Metka is an opportunity to buy a good, high ROIC engineering business at a very attractive valuation of 3.6 times EV divided by the Average Net Profit of the last 4 years. Metka has compounded cash adjusted BV per share by 15.9% since 1999 through June 2014. It’s headquarter is located in Greece and it has good management that eats its own cooking. I believe this to be a great opportunity where management will continue to grow the business while building value for its shareholders.

Syria and Iraq

So let’s first address the elephant in the room and get this out of the way … this company currently has large contracting projects going on in Syria and Iraq. Let me assure you, all these projects have standing letter of credits from high quality investment grade banks in place that guarantee payment based on progress. Metka takes limited credit risk for work performed.

The Company

Metka was started in 1962 by the Greek government. It was privatized and in 1998 the Mytilineos brothers took control of Metka. At that time the business was a contractor on Greek infrastructure. From that base the Mytilineos brothers build this business into a competitive engineering, procurement and construction business (EPC). Currently the Mytilineos Group owns 50.4% of Metka. Metka has been overseen by Ioannis Mytilineos since 1999. Since 1999 Metka has compounded book value adjusted for cash payouts to shareholders by 15.9% through June 2014. Ioannis and his brother Evangelos Mytilineaos together own 31.8% of Mytilineos Group, split almost evenly.

Metka is active in three segments. Most importantly it builds utility plants for electric power operators. It also has an infrastructure business and a defense business. At this time the utility plant engineering and contractor business represents more than 90% of revenues.

With its utility engineering and contractor business Metka is focused on building Combined Cycle Gas Turbine Power Plants, Simple Cycle Gas Turbine Power Plants and Mobile Gas Turbine Power Plants. The company also has prior experience in building Conventional Thermal Plants (mostly Lignite) and Hydro Power Plants. Most of the focus now is on CCGT (Combined Cycle Gas Turbine), SCGT (Single Cycle Gas Turbine) and fast track projects like Mobile Gas Turbines. Fast track is important as fast growth in demand for power often requires fast turn around times. For example you might have a Jordanian city of 150,000 people that suddenly swells to 250,000 people because of refugees. In that instance a fast expansion of capacity is more important than the most efficient way of producing electricity. CCGT is the gold standard nowadays when it comes to gas powered utility plants. New gas driven utility plants overall, but especially CCGT, allow for lower environmental impact, more flexibility, relative low cost to build, low cost to operate and high efficiency. Currently Metka’s main business is in the MENA region, meaning the Middle East and North Africa. This is a region with fast growing demand for power and large amounts of natural gas. The demand growth is driven by population growth, the median age of the population and increased GDP per capita. All the countries in MENA are expected to see significant and continued increases in population for the next few decades and it is not just the number of people that is relevant but also the median/average age of the population. Adults use a lot more power per person than children and most of the MENA countries have a median/average age that is low. For example, the median age in Egypt is around 25 years old. 75% of the population is 40 years old or younger. And you will see this is the case in most of the MENA countries. Actually, the outliers from the Egyptian profile tend to have even younger populations. In short, there is this bulge moving through the population pyramid which will continue for a few more decades which means we will continue to see increases in power needy populations. In addition, North Africa and the Middle East do have reasonable potential for GDP per capita growth. If we assume 2%-3% per capita GDP growth in addition to about 2% to 3% demand growth due to population growth, then it is easy to see a need for a lot more power generation in the region. Compounding demand growth at 5% for 15 years gets one a little more than a doubling of demand. Also let us not forget that many countries currently lack enough stable capacity to supply current demand. Even in Iraq with all its political problems they are investing in electricity generation. Electricity tends to be a big priority for any government. After all it is one of the things that has a huge impact on the quality of life of a population. If you want to check, don’t recharge your phone and turn off the breakers in your house and office for a week and you will see what I am referring too. I think we all know this would be inconvenient, but from the perspective of many in the MENA region it is even worse because at most times they don’t even know when power will be available. For example in Iraq there is a peak demand of 14 GW, with 9 GW installed but only 5 GW functioning at this time. Power has a food and water quality to it. You don’t think about it when you have it, but you hate it when it is not available. My point is that there will be a lot of demand and fulfilling that demand will be a large priority for the respective governments.

Below is a graph that lays out the power consumption on a per capita (per 100K people) in different countries. As you can see total power consumption is significantly below that of advanced countries by multiples. A decent part of that demand is naturally also related to industry in developed countries, but we still see huge gaps.

Much of the additional demand for power in the MENA region will be supplied by gas powered plants as the region has an ample supply of natural gas which is much cheaper than exportable oil reserves.

