Market Commentary - Housing, Infrastructure, Construction and Services 10th October 2016
Mitie’s CEO Ruby McGregor Smith will step down on 12 December 2016 to be replaced by Phil Bentley who has held senior roles at Cable and Wireless, British Gas and Centrica. Interserve has come out very strongly today with an announcement that its equipment services operation, Kwikform, will remain part of the business following a strategic review. The review process was widely expected to result in a sale. Mears and Wolseley were the best risers on Friday last and for the whole of the week beginning 3rd October . They were both up around 4.5% for the week, for different reasons
Mitie’s CEO Ruby McGregor Smith will step down on 12 December 2016 to be replaced by Phil Bentley who has held senior roles at Cable and Wireless, British Gas and Centrica. The statement does little more than indicate the switch and that the succession has been ongoing since late 2015. The timing of the recent profit warning is interesting. The question for investors now is of course whether the new CEO will need a big kitchen sink or not. Our sense is that the new man has time to look fully at the issues at Mitie. Our “mantra” has been that it is not a bad company but it’s not as good as the claims suggest. Underlying margins are nearer 4-5% and not the 5-6% claimed and it is not growing revenue or earnings organically. There may need to be some write-offs for the new CEO but we believe that they will not be substantial. The more interesting element is where he will take the business in the future. His previous experience is the only guide we have so far and that does not include Care services. More below.
Interserve has come out very strongly today with an announcement that its equipment services operation, Kwikform, will remain part of the business following a strategic review. The review process was widely expected to result in a sale. However, it was also clear to all outsiders that a realistic consideration for the business was highly unlikely to provide a level of returns to investors that would balance the loss of Kwikform’s earnings for some time. The release includes a number of actions to improve the business that will cost around £17m, of which £5m will be cash to be spent over the next 12 months.
Interserve will outline its plans at an 8.30 conference call this morning and on 19 October at a CMD. Importantly the company tell us that Kwikform is trading in line with expectations. We have to wait until mid November to get a steer on company trading this year but realistically the avalanche of questions will mean that it needs to bring that date forward. Investors can take some guidance from the fact if here are issues the board could and should have used today to reveal them. We believe the market will greet the plan for Kwikform as good news and with the shares at 355p last night the stock will see some relief from the constant downwards pressure. More below.
Other items to guide investors today include the consultant Waterman which has announced a positive outcome for the year to end June 2016.The business has been on a mission to bring its business back to the basics of working mainly in the UK and improving margins. It has succeeded with both and while margins remain weak at 4% that also suggests that there is room for them to grow further to the target of 6%. It claims that there has been little change in enquiry levels since 23 June so the read across is positive for organisations operating in some similar areas to Waterman, such as Atkins and WYG.
The week may have started with significant news but there is little panned for the rest of the week. Countryside is scheduled to update the market on Wednesday and Inland Homes reports its Finals on Friday. Morgan Sindall and Mears go XD on Thursday this week.
Mears and Wolseley were the best risers on Friday last and for the whole of the week beginning 3 October . They were both up around 4.5% for the week, for different reasons. Mears closed Friday’s session at 478p as its activities are substantially Brexit proof. The rating at around 13.5x current year earnings 12x next year is not seen as too stretching for investors of all types. Wolseley rose given the relatively safe status of 85% of earnings last year from the US and FX moves last week. If/when the £/$ unwinds a little we may see WOS react. Arguably therefore should FX unwind WOS may see some support drain away.
Short term, as with much of the FTSE100, WOS is more a currency play than it has ever been. That is part of what Brexit means as the “bumps in the road” from Brexit are peoples’ investments and money. UK biased stocks in the sector have generally underperformed significantly in recent weeks given the perceived prospects of a “hard” Brexit . Whatever the short term perturbations there appears to be broad agreement that UK GDP will be lower over the next five years than it might have been due to Brexit, without a stronger fiscal boost than applied to date.
Forecasts for 2017 are more likely to go down than up for mainly UK exposed companies in the current situation. The most vulnerable areas at present in the HICS area seems to us to be the house-builders. There is already evidence of 20% fewer transaction since 23 June for Knight Frank, mortgages are unlikely to become much cheaper, subsidies to the new build private sector are already ready substantial and with the prospect of fewer jobs, especially in financial services jobs, not just in London, demand will decline. The bell weather is the Nine Elms development in Battersea.
At Mitie the new CEO is spared the blushes of announcing a substantial profit warning early in his tenure as Ruby had to do it herself. She remains in place until 12 December, the next board meeting and one of the first acts of the new CEO will be to decide whether six board meetings a year are really enough; we suspect there will be more frequent ones in the future. Frontline news is that Mitie has won an FM contract in the UK airports sector, which should get the new man off to a flying start. The obvious issue is whether he will need to announce more adjustments to the numbers and we shall not know that until the Spring update at the earliest and probably realistically not until the full year results in May/June. We expect he will make some changes but that they will not be substantial and certainly not involve a fund raising. The share price is likely to respond positively today to this news and with EPS of c 20p expected this year a p/e of 12x is possible on a 12 month view, is the likely market view.
Interserve’s share price should in theory soar today given the news and the likely level of earnings that are in the market. The level of increase will depend on how well it explains the about turn on the sale of Kwikform, sorry, Strategic Review. The intention to take a look at the business was announced unexpectedly in February a few months before the £70m hole in the Glasgow waste to energy contract was revealed. The high level of earning from the business and the way the world has evolved since the Spring has suggested for some time that retention was the most likely outcome. With EPS of 60-65p expected this year and the price at 355p at close on Friday a strong bounce is expected, especially as retention of the business provides for greater comfort around the dividend. There are still issues to resolve of course and we may not have seen the end of the story in Glasgow but the future earnings potential of the business is now higher than it might have been if Kwikform had gone and that is good news
Moves last week
The FTSE 100 broke through the 7000 level on Tuesday and closed the week up 2.1% while the sector was up around 1%. The 2.8% rise in the Construction and Materials segment was offset by a 1.3% fall in the Housebuilders. Services stocks rose by 1.1%
Comment beyond saying that stocks with currency exposure performed relatively well last week versus a weaker showing and declines from most stocks with just UK exposure. That macro direction is clearly important but will run a course and may rebound very strongly. There are however some specific comments that we believe are worthwhile raising.
Capita’s fall from grace was made worse last week with a 10% fall to 604p, which competes a 50% decline YTD. We indicated at 667p that there may be some retrace but no such evidence as yet. We have indicated our view that in the last 10 years the business got bigger but not necessarily better. However while the business stood still the Balance Sheet did not and in the current situation that might get worse as customers, suppliers and employees make greater demands. The question therefore is whether Capita is already in a spiral that can be controlled or not. Our sense is that it can be controlled and unlike some outsourcers in a similar financial situation many of its activities are so core to their clients’ operations it will support them in the short/mid term. The longer-term position is different.
The approach from Capita so far is that the events are a blip and it will be back to normal next year. Well the market disagrees and is waiting for the usual three warnings. Our view is that a return to normal will not happen as “normal” was not sustainable. So Capita needs urgently to outline a more realistic future which is not easy given the difficulties in some parts of its operations.
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