Transfield Services – An analysis

Transfield Services (ASX:TSE) is an Australian listed company providing services such as operations, maintenance, and asset and project management services to the  Resources and Industrial, Infrastructure Services and Property and Facilities Management sectors. It was listed in May 2001.

In this report, I’m going to have an in-depth look at Transfield’s financials and its current valuation. I’ve also attached an Excel model for the company, so you can see the financials for yourself.

Financials

Transfield reported a net loss of $19.3m for the 2011 financial year, although the companies operating profit was $100m. Thanks to non-recurring items of $119.9m, which include $50m of foreign exchange losses, $19m loss on the sale of USM (a business they only bought in 2008), and $36m due to the sale of the Infrastructure Fund (launched in June 2007). While these costs may be non-recurring, they do reflect bad business decisions and as such abnormal costs should be included in an analysis of the business performance.

Profit margins for Transfield are very skinny. An average profit margin of 1.5% is more akin to a company like Woolworths which has sales of over $54Bn. In fact, Woolworths (ASX:WOW) had a profit margin of 3.9% in 2011, and averages over 3% over more than 10 years. The problem with such skinny margins is that any downturn in business or minor mistake in business decisions, will have a severe impact on a business like Transfield. While the business cycle is sailing along smoothly, companies like Transfield can mask their actual performance and quality, but any bumps along the way soon reveal the company for what it really is; and that’s a poor quality company that should be avoided at all costs by investors.

When I see a company report a loss, but then talk about how they’ve increased their EBITDA margins, it rings alarm bells to me. The further the number is away from the true reported profit, the more the company’s trying to pull the wool over investors eyes. Have a read through Transfield’s 2011 annual report and you’ll see EBITDA mentioned a lot.

Here’s some other warning signs:-

• Transfield has raised $1,127m in equity since listing.
• Its total net profit over the same period is $313m on revenues of $21,777m ($21Bn).
• Debt has increased from $320m to $516m since 2000.
• The company’s total “cash” profit since listing, which includes debt raised and equity raised, is actually a loss of over $1Bn.
• Shares have grown from 33m to 492m.

Takeover target?

Transfield has long been mentioned as a potential takeover target, and United Group was rumoured to have made an initial approach in 2010 offering between $4-$5 per share. However, it was apparently knocked back by management of Transfield. Maybe they wanted to keep their jobs?

In my opinion, United would be crazy to go after Transfield now. While Transfield’s share price is now languishing around $2.30, my primary method of valuation is $1.65, indicating Transfield shares are still overpriced.Even using relative valuation methods it looks expensive. With a PE of 12.9 and EV/EBIT ratio of 17.7, it doesn’t look cheap.

Shareholders can only hope United loses it head and comes back with another $4-$5 per share offer.

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