Currently the company has contracts ongoing in Algeria, Jordan, Syria and Iraq. Turkey is an important market for Metka too as two large projects were recently finished in the country. Metka’s focus on the Middle East and North Africa has been quite successful. It is not an easy market to operate in but the company has shown it can successfully navigate this challenging geographic region. By now the company has built a skillset navigating the territory successfully. Foremost the company is very careful about getting paid. For example all its current projects Metka has letters of credit in place securing the payment of goods and services. Metka also focuses on working with high quality vendors like GE or Ansaldo for equipment in order to improve its success rate. When selling these plants at fixed prices it is important to have the partners that can execute.

Metka sells its projects for fixed prices, which allows for higher margins. Metka has a good reputation for finishing projects on time and within budget which is confirmed by its work for RWE and OMV for whom it finished two separate and large projects in Turkey in 2013. RWE is a large German power generator, while OMV is an Austrian counterpart. Both companies work according to the highest German standards and these projects will be of great reputational value for Metka in the years to come. This will allow Metka to sell more projects and allow it to expand beyond MENA into other regions. Besides building additional capacity, many existing plants are approaching their expiration date, provide little flexibility, are more expensive to run, use the wrong fuel source, are bad for the environment, and are a political nightmare. This will drive additional demand. The main problems are nuclear, coal and lignite plants. Nuclear, especially in Europe and Japan, has become a political nightmare. In addition a number of nuclear plants are starting to reach their planned expiration date. Another bad fuel source is lignite which is widely used in many countries and has an environmental profile much worse than that of coal. For example Greece gets 50% of its power through lignite, Germany about 25%. In Germany because of the closure of the nuclear installations there will be increased reliance on lignite for a large percentage of their supply. The closure of Germany’s nuclear facilities will reverse much of the progress Germany has made on global warming during the last decade. And then there is coal which creates the same environmental issues as lignite just less of them and we can see how the Obama administration and other governments around the world continue to increase emission regulations around burning coal (and lignite).

But there are solutions available, like gas powered plants and renewable energy. Many countries are placing a huge bet on renewable energy, mostly wind and solar. Another trend is towards more gas powered plants, especially where there is plenty of access to gas. Actually the drive for renewables also drives demand for gas powered plants as renewables currently need a back up source for the production of power when there is no wind or sun. The best backup source is gas powered plants as they can provide the flexibility of fast startup and shut down times where others, like lignite, coal or nuclear, do not have those properties. For example it takes more than a day to either shut down or start up a lignite power plant. In addition doing so is very stressful on the equipment. So even if there is no demand for power from lignite plants the power companies still have these plants running at 40% rather than shutting them down. This is happening on a large scale in Germany. Another valuable alternative is more hydro power, although building one of those tends to take a very long time and is very political. So based on the current group of technologies available the profile for gas powered plants looks very good.

This brings me to Metka’s future growth. But before looking forward, I’d like to discuss the job management has done over the years. Current management took over the business at the start of 1999. At the end of 1998 Metka’s business was entirely focused on Greece with revenues of €45.1 million and profits of €2.1 million. At the end of 2013 revenues were €606.5 million and profits were €91.6 million. Since 1998 through 2013 revenue growth compounded at 18.9% and profit growth compounded at 28.6%. Also since 1999 through June 2014 management compounded cash adjusted book value per share by 15.9%. At the end of 1999 cash adjusted book value was €1.78 per share. In June 2014 cash adjusted book value per share was €15.08 per share. Cash adjusted book value adds back all the cash management paid out to share holders over that period. In 1999 the business was 100% focused on Greece, now over 90% of revenues come from outside Greece. Despite going through the Greek financial crisis, which started in 2008, the business increased its cash adjusted book value per share from €5.5 per share at the end of 2007 to €15.08 per share in June 2014.

Below is the progression of the adjusted BV per share:

In June 2014 Metka’s back log was €1.308 billion.

My thinking about the future of Metka’s business I will separate into two segments. A. How will Metka do within MENA? B. Will Metka be able to grow outside of the MENA region?

