Consti - From a Turnaround Company to a Growth Company

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Consti’s difficulties continue.
Competitive bidding in renovation construction is a brutal game.
Typically, the one who promises to do it the cheapest is the one who ends up having to do the job.
I deliberately wrote “ends up having to,” because the winner of a renovation tender typically gets the contract with very low margins. Often, the project is even loss-making.

Consti’s disadvantage compared to its competitors is the company’s significant administrative and group costs, which are massively smaller for more agile players.

A housing cooperative’s renovation (e.g., plumbing or facade renovation) is a typical example of a Consti competitive bid. Due to my career path, I have been involved in over 200 such renovations.

It has been common in these tenders that about 40-50% of the bids received are priced “correctly.” In other words, they are very close to each other in price. They have been calculated seriously, and great care has been put into the bid estimation. As a result, the cluster of correctly calculated bids is a tight group with a spread of only a few percent.

Typically, about 40-50% of the bids received are somewhat expensive, meaning their price tag is 10-50% higher than the “correctly” priced ones.

Often, the bids also include one that has offered the job at a price that stands out as an “underprice” (when compared to the “true” market price). Typically, this underpriced bid is 4-8% cheaper than the second-cheapest contractor. So, not massively, but distinctly cheaper nonetheless. There are no longer any margins to be seen in a contract like this.

Then there is one more group that pops up every now and then in tenders: Unhealthily underpriced bids. In these cases, the bid can be 10-20% cheaper than the second cheapest.

It has been striking that these outrageous underpricings have almost without exception come in envelopes with the Consti logo. Private entrepreneurs do not fall for such mistakes. Their own pockets are on the line.

Everyone can think for themselves how profitable renovation contracting is if “correctly” calculated bids yield, for example, 3-5% margins.
Namely, if you calculate the technical lines correctly and put, for example, an 8% margin on the margin line, someone else will take the job for absolute certainty. In a competitive industry, contractors have to settle for low margins.

Consti is poorly equipped to succeed in competitive bidding with good profitability. The customer (e.g., a housing cooperative) typically buys from wherever they can get it cheapest, and that means very slim margins for the contractor, if any margins at all. The industry is competitive and many bids are received.

I do not intend to become a Consti owner in the future either, because smaller, local companies with a turnover of 3-15 million are capable of profitable business with significantly lower site margins than this giant. Therefore, they will continue to keep Consti in a tight spot in the future.

Does anyone have any thoughts on how Consti could turn this plight, caused by its heavier cost structure, into a success?

Correctly calculated bids are of course one way, but you won’t win many percentage points or tenths of a percent with that, otherwise smaller contractors will start snatching the jobs away, as their business can tolerate a thinner site margin than Consti.

Edit:
And of course, Consti does not systematically or even typically miscalculate its bids; much more often it is not selected because it is in the middle group of the bids received.
Clear cases of underpricing, when they are encountered, are however most often Consti’s handiwork.

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Good comments and insights, and I don’t have a clear answer to your question. The industry is challenging and fiercely competitive in Finland, and Consti, in my opinion, doesn’t have significant competitive advantages or the possibility of achieving high margins in the future. Our forecast also indicates that Consti will only reach a 3% EBIT margin in the long run, which is clearly below the company’s own target of 5%.

However, I wouldn’t be quite so definitive in all your assessments. “He who promises to do it cheapest typically ends up doing the job.” I myself have been involved in two housing company boards deciding on significant facade renovations. In neither of these cases did we end up choosing the cheapest contractor to implement the project, and Consti was chosen as the implementer for one. The justifications were that the cheapest bidder was in a financially weak condition based on financial statements, and the board was not certain whether the company could carry out such a significant project. Ultimately, the contractor’s reputation and references weighed heavily, as did the fact that Consti could also carry out other repair works in addition to the facade renovation. This is certainly not always the case, but these are just examples.

Regarding fixed costs, I completely agree when compared to small competitors with a few million euros in turnover. These can almost always offer cheaper prices due to a lighter cost structure. However, Consti’s actual fixed costs have, according to our estimate, only been 5-6% of turnover in recent years, and I believe this is competitive against competitors with over 10 MEUR in turnover.

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Indeed, in some cases, that’s a choice the board faces if the companies selected for the tender haven’t been pre-screened with sufficient criteria.

