Market Commentary - Housing, Infrastructure, Construction and Services 12th June 2017
Mitie’s numbers for 2016 were released this morning and as expected they make grim reading but no grimmer than expected. The election result was the main driving force in the sector and, as we know, will remain so. For the remainder of the year the issues are clear; it depends on what you think will happen with Brexit.
Mitie’s numbers for 2016 were released this morning and as expected they make grim reading but no grimmer than expected. The company will tell us about the new “connected workplace” strategy later this morning. There are no guarantees there are no more accounting issues to come but KPMG’s Accounting Review seems to have been thorough. Revenue last year was up 0.3% to £2.1bn and adjusted operating profit was £82m. The statutory operating loss was £43m. Year-end net debt has fallen to £147 from £178m but no final dividend is to be paid; the covenants have been rearranged given the net debt/earnings ratio. The statement plays down future opportunities simply indicating that it seeks transformation and, much improved use of technology as a strategic weapon to create a higher growth/higher margin business. The ambition side of the goal is played down but the determination is there. The investment proposition is very clear; the company does FM in the UK and will improve its position through the use of technology and be much more careful about cost control, stating that a £45m programme to reduce/transform cost is underway. Understanding progress to date on cost reduction will be a key question this morning.
The cost of restructure has been high for Mitie holders but what is emerging, quite swiftly, is a well-managed operation that is presenting a sensible platform for customers and investors. We shall be interested to see this morning what the applications of technology might be but what is key is getting right (and reporting right) what exists within the business. Our contention has been that Mitie, under Ruby, was not a bad business, it was just not as good as the numbers made it appear. The data released today, showing an underlying margin of 3.8% tends to bear out what we have been saying. The fact that it has retained its revenue at a low but still positive margin indicates it is doing some sensible things for customers. Some of the work it does is relatively low value/low skill but that may alter over time.
Setting aside the detail if Mitie has £2bn revenue, 4-5% operating margins and reducing debt it should be capable of 16-20p of EPS, depending on interest costs so at 242p it may be fully valued but with some growth in revenue and margin the price does not look too out of line with peers. The company is promising some progress in earnings this year as the impact of cost reduction improves the bottom line. Mitie’s approach is good news for the FM sector as well as it will behave as a sensible competitor. There is not much in the release about contacts and customers but that can follow; the main job was to get its own house in order and show that beneath the surface a good operations exists and it seems to have done that today.
Elis and Berendsen have announced that an agreement has been reached for Elis to acquire Berendsen at 1261p (including dividend) comprising 540p in cash and 0.403 new Elis share for every Berendsen share. Looks like the show is over as a quoted entity for Berendsen.
The other notable announcement today is the intended IPO of Residential Secure Income Reit, a £300m IPO of another company offering housing as the core investment of an income stock. This adds to our observation made on Friday last about the size and scale of funds going into housing due to limited income stocks, need for housing in the UK and the reduced attractions for individuals of Buy to Let.
The election result was the main driving force in the sector and, as we know, will remain so. The leaders on Friday were Compass, up 1.0% and Rentokil up 0.7%, given the importance of overseas earnings to both companies that make sense. Only six stocks rose in our universe of 22. The losers were Travis Perkins, down 2.9%, Babcock, down 2.9% and Grafton, down 2.2%; clearly concerns about UK MoD contracts and spend on housebuilding had an adverse impact. The odd outcome, in stock market terms, is that the reaction was quite mild, so maybe some concerns are priced in already and/or the impact of the 2017 election outcome has yet to sink in. An alternative view is, of course, that the outcome might be a much softer approach to the EU exit, possibly ending with no exit at all. The weekend press was full of Mayhem’s “woulda, coulda shoulda” and its consequences and will be for some time. We can take no view on that but the prolonged uncertainty, as we all know, are unhelpful but create opportunity.
Moves last week
The sector was a slightly weaker performer than the market, which fell 0.4%, despite Friday’s rally. The sector’s performance varied, however, as previously discussed overseas earnings got a tick on the box, so G4S and Rentokil did well but UK earnings got a black mark, especially the housebuilders down 1.3%, though still 17% higher YTD.
For the remainder of the year the issues are clear; it depends on what you think will happen with Brexit. It not appropriate to discuss Brexit here but the consequences. But it is clear that London has already suffered some damage, in terms of global companies reassessing their need to be so heavily weighted in London and decisions on investment are being delayed. The leads and lags in economics are often deceptive and never regular but surveys of intentions, the UK slipping in the EU league table for Foreign Direct Investment and London house price moves are all telling us things we need to hear.
Berendsen led the table last week in terms of weekly movers, up 9.6% as Elis raised its proposed offer to 1261p (including dividend) and the BRSN board is inclined to recommend. The strong language used to reject 1180p suggested the BRSN board had much higher number in mind so accepting 1261p looks a tad tame. But no doubt soundings with shareholders allowed new information into the board discussion!
Only five stocks in our universe of 22 last week which is also a signal that the HICS shares are under pressure. The other risers were Morgan Sindall, up 3.3% after a positive CMD, Mitie up 2.2%, G4S up 2.8% and Rentokil up 3.9%. FX will also have aided some of these stocks but WOS and Compass were fallers, so it’s universal.
The largest loser was Capita, down 9.7% as hopes for more new public sector in the next six months fade a little. CPI has problems of its own of course! Babcock was down 5.8% for similar market reasons. Perhaps the market is forgetting that extensions to existing contracts can often be very lucrative and that delay in replacements on existing essential work are sometimes no bad thing at all!
Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.