By Ben Temkine

In a month's time, Wilson Bayly Holmes-Ovcon's (WBHO's) results for the first half to December are due to be published. As the company is a star in the construction sector, and as this sector is enjoying a boom, the results are expected to be excellent.

Market expectations are confirmed by the company's share price, which, in five years, has risen to R76,50 from R6,80, an annual compound growth rate of more than 60%.

Over five years headline earnings per share have grown from 113,1c to 357,5c, an average annual compound rate of growth of 26%. The much higher growth rate in share price than earnings shows the market expects at least 25% growth over the medium term.

As the accompanying chart shows, the share price is still in a bull trend.

It may seem surprising, therefore, that the Forecast Factory is not recommending buy, although its hold+ is close to buy. The feeling, perhaps, is that the experts believe the construction sector is becoming a bit overheated. The market disagrees - the bulls are stampeding through the construction corral and the company is in the leading pack.

It has to be accepted, though, that its historic share price-earnings ratio of about 22 looks demanding. It certainly needs a closer looks at its investment fundamentals.

A good starting point is the return on assets managed model, based on Share Friend Executive. Bear in mind, as has been mentioned before when discussing construction companies, that a substantial content of the assets of a construction company are in work in progress.

WBHO has to build its projects before it is paid. On contracted projects, it will receive income in stages but the full profits on these projects will be realised only when the projects are completed. So it needs to finance work in progress.

But then this is not so unlike a retail operation, which buys inventory and has to finance these stocks until they are sold before it makes a profit.

The big difference is that it may take years for WBHO to finance work in progress even though it is paid in stages when work is in progress - while Pick 'n Pay, for example, often sells much of its inventory before it has paid its suppliers.

In its past financial year, to June last year, WBHO's turnover was R5,795bn and its assets R3,008bn, a ratio of 1,93. Earnings before interest and taxation were R275m, which as a return of turnover, or sales, was 4,75. The product of the ratio and the return was the return on assets of 9%.

As you would expect, the ratio of assets to equity was high - 3,94, which again confirms that a large content of its assets are "temporary". At the financial year-end, work in progress was R1,25bn compared with total assets of R3bn.

The product of its return of assets of 9% and the ratio of assets of 3,94 produced WBHO's return of equity of the year, which was just under 36%.

Using WBHO's figures, its return on equity was 27,8%, much the same return it has achieved over the past seven financial years. Its return on assets over the past seven years has also been remarkably consistent, between 8,3% (financial year 2002) and 11,7% (financial year 2000).

Operating margin (the percentage return from operating profits on turnover) is a core investment fundamental. Maintaining margins while increasing turnover increases profits. If, at the same time, you can increase the operating margin, this accelerates profit growth.

Over the past seven years, WBHO's higher operating margin was 4,7% in financial year 2004. In 2005 it fell to 3,9% but in 2006 it was a healthy 4,5%.

In the annual report, WBHO's debt:equity ratio was calculated at 30,3%; the gearing created as short-term financial liabilities related to work in progress were not - correctly - regarded as fundamental to this important ratio.

It is interesting to note that the debt:equity ratio at the end of the financial year 2005 was 12,8%. The rise in borrowing - increase in gearing - was well-timed.

Management deserves a pat on the back for putting more financial resources into the company at the same time as improving its margins.

Of course, the prospects reported in the annual report were optimistic, the main negative being the shortage of professional skills.

Headline earnings per share in the financial year 2006 were 357,5c, 40% higher than 255,1c the previous year. The Forecast Factory consensus for the current year to June is 432c for headline earnings per share, an improvement of 20%, with another increase of 22,5% in 2008.

These forecast consensuses may well be right, considering the strains on technical resources. If so, the forward earnings yield for 2007, on a share price of R76,50, is 5,64%, the forward price-earnings ratio is almost 18 and the projected dividend yield is about 1,3% - not a share for investors who want income.

But in a raging bull sector, in a bull market, there is room for the price to R84, perhaps more, over the year.