1. So what about MENA and Metka. All of the MENA countries need more capacity. There are some trouble spots, being foremost Yemen, Libya, Iraq and Syria. The rest currently has a good amount of stability, enough for projects to happen going forward. It seems there is still plenty of market to be had from the growth of the non-troubled countries. But even in the real problem countries, like Syria and Iraq, Metka has been quite able to execute projects. As long as the area is not a full on war zone Metka can finish projects. At this time Metka has 1 active project in Iraq and 2 active projects in Syria. The 1 active project in Iraq is near Basra and Metka is executing quite well without interference to the point that Metka recently accepted an additional order for work at the same plant. Since the current troubles in Iraq are mostly focused around Mosul it seems unlikely that this project will be halted. One never knows, but it would be a long way for IS from Mosul to Basra mostly through majority Shia country and exposed to US air strikes. In Syria there are two projects. The first project is in Deir Ali, near Damascus. At the end of 2013 this project was 85% finished and the plant is expected to be commissioned early 2015. Work had to be stopped at one point, but Metka is getting the job done under difficult conditions. Now that the government has made significant ground on the opposition it is likely this project will be finished as projected. The second project in Syria is in Deir Azzour. Well Deir Azzour currently is on the frontline of the battle between the Syrian government and rebels. Work on the ground has not yet started, although preparatory work is being done. As long as the Deir Azzour region is not stabilized it is unlikely work will start locally. Then there was a new $1 billion project that was awarded to Metka recently in Al-Anbar province in Iraq before the recent IS troubles. In this case Metka decided to partner up with Sepco, a Chinese contractor. Sepco will build the project on the ground while Metka will maintain a supporting role doing the engineering and project management. Basically Metka will do work needed outside of Iraq and Sepco is committing to do the work inside of Iraq. I guess the thinking goes that Chinese companies are less of a target than Western companies.

Always keep in mind though that for any of these projects there are active letters of credit in place guaranteeing payment based on progress. So even for the work done until now on Deir Azzour Metka is getting paid. Metka is very careful about avoiding credit risk.

Overall, as long as the MENA region does not turn into an all out war zone I believe there to be significant opportunity for business and growth for Metka in the region. Especially in case the region stabilizes there is a lot of upside to be had in MENA. As I mentioned before it is not hard to see demand grow at a 5% clip annually for a long time to come in MENA. For example just Iraq needs between 10 and 12 more GW capacity built by the end of the decade. Also Iran is a closed market at this time due to long lasting sanctions. Iran has a huge need for the replacement of old plants and the building of new gas fired plants with a fast growing population. In case of a positive outcome to the negotiations with Iran and a lifting of the sanctions, there will be a huge new market opening up within MENA.

On the other hand what happens in case more countries in MENA are engulfed by problems? Then we need an alternative. Metka has proven in the past that it can be flexible and adjust, like it did when the Greek crisis made Greek business dry up.

1. So will Metka be able to grow its energy business outside of the MENA region? I believe moving away from MENA would be possible. Expanding into other regions is the logical next step for Metka anyway. A decade ago most of Metka’s business was in Greece, now very little is. Metka understands the need to adjust. Lately we see signs of that good operational performance being rewarded. In 2013 MENA finished two separate projects in Turkey for top of the line power generators. One large project, 870 MW, was for OMV, a large Austrian power supplier and the other one was 775 MW for RWE, a large German power company. These were both huge reputational wins for Metka and because of those experiences it will now be able to use that going forward in MENA, but also in other areas like Africa, Europe, Asia, etc. You can also see the good reputation Metka has due to continued reordering in MENA countries. The clients like what they see and continue to order new plants from Metka. For example Metka recently finished a 146 MW single cycle plant in Jordan and was awarded a new contract to build another 143 MW combined cycle plant at the same location for the same client. The same is going on in Algeria where Metka has 4 projects, 1 recently ordered, under contract at this time and the Algerians keep ordering more. I believe that Metka should be able to translate that reputation and experience into other regions. Basically Metka has the best of both worlds at this time. It has shown it can execute projects in very challenging environments and it has proven it can deliver product up to German expectations.

There are plenty of markets where Metka can expand into. The next most logical choice is Africa. Africa has very good fundamentals going forward, being a very young population with the median age in Africa being less than 20 years old, and fast population and GDP growth. Africa currently has a population of 1.1 billion people growing annually at a conservatively projected 1.5%. In 10 years that gets us to a population of 1.28 billion people in 10 years and 1.48 billion people in 20 years. Also know that the median age being below 20 means the number of adults will explode and adults use a lot more power than children. Add to that some GDP per capita growth and suddenly you have demand expanding at 4% to 5%. And there are also plenty of old utility plants that will need refurbishing or replacing. This all means there will be a huge need for more power plants in Africa and Metka has the skills and reputation to execute those projects in challenging environments to stringent quality standards and on time. Or let me say it differently … if you can finish a power plant in Syria in the middle of a civil war you can build power plants pretty much everywhere possible. As long as people aren’t shooting at Metka it seems they can build it.

Metka can also look towards the European Union. The European Union’s electricity strategy is a total mess. Countries are actively looking to shut down their nuclear power plants while not having adequate supply of power available. There is a huge drive for renewables which will also drive demand for combined cycle gas turbine plants. Now there is a lot more competition in the European Union for business than there is in MENA or other regions. Also besides Greece, Metka does not have a lot of experience in the European Union. Lastly gas is a controversial issue in the European Union as it is partly dependent on Russian supplies which drives geopolitical complexities. I believe Metka will do better focusing on developing countries with young and growing populations, GDP growth per capita and adequate availability of gas. Beside MENA and Africa, South Asia comes to mind. Metka already executed one project in Pakistan. Other areas that fit those criteria are other parts of Asia and Latin America. Basically there is plenty of business to be had for a company that executes well in this space.

