis
By Eyal Weitzner
A well-managed, growing Israeli infrastructure construction micro-cap with a compelling valuation and a massive future tailwind.
Current price: 3.92 NIS per share
Target price: 8.15 NIS per share
- Founded in 1969 and public since 2017, Lesico trades on the Tel Aviv Stock Exchange.
- Lesico is a nano-cap with a market cap of 53M USD (~178M NIS).
- Key specialized niches within its core infrastructure construction market include process piping for the semiconductor industry (used in clean rooms), power plant turbines, and above ground or underground data centers.
- Lesico belongs to “The Big Boys Club,” a group of 15 leading infrastructure contractors who can compete for contracts larger than 100M NIS – and our research suggests that competition for such large contracts is diminishing.
- CEO Eyal Leshman, the founder’s grandson, maintains an owner operator mindset in a family-controlled company; Insiders have plenty of skin in the game holding ~69% of the company.
- Lesico is profitable and has a rock-solid balance sheet with 93.5M NIS cash and traded financial assets.
- A recent strategic, value-creating acquisition went completely unnoticed by the market – despite increasing EBIT by 22% and backlog by 10%.
- Current adjusted EV/EBIT stands at a multiple of 3.5, a steep discount to public peers.
- Israel’s new strategic government infrastructure master plan is poised to drive the Israeli infrastructure market with a strong, decade-long macro tail wind.
- Lesico’s business has little exposure to COVID-19 financial disruption.
- “If all the approved government plans in Israel move forward, there’s just not enough contractors in the country to take on all those projects.”
Israeli infrastructure company CEO predicting the industry’s potential (May 2020).
*Israel’s currency is the New Israeli Shekel (NIS) ₪. 1 USD = 3.37 NIS as of September 04, 2020.
Founded in 1969 By Shlomo Leshmanm, Lesico is a leading infrastructure construction company in Israel. Lesico’s key capabilities, from its webpage, include [sic]: “the planning and execution of complex engineering projects in various fields of activity such as construction of buildings for various authorities including public buildings, laying of railroad tracks, sewage treatment plants, pumping stations, systems at power stations, complex piping systems, storage and transportation facilities of fuels And gases, designated facilities, protected structures, water pools, laying of high voltage lines and more”.
Lesico is still managed and controlled by founding family members Yehuda (73) and Yehiel (70), are co-chairmen of the board, and Shlomo’s grandson, Eyal (51), is Lesico’s CEO.
In May of 2017 Lesico became public via an IPO in the Tel Aviv Stock Exchange. Currently, insiders have a meaningful 68.73% stake in the company. We calculated the ratio between company ownership and combined insider salary to be 22, a high ratio we believe implies an alignment of interest between insiders and minority shareholders.
In March 2018, Lesico bought a specialized military construction engineering company, Poldmir, in its first acquisition. Lesico bought a 56% controlling stake for 9.75M NIS, implying Poldmir’s overall value of 17.4M NIS. Poldmir’s backlog at acquisition was 350M NIS, and in 2019 Poldmir earned more than 6M NIS, so the acquisition essentially was done at a P/E of 3. It is our understanding that there are several similar opportunities in the infrastructure industry today ,and further, that Lesico is open for more M&A opportunities assuming companies are aligned with Lesico’s core strategy.
Strategically Lesico is a specialized infrastructure niche company. Management aims to find new niches, as they have lower competition and higher margins.
An example of such a niche is Lesico’s decade-long business relationship with Intel Israel (Intel has a large manufacturing facility in Kiryat Gat, Israel). Lesico is one of a handful of contractors certified in, and with experience in, building process piping and other particular structures needed for constructing and assembling clean rooms for the semiconductor industry.
Another example is its long-term sub-contractor relationship with Mitsubishi. Lesico builds turbines for power plants, and through this relationship, it has gained several international projects over the years for Mitsubishi.
Overall we find current management led by CEO Eyal Leshman to be capable, highly motivated and financially conservative.
