Should You Be Tempted To Sell United Engineers Limited (SGX:U04) Because Of Its PE Ratio?

U04 is currently trading at a high trailing PE of 19.67x, considerably outstripping the 12.36x average multiple of the Construction. Yes, this expensive multiple can initially be deterring, but there are many company-specific elements which are not captured in such a static ratio – such as its growth outlook and debt obligations. To resolve this problem, I’ll identify some important factors to consider when judging the relative valuation of U04. Let’s dive in.

How much does U04 earn?

The PE multiple is useful for when a company is profitable, which is the case with U04. This is because the multiple is not applicable to companies that are not generating positive earnings. For these companies, it is possible to compare price to other fundamentals like sales or book value where applicable. Previously, U04 has always produced a positive bottom line. With upcoming earnings expected to remain positive, PE can be a valid multiple to apply to the company, but let’s see if there is a better alternative.

SGX:U04 Future Profit June 24th 18
SGX:U04 Future Profit June 24th 18

Does U04 owe a lot of money?

Using debt-to-equity as a guide, U04 does have debt on the balance sheet but it is at a prudent level at the moment. Currently, ’s debt represents 37.31% of equity, meaning that for every SGD1 you invest, the company owes SGD0.37 to debtors. Though this range is relatively optimal, investors should still be aware of the risks associated with debt obligations, in particular the priority over asset claims in the case of bankruptcy.

SGX:U04 Historical Debt June 24th 18
SGX:U04 Historical Debt June 24th 18
So, what does debt have to do with valuation? The company’s share price theoretically reflects the value of U04’s equity only, but its important to account for debt, because using leverage alters the capital structure, and influences the risk and performance of the business. The EV/EBITDA multiple, which uses EV as a substitute for share price, allows us to incorporate debt into our valuation.

U04’s EV/EBITDA = S$2.45b / S$0 = 28.82x

U04’s multiple appears overvalued when likened to the industry’s average of 28.82x, and whilst the price-to-earnings multiple also showed this, the EV/EBITDA suggests an even greater premium to fair value.

Does U04 have a fast-growing outlook?

With an expected annual decline of -32.93% each year for the next 5 years, I’d say U04 has a very undesirable outlook. The issue with using current earnings in the denominator of a multiple is that it doesn’t reflect this expected decline in the future, which is a setback for trailing multiples. Buying a stock means you’re entitled to future earnings, not the past. Therefore, it’s more useful to focus on what you’ll receive. To account for this growth we can use the one-year analyst-consensus future EBITDA (this is a “forward” multiple).

U04’s forward EV/EBITDA = S$2.45b /S$53.14m = 46.06x

U04’s multiple exceeds the industry’s 9.44x. This implies an overvaluation on a forward basis, and to a greater extent than what was indicated by the trailing EV/EBITDA ratio.

Next Steps:

Basing your investment decision based on relative valuation metrics alone is certainly no sufficient. There are many important factors I have not taken into account in this article. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for ’s future growth? Take a look at our free research report of analyst consensus for ’s outlook.
  2. Past Track Record: Has been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of ‘s historicals for more clarity.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.