The tender process should always be organized so that only companies with the qualitative, financial, and technical resources to complete the project are selected. This means any participating company can be chosen to complete the project without unnecessary speculation. So why even include a company in the tender that cannot be selected due to its poor financial position? It’s best to leave such companies out from the start.

After tendering with the right quality of companies, the selection is no longer significantly guided by anything other than price (of course, there are always differences between companies, but typically it’s easiest for a housing company’s board to operate in a situation where the selection criterion is as simple as possible).

At worst, some shareholder might question the more expensive choice and complain, quite justifiably, why the shareholders’ money is being wasted by choosing someone other than the cheapest company. All of this can be avoided by carefully selecting the participating companies from the outset.

If renovation is challenging, sometimes buying it is too :wink:

Off the cuff, I’d say that in over 200 renovations I’ve been involved in, boards have chosen the contractor who submitted the cheapest bid 95% of the time.

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In this particular case, the decision-makers were strongly influenced by the fact that about 10 years earlier, the housing company had commissioned an extensive pipe renovation (traditional pipe replacement, ventilation, electricity, and wet rooms), for which the cheapest possible implementer was chosen. The contractor then went bankrupt in the middle of the pipe renovation, causing significant harm and costs to the housing company. After this, they were very cautious with the facade renovation. The final price difference between the contractors was also very small, so the majority decided this way.

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The cheapest among the best is a good criterion for choosing a contractor.
You should follow it.

You should leave out poor and mediocre ones from the entire process.

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Yeah, repair work is no star business::frowning: My uncle’s favorite, Lehto, is making heavy losses with it and luckily it’s now trying to get rid of repair work altogether. And for good reason, as Lehto’s papers are currently a real pile of losses hidden under the secret bottom of the portfolio. Then one day, when Lehto is pressing pure new modules in Sweden at a fast pace and with good margins, it will probably be time to see if the papers can still be sold honorably.

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Hesarilla discusses the target of Consti’s (potential) profit warning.

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Isn’t that already very questionable investor communication, not to open up with sufficient accuracy the factors/projects that influenced the negative outlook?

SRV, at least, seemed to have brought the difficulties of Redi quite openly to the market’s attention.

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Admittedly, the reasons for the profit warning could have been communicated better. In interim reports and briefings, the management has been very open about the problems and measures Consti has taken. It is essential to recognize that this project is more of a symptom than a cause of Consti’s problems. The 2017 financial statements summarized well what causes these problems:

“Especially the profitability problems related to the implementation and management of projects in the Building Technology business segment proved to be significantly greater than initially estimated. Further clarifications revealed clear problem areas related to organization, management, and project implementation. We also identified that profitability problems were partly due to project personnel turnover and price competition in the industry.”

In addition, in the Q3’18 interim report: “During the review period, we continued our measures to improve project performance, still focusing on implementing operating models that improve project steerability and monitoring. Our measures have been correct, and we have been able to see their positive effects on our new ongoing project deliveries. During the review period, however, we had to conclude that our corrective measures have not yet been fully implemented in all business units of the group as required. To ensure the improvement of project performance, the entire organization must take a step closer to site implementation.”

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Consti’s constant low flight doesn’t seem to be correcting its level to an attractive flight path for investors.

Still relying on my original theses, Consti is not a “buy” now, nor in the immediate future.

The company would have to come up with something completely revolutionary that would shake the foundations of renovation construction in terms of profitability to make returns interesting to investors in the current competitive landscape.

While waiting for those innovations, I’m keeping my money elsewhere than in Consti.

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I’ve also been in contact with Consti, and they are indeed involved in many projects, but last year, for example, they seemed to have difficulty finding skilled labor in a certain locality. This might ease up if construction slows down.
I don’t know if that would help much, though.

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The development has indeed been weak. Even if a turnaround in profitability were to happen now, the market will likely demand evidence of the turnaround over several quarters before pricing this turnaround into the stock. Last year is still fresh in memory, when Q2’18 brought a reasonable result, but after that, new project problems, two profit warnings, and the result again turned into a loss :expressionless:

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Statistics Finland is creating a new price indicator for renovation. The deadline for the survey was August 30, so I guess data will be released this autumn.

My own money has stayed far away from the sector, but it’s still interesting to follow the market’s development.