Operations and Financial Results
The following table summarizes key financial data from recent years:
At the end of the second quarter of 2020, Lesico is a profitable 178M NIS market cap company, with 93.5M NIS net cash and financial assets on its balance sheet.
The company’s general direction is growth and building a capacity to take on more projects. Form our understanding, a decade ago, Lesico’s revenue were approximately 150M NIS as a private company. We believe in 2021, revenue will surpass the 700M NIS benchmark.
Lesico operates in two segments. Its primary segment is Establishment, representing roughly 80% of revenue. Such projects include building factories, railroads, water distillation facilities, power plants etc. The smaller recurring revenue-based Maintenance segment provides services such as water and sewage infrastructure maintenance and service in energy facilities.
In 2019-2020, margins were weaker than those of previous years. The key drivers were mainly completion of lower margin projects and a continued investment in a U.S. subsidiary that has not matured yet as a business (See below for more information). Lesico also continued investment in a large future mega-project in the Republic of Ghana backed by E.U financial institutions. In the beginning of Q3 2020, Lesico had a backlog of 958M NIS, a backlog that equals almost 2 years of revenue.
We believe that there is a good probability for a stronger 2021 due to revenue recognition from higher margin projects, especially a long-awaited expansion of the local Israeli Intel manufacturing site.
*We use an adjusted EBIT margin as the acquisition of Poldmir created a non-tangible asset which is appreciated annually. We find this expense to be solely an accounting issue.
Raising an Additional 50M NIS via Bonds
On July 27th, 2020 Lesico announced a public raising of an additional 50M NIS via issuing bonds on the Tel Aviv Stock Exchange. This money comes in on top of the 93.5M NIS that Lesico had on its balance sheet by the end of Q2 2020.
This action was met with some distrust by the local market, that questioned the need for more cash. However, according to management, they want “fire power” on their balance sheet in preparation for a scenario allowing them to make a large acquisition, perhaps in the range of 50M-100M NIS. Management believes COVID-19may be a catalyst for such an opportunity.
Recent Strategic U.S. Acquisition
On August 6th, 2020 Lesico announced a first U.S. acquisition, of two local companies operating in North Carolina and Massachusetts specializing in road construction. It is our understanding that this has been a strategic goal for Lesico and that the company has been investing for several years in the U.S. in order to develop a U.S. subsidiary to enable such an acquisition. This announcement was accepted by the market with relative indifference.
According to the financial data that Lesico published regarding the two purchased companies, Lesico bought a 70% controlling stake for 9.35M NIS, implying an overall value of 13.4M NIS. We believe that the acquired companies will contribute at least 4.7M NIS of additional EBIT annually, and that is before any business development initiatives within them.
We believe that pre-acquisition, Lesico was generating ~25M NIS of EBIT annually (with deviations between years). Post-acquisition current EV/EBIT run rate should be close to 30M NIS annually, thus the EV/EBIT multiple stands at an undemanding 3.5.
Another important impact of the acquisitions is an additional 90M NIS added to Lesico’s backlog, representing an increase of 9.4% of Lesico’s backlog at the end of Q2 2020.
Valuation and Peer Group; Major Industry Trends
The following table summarizes key metrics for Israeli infrastructure contractors:
*Please note that some companies displayed in the table are not pure play infrastructure construction companies. Some have other business, such as residential construction or quarry mining activities.
Data is updated for September 04, 2020.
One fact outstanding is that Lesico, with 93.5M NIS net cash on its balance sheet (not including 50M NIS raised in July 2020), is not leveraged at all. This cash can provide future opportunities for M&A activity or new large projects.
While the industry average EV/EBIT multiple is 37, Lesico trades at a low valuation and an EV/EBIT multiple of 5 for TTM result, and an EV/EBIT multiple of 3.5 for what we consider as current EBIT run rate. Our research has led us to believe 2019’s result is below “regular” earnings power.
We believe that in recent years, Lesico has matured as a business and evolved to be one of very few companies able to win projects valued at 100M+ NIS. Our research has led us to believe that competition is even decreasing among ”the big boys club” that competes for such projects. Some companies already have full backlogs and limited capacity to take on future projects, while one major competitor filed for bankruptcy.
