Market Commentary - Housing, Infrastructure, Construction and Services - 15th November 2016
Polypipe and Crest Nicholson have something to tell us this morning in positive trading updates and McCarthy and Stone has issued it finals. We also note news from Waterman and Costain. Capita was the leader of the pack yesterday, rising 4.1% to 573p. The main loser yesterday was Berendsen, down 1.8% to 933p, the lowest level since October 2012
Polypipe and Crest Nicholson have something to tell us this morning in positive trading updates and McCarthy and Stone has issued it finals. We also note news from Waterman and Costain. The former, a property and engineering consultant, has a announced it is a design partner for 50% of the £1.1bn Aspire programme which is potentially a transforming project for the company. Costain has announced that its JV with Skanska has won a £300m contract for enabling works on the South part of HS2 which will start immediately. Good news not just for Costain but also the industry as it shows that at least some Infrastructure work is going ahead. HS2 is needed for capacity reasons on the West Coast mainline; the “high speed” moniker is unhelpful. And finally, Lavendon has told us that its revenue in the nine months to end September is up 8% in the UK (c.50% of revenue) and 20% in the Middle East with Euroland revenues broadly flat. More below on some of these stories. The key take away is that UK construction seems to be trading well at present
Polypipe’s revenue in the first ten months of its year to end December were ahead of expectations a little with 7.1% growth, at CER and L4L and 23.7% in headline terms. Interestingly the company reports no impact on trading from Brexit and sales in the four months to end October were up 8% in the UK L4L. The company uses raw materials that are priced in US$ which has had a negative impact on margins until these are recovered; the competitive trading situation is such that input costs increases can be recovered , usually within three months. The difficulties experienced by the Merchants in plumbing and heating are mainly in copper based products and boilers. Overall PLP is trading in line and this update should help to reverse some of the recent unjustified weakness in the share price.
The numbers Crest has provided show the business to be in a healthy position. In the year to end October unit completions rose by 5% anmd ASP by 20%. Forward sales are around 5% higher in both value and volume. The company noted a dip in demand in July which picked up in August and the sales rate was 0.77 in the final quarter of the year. Performance in 2105-16 s in line with expectations. And the company now has net cash of £77m. McStone’s results for the 12 months to end August are positive and show revenue growth of 31% and underlying operating profit growth of 12%. Its market position in retirement homes makes it rather more dependent on the second hand housing market in the UK and that remained soft through August, post referendum, thereby impacting on trading. The company is keen to tell us that since the year end ten weeks ago sales levels have picked up and cancellation rates have fallen. Clearly life has been a bit tougher for McStone than the mainstream new build operators but the performance is still positive and looking at the data we agree with the company that in terms of forward sales, land ownership, balance sheet (cash of£53m after £500m of land spend) and end user demand.
Capita was the leader of the pack yesterday, rising 4.1% to 573p. The last time it closed at this level was 1st November 2006.
• In 2006 the company reported revenue of £1.7bn, PBT of £200m , EPS of 23p and dividend of 9p a share.
• Current forecasts for 2016 show revenue of £4.5bn, PBT of £540m, EPS of 65p and a dividend of 32p.
What changed to create a massively different valuation are the growth prospects, net debt/EBITDA and management credibility. In the Pindar era the company tried to buy its way to growth and a bloated M&A “machine” grew while the internal BD was sacrificed. Arguably, as with Serco, G4S, Mitie and Interserve it was seduced into growth through deals which at some point fizzled out. The share price took time to adjust but the seeds of the problems were sown years ago.
There are two key issues for investors is
• Firstly, whether Capita has a viable future as an operator in its markets which are becoming more global and more sophisticated. The Pindar mantra was why go overseas when there is so much to do UK. His successor did not take long to buy Avocis based in Germany so what was he saying when he worked for Paul? The arguments are finely balanced on the technology front, perhaps but in terms of UK market positions Capita is well positioned but most are stable markets with little organic growth.
• Secondly, whether the balance sheet is robust enough at present to withstand more shocks and the outcome is probably that it is not. Hence the share price at present. It is likely that Capita can trade through current events. The bloated overhead can be cut and acquisition spend is already much reduced. The review of contract now underway and scheduled to report early in the New Year is likely to generate some costly issues. The board must suspect some problems and industry sources say there are some. If bold steps are not taken at this point there will be no second chance for management, assuming that it survives in the current climate.
