Dec 6, 2023

Introduction:

Somero Enterprises (SOM). This London-listed company trades at a market cap of $206.5 million. It is based in Fort Meyers, Florida, but its main factory is in Houghton, Michigan, and it has offices worldwide, with minimal revenue generated in China. Somero designs, assembles, sells, and services patented laser-guided equipment (screeds) that automates the placement of concrete horizontal floors.

A laser screed levels concrete precisely and quickly. Contractors purchase and use these screed machines in large and small projects, from warehouses and roads to houses and skyscrapers. Larger and more expensive projects require higher degrees of precision. 

Somero holds patents (90+) on its inventions and recently released an entirely new line of screeds designed specifically for skyscrapers (2019).

Investment Thesis:

As pundits declare interest rates likely to decline, and there is a Western national trend towards on-shoring and friend-shoring, there is likely to be a surge in industrial and distribution construction. Chips Act and Inflation Reduction Act offer billions in incentives to build supply infrastructure in the United States. Massive concrete slabs must be laid to build those complexes, warehouses, and centers. The market capitalizations of materials suppliers Cemex (70%+), CRH (50%+), and Eagle Materials (30%+ YTD) demonstrate that raw materials (especially concrete) are in demand. 

There is a lag between this demand for concrete and the start and completion of new projects. The disconnect, as Somero CEO Jack Cooney puts it, is a skilled labor shortage, especially in trained drivers. He gives the example that if a project requires 40,000 pounds of concrete, but only 10,000 pounds can be delivered that day due to driver shortage, the contractor must delay the project until the full amount is delivered in a single day. Pours are all or nothing. Speed and precision of concrete screeding are key performance measures  for concrete-pouring subcontractors. Consequently, Somero’s laser screed vehicles and devices are preferred for higher-end products.

A 2023 high-rate environment lowered the frequency of project starts, as the depressed stock price indicates. Developers pushed off or delayed projects and, by extension, discouraged sub-contractors from purchasing new or refurbished machines. 

2022 was a record year for industrial starts, and the fall-off in construction starts of 26% between 2022 and 23 corresponds to the roughly 30% drop in market capitalization between mid-year 2022 and 12/2023 market capitalization. 

The company’s market cap variation largely  follows the United States industrial starts graph.  

Financial Strength:

Somero is financially sound. It has a strong balance sheet with virtually no debt and a projected $32 million cash cushion by year-end. The company holds a comfortable 4.8 EV/EBITDA multiple and a welcoming 7.78 P/E ratio. 

Additionally, the company regularly distributes a steady 6-7% dividend yield to its shareholders. The company recently restated its dividend policy as 50% of adjusted income will be a dividend, and 50% of any profit over $25MM will be returned to shareholders as a supplemental dividend.

Market Positioning:

Somero’s leadership in the laser screed market is undeniable. Having invented the technology in 1986, they maintain an (albeit self-estimated) 80-90% market share, with competitors remaining private. This dominance suggests a strong track record of innovation and superior product quality. They hold scores of screed technology patents and have successfully defended their patents through litigation. 

Over the past five years, consistent ROE, ROA, ROC, and ROIC above 30%, often above 40%. Consistent gross margin of over 50% over the past five years, with a 30% operating margin. 

80% of revenue is in North America and Canada, and 20% in the Rest of the World. 2022 (record year revenues) revenue impact from China was $1.1MM, so an economic slowdown in China would have a negligible effect.

Product line and 2022 Revenue:

Somero sells and services concrete screeds, and trains its customers on the use of the products. It has 6,000 customers across 90 countries.  Service is included in “Other Revenue.”

A recent focus on international growth is showing promise : Australia (32%+ revenue 1H23) and Europe (46%+ revenue 1H23). The  the bulk of operations are still in the United States.

Margins remain consistently high. Furthest to the right is FY2022.

Competitors and Moat:

RAF Industries, a private PE firm, recently acquired competitor Ligchine International. Founded in 2007, Ligchine also makes laser-guided screeds. Ligchine has six patents and eight pending, while Somero has 90+ patents. They compete around the mid-to-higher price point on screeds. 

Relatively high labor costs in the United States, Europe, and Australia incentivize utilization of advanced machinery. In the recent earnings call, the company affirmed that Chinese competitors (dynamic-eq.com, http://www.vansemac.com) do not provide the precision of Somero products.  At the same time, in many other developing economies, the scale of projects and slope tolerance (precision) required need to be increased to necessitate these higher-tech devices’ higher price points. 

Tailwinds and Opportunities:

Several tailwinds are poised to propel Somero’s growth. The recent Chips and Inflation Reduction Acts in the US are pumping billions of dollars into infrastructure and on-shoring initiatives, which translates to increased demand for construction projects. Somero’s newly launched 2019 Sky Screed technology, although requiring a typical 5-to-8-year adoption cycle, holds potential for future growth. This is a screed device specially designed for crane lift onto skyscraper floors. The reason stated on a recent earnings call for lack of adoption is that it changes how floors are screeded. Although it is more efficient, it is a newer technology, so standard practice has yet to catch up. The company states that a similar phenomenon occurred when laser screeding was invented in 1986 and took several years to become the industry standard.

The company’s continued strong performance in Europe and growing Australian presence indicate potential for successful expansion beyond its current North American focus.

Customers report a large backlog of orders and project starts, indicating reasonable potential demand, but supply chain issues remain. Machines must typically be replaced every 5-7 years, indicating a consistent and repeatable demand base. 

Challenges and Headwinds:

However, Somero faces challenges. The construction industry struggles with skilled labor shortages, particularly truck drivers who can deliver concrete on time. This timing issue is incredibly challenging for concrete construction projects. This reality of concrete construction means that delays in concrete deliveries limit the number of projects contractors can undertake. 

Furthermore, a delay in rate reduction or further rate rises may dampen developers’ confidence and further stifle construction starts.

Risks:

The company recently promoted and then removed its CEO, John Yunca, after a two-year stint. The current CEO, Jack Cooney,  the previous CEO before the departed Yunca, is in his late 70’s. The company recently affirmed in an earnings call that it has a good succession plan, but there is a key-man risk. 

Catalysts for Growth:

Key catalysts could unlock significant shareholder value:

• Lower Interest Rates: Decreased interest rates could revitalize the construction industry and boost demand for Somero’s products.
• Management Change: The recent departure of the former CFO, John Yunca, who oversaw a 20% decline in share price, presents an opportunity for a fresh perspective and potentially more dynamic leadership.
• The recent 50,000 square-foot addition to the Houghton, Michigan factory increased by 50% square footage and 35% operational capacity, completed in line with the $9.5MM budget, and its Q12023 functional increased maximum capacity. 
• Utilization of the SkyScreed product line ($1.1MM in 2022) increases the product line. Look for greater industry adoption. 
• The purchase of competitor Ligchine by a private PE group raises the possibility of acquisition. CEO Jack Cooney, the largest private shareholder, owns less than 1% of outstanding shares. No acquisition offers were described as of the most recent earnings 3Q23 call. 

Conclusion:

While Somero Enterprises may not be a household name, it possesses the essential qualities of a potential value investment: a solid financial position, market leadership in a growing industry, and a path to future growth. With solid leadership and favorable economic developments, SOM could offer a compelling combination of value and capital appreciation appropriate for a longer investment horizon.

Disclaimer: I hold a long position on this stock.