So what about the Metka infrastructure business? Well that business has been close to dead for a number of years. The infrastructure business was focused on Greece and with the economy suffering there were just no large and complex infrastructure projects being undertaken. Although that seems to be changing somewhat. Currently Metka is working on €17 million 37 km road project and recently Metka has been appointed as the contractor for the Kiato-Rododafni railway line project in Greece, a €273 million project to be executed over a period of 24 months. Since 2008 so little maintenance and new construction has been done in Greece that a back log is developing for necessary work to be done. Once financing comes back there should be a fair amount of projects in the pipeline. For now this business is an option on the future.

Lastly there is the defense business which is fairly small, Metka has experience in contracting on different defense projects from building parts for submarine hulls to contracting on Patriot missile systems. It currently has a contract to build semi trailers and launching platforms for Patriot PAC–3 air defense systems. Revenue for 2013 for this business was €19.5 million.

Competitive advantage

Would I say this company has a moat? I do not think so. There are multiple companies that the build power plants and there is competition in the space. They do have a good business I believe which is expressed in good ROICs and ROEs. After all it is not easy to build a franchise in this niche. Most important in this business is execution. You have to be able to execute within a specific time period to a specific standard or your margin is gone and you might even start paying penalties. Metka has executed correctly each time until now. Starting up this kind of power engineering and contracting practice is not easy as one needs to have a customer that is willing to take a chance with an unknown engineering company for a projects that can cost hundreds of millions of dollars. This is difficult to achieve as electric power providers are notoriously conservative companies and because there is a lot of career risk in going with an unknown quantity. The only reason why Metka was able to startup its electric power engineering franchise was because it was given contracts by its parent, the Mytilineos Group, which allowed it to build a reputation. Then slowly it was able to further build its reputation by growing its business outside of the Mytilineos group to the point that currently most of its power plant business is outside of the Mytilineos group. Reputation is of huge importance in this business. That is why the RWE and OMV projects that were finished in 2013 were of such importance. Both are highly regarded conservative power providers from developed European economies with strict regulatory environments. The fact that Metka was chosen for these projects and executed well was a huge win. This will be an attractive part of the sales pitch going forward.

Devaluation

In the past I looked at what I call “Euro problem countries” for ideas, including Greece, and I was always worried as to what would happen to those companies in case any of those Euro problem countries would leave the Euro. Now I do believe that as long as there is a Greek government that wants to maintain the Euro Greece will continue to use the Euro. The problem becomes what happens when you get a new government that chooses to leave the Euro. In Greece, Syriza has made plenty of noise in that direction. At that time it seems to me that there would not be much that could stop the New Drachma from returning which would involve a huge devaluation. And a devalued currency is exactly what the Greek economy needs, it all makes sense to do so. The problem is that this could create substantial problems for domestically focused businesses, like for example banks. But this would not be much of a problem for Metka. Almost all its revenues are gotten from selling contracts in dollar or euro in international markets outside of Greece. So if the New Drachma returns Metka would actually benefit and see a reduction in costs while still being able to sell services in hard currencies. Because of being so internationally focused Metka has not been impacted and likely will not be impacted much by the Greek economy going forward.

Cash

Metka has a lot of cash or cash equivalents on its balance sheet. On first sight one would think that net cash was €283.03 million (€5.45 per share), but there is more cash hidden on that balance sheet under Other Receivables. (Note 7 of the June 2014 report) First there is Receivables from Subsidiaries for the amount of €38.3 million, which concerns money invested through Mytilineos Financial Partners in liquid financial assets. For some reason this cash equivalent asset is booked as a receivable. In addition there is also cash under Other Debtors, for a total of €23.8 million, which is pledged cash as collateral for the issue of letters of guarantee. So total true cash balance available at the end of June 2014 was €345.13 million (€6.64 per share). In my valuation I will assume the current business needs €100 million in cash to run and that €245.13 million is excess cash.

Valuation

As you can see below according to my calculations and expectations Metka currently trades at 3.6 times its EV/net profits assuming excess cash is €245.1 million.

Calculating my upside I assume that

• I will keep the stock 3 years.
• Earnings grow at 5% each year.
• A reasonably conservative multiple is 10 times the average net profit for the last 4 years.
• Then I add back the excess cash on the books and I add the past year’s profit to that cash balance.