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Lehto leaves the harassment, does it help?

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This will negatively impact the market size for renovation if renovations are left undone due to lack of loans.

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Would a corona rap be coming, @Jesse_Kinnunen? :blush:

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The goal in the current situation is to maintain an active update pace and to comment on the effects of corona on all companies we follow. Unfortunately, the publication times of the reports cannot be announced in advance.

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Based on the news from Kauppalehti, I bought Consti. This chain has been very quiet, but does anyone have any thoughts on the company?

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In my opinion, Consti is one of the most interesting stocks on the exchange in terms of valuation.

  1. The company seems to have overcome its problems, as it has shown 4 consecutive quarters of improved results without the shadow of problem projects.

  2. Insiders and management bought shares between November 2019 and February 2020 at levels of 5.1 to 8.1 euros. They surely knew that the problems were behind them and bought the shares. Management owns significant amounts of shares.

  3. In light of the realized figures for the last 12 months, the valuation is attractive in the current market (P/E 12.8, EV/EBIT 10.0). Operating profit is 7.7m EUR (EBIT margin 2.7%), EV 78 MEUR, and market cap 67 MEUR. In addition, operating profit has the potential to improve significantly with so-called basic normalization. Corona does not seem to affect the profitability of construction much. The company operates in renovation construction, which is needs-driven and not very cyclical compared to new construction, where most construction companies primarily operate. The outlook for renovation construction in Finland is very positive for the next 5 years due to, among other things, the need to repair the building stock constructed in 1970-1980. Many investors do not notice this, and it is certainly reflected in the valuation (the company is valued as a cyclical company). The average EBIT margin was 3.6% in 2013-2016 before the problem projects began (years 2017-2018). As the result normalizes to the 3.6% level with current turnover, EBIT will rise to the 10m EUR level. This means approximately 1.03 EPS. With current multiples (LTM), this would mean a share price of approximately 12 euros, which has an upside potential of 35%. Inderes’ forecasts reflect such a basic performance level, but Inderes is still quite cautious with its target prices and recommendations. In my opinion, the multiples also have the potential to rise from the current level, especially if turnover can be grown and investors’ attention is drawn to Consti. The construction sector has not been favored by investors in recent years due to poor performance across the sector (e.g., Lehto, SRV). All companies have had problems, which has been reflected in valuation levels.

  4. Consti’s business ties up little capital, which means that most of the profit accrues as cash flow. Inderes’ dividend forecasts do not quite reflect this. Normalized free cash flow of 7-9m EUR at the current profit level can practically be distributed as dividends. FCF/EV is at the level of 9-12% of the current share price as a dividend if it does not find investment targets (growth investments are mainly acquisitions).

  5. Consti’s financial targets indicate that it primarily aims for profitability rather than rapid growth. (The >10% turnover growth target was abandoned). The company wants to grow faster than the market. The profitability target of EBIT-% 5% was maintained. The drivers of profitability are likely to be very selective project selection/bidding processes and controlled growth, which to some extent allows for the scaling of fixed costs. As Consti’s EBIT margin rises to the 5% level, which Consti aims for, operating profit will rise to approximately 14m EUR with current turnover, which corresponds to approximately 1.45 EPS. With current multiples, this would mean a share price of 17-18 euros, i.e., a doubling of the current share price.

  6. The share was listed at the end of 2015 at a price of 9.50 euros. From this, it rose within a year to 17.5 before project problems began.

In summary, I see significant upside potential in Consti’s stock from the current level of 8.8 euros, both in the form of a higher valuation and improving results. The downside risk is, in my opinion, limited and within the company’s control. There is no significant market risk as demand is quite stable. The risks are quite diversified, with the median size of renovation projects being a few hundred thousand euros. The biggest risk is related to the recurrence of broader management and project problems, but I believe that management’s focus and ownership in the company will ensure that the same problem does not recur in the companies.

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Good stuff, I agree with most of it and I also started looking into this a year ago. However, I want to see something concrete about the turnaround happening, and now we’re starting to see it from several quarters.

One big thing you didn’t cover in your otherwise high-quality analysis is the arbitration of the St. George project. Somehow, I think the market is still pricing in the uncertainty of the arbitration outcome. A decision should be made by December 31, 2020.

A 5% EBIT target is also quite ambitious to maintain over time, considering the industry.

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