We initiate coverage of STRABAG , Germany’s and Austria’s largest construction contractor, with a Buy rating and a price target of €44.00, implying c20% upside.

 

●  STRABAG’s technological advantage should enable it to take market share and improve margins: We believe STRABAG’s advanced building information modelling (BIM) platform, BIM.5D, puts it at the forefront of the industry’s shift to more innovative and integrated end-to-end solutions. BIM digitalises the project lifecycle to increase efficiency and risk management. We expect that BIM will become a bidding prerequisite for government contracts. As an early adopter, STRABAG could take market share while having scope for margin uplift. We believe small to mid-sized firms will struggle to compete given that they lack scale and the skilled engineers required to integrate BIM.

●  The group is well-positioned to take advantage of a tailwind of volume uplift and a more favourable tendering environment: The group’s largest markets are Germany (46% of output volume), Austria (16%) and central and eastern Europe (22%), where it holds leading positions. We believe volumes in these markets should continue to improve as sound economic fundamentals underpin construction demand. The order backlog, which is at a record high, is evidence of this. Meanwhile, an ample supply of government-funded infrastructure investment provides greater scope to selectively bid for projects. We believe STRABAG’s broad network of raw material production plants will be a competitive advantage in an environment with rising tender volumes and input cost inflation.

●  STRABAG is attractive on a relative and absolute basis: We prefer STRABAG to PORR , its closest peer. STRABAG’s widening premium to PORR does not appear to be indicative of its relative value given PORR’s company-specific issues. STRABAG’s higher EBIT margins (+25bp in 2018E) and FCF yield (+460bp in 2018E), alongside PORR’s consensus EBIT downgrades versus STRABAG’s upgrades, support our view. STRABAG trades on 12.1x P/E 2018E (a 9% and 5.5% discount to its historical average and the peer group respectively) and 8.9x EV/EBIT 2018E (in line with its historical average versus PORR’s 11% premium). We estimate that the current share price assumes flat revenue growth and EBIT margins from 2016 to 2018. This is unwarranted, in our view. We forecast a 5.2% revenue CAGR 2016-18 and a c10bp uplift pa.

●  Higher liquidity may be on the horizon: STRABAG has a 13.5% free float due to its 80% syndicate holding. A stake sale from one of its four syndicate members would bring a welcomed increase in liquidity. We believe such a scenario is not unlikely given that one member has publically shown interest in selling, while another has expressed a desire for higher liquidity.