Edison Investment Research

Market Commentary - Housing, Infrastructure, Construction and Services

Some signs of confidence returning

There is no directly relevant UK news released today. However Sodexo has issued it third quarter trading numbers, read across to Compass and others.
The price moves yesterday indicated that we may be starting to see some stability in the HICS sector with a glimmer of recovery though enthusiasm was not universal. The UK FM market has been of considerable interest to overseas companies and Sodexo has been one of the most successful. Others such as Emcor, Aramark and Elior are also taking a keen interest and there are some large private companies with £500m+ annual revenue in the space

There is no directly relevant UK news released today. However Sodexo has issued it third quarter trading numbers, read across to Compass and others and the go-ahead has been approved on an interesting residential development in Rotterdam. Sodexo has reported revenue up 3.3% organic in the first nine months of its year to end May 2016, including 18.1% growth in the UK and 10.3% in North America; the headline increase, including currency and acquisitions was 3.7%. Reported revenue was €15.7bn in the period. More below on Sodexo.

The apartment complex Rotterdam will comprise 350 dwellings specifically intended to encourage highly educated individuals just starting a new job to stay in the city for a long period of time. Common functions, such as a cooking studio and flexible working spaces offer residents additional comfort and reinforce social bonds. The buildings will also have facilities such as a restaurant, a dry cleaner, a bicycle shed and a parking facility. The project is in a former run down area of Rotterdam that is undergoing gentrification. It is mentioned here this morning as an example of what may be happening in Europe in attempts to mimic developments that have occurred perhaps more naturally elsewhere and as an example of what might be adopted in UK cities. The two towers housing the 350 dwellings will be completed in 2019

The price moves yesterday indicated that we may be starting to see some stability in the HICS sector with a glimmer of recovery though enthusiasm was not universal. When 84 Tory MPs believe that a person with no Cabinet experience, no evidence of previously successful leadership roles and a disputed CV should be our next PM we cannot expect investors to get too enthusiastic; that is not a comment on the individual simply one on the uncertainty of the current situation. Serco was the biggest riser, up 5.5% to 112p as it regains support. Investors mat recognise that it is some time before the current price level might be justified by earnings but by that stage it may be too late to get a reasonable stake at a reasonable price. Rentokil climbed 3.4% to 203p at close which puts the stock on a prospective p/e of c 20x 2016 earnings. That is justified as we see it by the growth prospects and resilient nature of demand for pest control. Read across that rating to Serco for 2018 when earnings might be moving towards estimates of c 9-10p for 2019 and the recent progress is not hard to understand.

The bombed out contractors and construction related stock, in general had a good day with SIG up 3.8% to 106p, Interserve up 3.6% to 229p and Carillion up 2.9% to 229p. Our sense is that these stocks might just creep slowly northwards as sentiment recovers and they offer good yields. Carillion in particular must be a little puzzled by the recent moves as it has very little trading exposure to areas affected by Brexit and its financial issues were already known and are in part eased by lower interest rates, save for the pension deficit. Soem stocks might be safely purchased at this stage with limited downside, such as Kier and Carillion but Interserve continues to get poor ratings from its peers and for that and other reasons should probably be avoided, even at current very low ratings.

We said the relief was not universal and note that Galliford Try continues to get a severe kicking, down 2.9% to 784p on 842,675 shares traded. It was the worst performer yet again. Its exposure to UK housebuilding for much of its earnings has weighed against the stock and there may be some adjustment for recent management chnages. But the selling does seem well overdone at present given the outlook for supply and demand in housing and GFRD’s earnings profile in other areas. EPS of 130p is likely to be reported for the year to June 2016 and when the dust settles it may be that a similar or slightly lower figure is likely for 2917 and not the 143p number in the market. The yield at 9.8% is one normally associated with stocks that have a very dubious balance sheet and that not the case at GFRD.

Back to Sodexo and the positive numbers released this morning. The growth shown provides interesting read across for Compass which has a roughly similar level of revenue but is more exposed to the Rest of the World than Sodexo and less interested in non catering related FM. The sodexo news should be supportive for Compass, not that it needs much help given its reent strong support.

The other element of Sodexo’s numbers is the strong growth in the UK (18.1% organic in the nine months) and the level of annualised revenue which is running at around £1.5bn. The growth is due to recent contracts wins of a long term nature in hard FM with MoJ and maintaining existing levels of business. The Rugby World Cup also provided a one-off boost. The UK FM market has been of considerable interest to overseas companies and Sodexo has been one of the most successful. Others such as Emcor, Aramark and Elior are also taking a keen interest and there are some large private companies with £500m+ annual revenue in the space. Our point is that the level of competiveness remains high but the market is attractive and the players are behaving in a mature way. When considering stocks the largest player in the UK is Carillion which has over £2bn revenue in the area and is achieving 5-6% margins. There may be some consolidation to come as some private companies are acquired but at present the predators seem to be leaving Interserve on the sidelines, another item for Institutional investors to note.

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