Israel’s population is 9.1 million, growing 2% annually, and the current level of the State of Israel’s infrastructure investment is significantly lower than the level in comparable countries around the world. McKinsey & Company helped the government strategize how to bridge that gap in the coming decade. It requires that Israel double its annual infrastructure expenditure to 60B NIS annually.
Many questions remain regarding just how much will be implemented, though. That said, it is clear there will be meaningful infrastructure investments in Israel, even with only partial implementation. Israel must maintain a certain level of infrastructure investment to remain a developed OECD nation. To put this trend in numbers, the strategic plan calls for an investment of over 600B NIS in the next decade. We believe, for conservative reasons, that 300B is a possible figure for total expenditure. Even that is extremely significant for a country with a GDP of 1.25T NIS (~370B USD).
An interesting view we just heard from an industry CEO is that the country does not have enough contractors to fulfill the government’s plan. We believe this dynamic will provide a strong secular tail wind for the Israeli infrastructure industry; in particular, Lesico, with its strong balance sheet and strategic focus on high value niches, is in position to be a major beneficiary.
We see management well aligned with this trend. We view CEO Eyal Leshman as a very capable operator, and the entire group of third generation managers in Lesico is a well- driven, focused team of experienced managers, all aged mid-forties to early fifties (a plus in the infrastructure industry). Lesico’s strategies focus on long-term value creation, and this is the kind of management we like to partner with.
In May 2020 a new government was sworn in after a year of political deadlock in Israel preventing formation. This new government is good news for the infrastructure industry. A new budget will finally be passed by the Knesset (Israeli parliament), and that will help advance planned projects that had been stalled by political gridlock.
We believe Lesico is undervalued and should trade on par with comps, the most comparable being Oron Group (TLV:ORON) that trades at an EV/EBIT multiple of 15. Damodaran’s enterprise value multiples by sector suggests that in the U.S. engineering/construction industry, EV/EBIT multiple is 16.4.
We believe a double digit EV/EBIT multiple is the bare minimum. Applying an EV/EBIT multiple of 10 on an estimated 30M NIS EBIT run rate leads us to set a price target of 8.15 NIS per share, representing a 108% gap to intrinsic value. We also believe that given the strength of the balance sheet and the alignment of interest between management and insiders there is extraordinarily strong downside protection implied by the current stock price.
Why does this opportunity exist? Lesico has been public for only a handful of years and it is relatively unknown to local Israeli investors. Furthermore, it is a small cap using Tel Aviv Stock Exchange standards. another factor is insiders owning almost 70% of the company, the public float is estimated to value 53M NIS (~16M USD). This is a thinly traded and relatively illiquid security. It is our philosophy that opportunity lies where other investors would not or cannot go, and we believe Lesico is a strong example of that.
Last but not least is the market effect of COVID-19. In 2020 Lesico’s stock price fell from 6.37 NIS per share to 3.03 NIS per share, quite volatile, although Lesico’s business has very little exposure to COVID-19 financial disruption.
Key risks include:
- A turn for the worse in the Israeli economy.
- Unsuccessful M&A operations.
- Losing key management owner-operator figures.
- A long-awaited expansion of Intel’s Israeli factory in Kiryat Gat brings a mega- project with anticipated high margins, expected to begin during 2021.
- A large strategic contract in Africa, in the works since 2014, is estimated to be worth 330M NIS (~third of current backlog). This is a high volume, high margin mega project.
- Successful development of the newly acquired U.S business.
- General increase in backlog following increased government spending on infrastructure in Israel.
In 2010, Lesico’s revenue was ~150M NIS; ten years later, that number has almost quadrupled. We believe in a good probability that the coming decades will be significantly better, and that Lesico will end the decade as a large contractor with around 2B NIS of revenue.
We view Lesico as a well-managed company, with a rock solid balance sheet, led by motivated capable managers with ample skin in the game. Thus, we also view current valuation as unreasonable and believe it represents a good buying opportunity.
Disclosure: Anafa Capital is LONG Lesico.