Steel firm builds on strong foundations

INVESTORS have an understandable impression that the whole construction industry is a disaster area because of the building slump. But in some areas, capacity has shrunk to the point that a new cyclical upswing is already under way. Even if demand never recovers to the once-in-a-generation levels of the late 1980s, companies in those areas are capable of startling profit increases as demand slowly picks up from the floor.

An exciting example of the potential comes with Severfield-Reeve, at 100p a relatively tiny Yorkshire company that specialises in fabricating and erecting steel structures for buildings of all shapes and sizes. It has recently reported nearly trebled pre-tax profits for the first half of 1995 and John Reeve, the chairman, promises "very impressive results" for the full year and an "excellent outlook" - strong words from a company that is really on a roll.

One reason why the company is doing so well is Britain's success in attracting huge investments from foreign electronics companies such as Samsung, Fujitsu, Sony and Siemens. These huge projects require enormous amounts of steel and contractors insist on top quality work. Thanks to the shake-out in the industry, Severfield-Reeve is one of a handful of companies able to quote. It is also helped by its close relationships with construction companies. McAlpine, for example, makes no secret of its admiration for the quality of the group's work. McAlpine has just won the contract for the second phase of construction on a huge Fujitsu facility; it is easy to guess who will be the frontrunner to supply and erect the steel structure.

Competition has been annihilated by a downturn in the early 1990s so severe that even the super-efficient Severfield-Reeve was struggling and went nearly two years without paying a dividend. In rough numbers industry- wide demand peaked in the late 1980s at around 1.4m tonnes against capacity nearer 1m tonnes. It then crashed to nearer 700,000 tonnes in 1991-92 with the steel companies among the first in the construction industry to feel the crunch. Pain was exacerbated as prices also fell by a third in two years. Not surprisingly, some 250 private steel erection groups have gone out of business.

It is still tough. Profit margins are only a third of peak levels even for low-cost Severfield-Reeve and contracts are being tendered for on highly competitive quotes. Mr Reeve says that as order books start to lengthen he expects quotes will harden, leading to higher margins.

The company prides itself on staying flexible so that smaller orders are readily accepted to keep customers happy and the plant busy. It is also having growing success winning business overseas.

One terrific fan is the corporate financier, Johnny Townsend, at the group's stockbroker, ABN Amro Hoare Govett. He says that the stockbroker has a policy of not taking on companies capitalised at less than pounds 30m. So what is it doing with Severfield-Reeve, capitalised, even after a jump following good figures, at just over pounds 15m? The answer, he says, is that the company will soon be capitalised at more than pounds 30m. In other words, he is confident that the share price will soon be more than 200p.

The numbers support his assertion that the shares are cheap. In the light of the excellent interims, profit forecasts have gone up from pounds 1.5m to pounds 1.8m, against the pounds 722,000 reported for 1994 and with pounds 2.5m pencilled in for 1996. On those numbers the price/earnings ratio falls to 13 and then nine. That looks modest for a company that should have plenty of growth still to come. The forecasts, particularly the one for 1996, may also prove too cautious.

The bear case for a p/e well below the market averages is that the business is so cyclical. But Mr Reeve believes it is going to be much steadier in future and that seems likely, with many rivals wary of expanding capacity after the drubbing in the early 1990s.

A further share price boost could come in October when the group's share price moves from building and construction to engineering. The shares look an exciting buy.