The conclusion is that Capita is more likely than not to need to bolster the balance sheet and the review is likely to discover some difficult projects. It is possible that the price will drift upwards towards the 700p level is we are wrong but for the time being the magic rating has gone and will take a very long time to return.
We commented on the unusual announcement from Interserve released yesterday at 14.15 regarding the CEO and show that below. The market did not know quite what to make of events and the shares retained earlier gains, closing up 3.0% at 370p
The main loser yesterday was Berendsen, down 1.8% to 933p, the lowest level since October 2012. There are still plenty of holders who bought the stock in 2012 at the 400-500p level and might be taking profit. Though they may have missed the peak levels the gain is still substantial and that may be weighing on the price. The business is fundamentally sound in our view and we suspect will recover from its self inflicted wobble in earnings. But regaining the rating of c 20x EPS is unlikely for several years and it will take a change in teh story which in its markets seems to us to be unlikely. Rentokil has drifted downwards quite a lot closing yesterday at 208p versus recent peaks at 230p; the current level seems to us to be a good entry point though it may slide to below 200p at which we expect demand for the stock to be very positive. It may also be “suffering” from some profit taking.
Polypipe has seen its price drift towards the 250-260p level in recent months for no obvious reason other than perhaps stories of difficulties in plumbing and heating markets. The business is on track to deliver 23-24p of EPS this year so in our view the current level is too low and around 300p is the lowest level of target price r that can be justified, higher is more likely. The update should aid support and make sure the company does not slip out of the FTSE250 at its next reshuffle in early December. The trading situation seems to be highly robust in the UK and improving a tad in mainland Europe which has remained profitable.
Costain’s price has been drifty in recent months without any new news. Stories of project cancellations may have affected the company but none of the main industry concerns affected Costain so the link was somewhat spurious. The market seems to be pessimistic about Costain’s prospects. The Manchester energy to waste project is being taken above the line. Exclude that from any EPS calculation and target prices of 500p seem to us to be easily justified.
COMMENT YESTERDAY ON INTERSERVE’S NEWS
The unexpected announcement today, at 14.15, that Adrian Ringrose is to be replaced some time next year as CEO at Interserve will not have surprised everyone. Like others IRV has over promised and under delivered for a few years in a tougher market and therefore was always likely to be vulnerable. The £70m exceptional cost for Glasgow and the unusual Strategic Review of Kwikform were unhelpful. It was always going to be a tough gig for Adrian as his experience, before taking the top job, was quite narrow and short. Arguably he has done very well in the role but recent years have been tough and the acquisitions of IFS, Advantage, several oil services companies and in UK Welfare to Work were not the best moments in the company’s history. And a £70m invoice in Glasgow did not help.
The statement today is unusual as it leaves the timescale to replace him open, saying a successor will be appointed sometime next year. The company says he will continue in his current role until the new guys starts.
Oh dear, somebody does not realise how that might work, in our view. Both Adrian and “his” appointees in the business are dead men walking. If the job of being CEO at Interserve was hard before it will be impossible until the new guy arrives sometime next year. Often companies have a vacuum at the top but it is rare to create one deliberately.
There is no doubt that Interserve has some good contracts and is capable of improving without a substantial restructure. But in the absence of a leader, indeed having one with one eye on the Sits Vac columns, investors will struggle to back it. Unless there is Corporate Action in the offing, which is always a possibility. The problem, of course, is that in the absence of corporate activity there are few if any experienced CEOs waiting on the sidelines.
In a separate statement Interserve has updated on trading indicating that overall it is in line with expectations, which are for 60-65p of adjusted EPS. Trading performance in the UK has been a tad worse than expected but overseas has chipped in with a better than expected performance. The £70m Energy to Waste exceptional appears unchanged but the cash profile has altered; payments will be accelerated on the Glasgow job to reduce risk and the rest of the group will be squeezed a bit harder to get to the promised £300-320m of net debt at year end.
Normally we might be reluctant to suggest investors get involved in an uncertain situation such as this. However, in this case there is potential upside from teh business, as long as he Chairman does not appoint a duck egg and from any corporate activity that could fill teh vacuum.
As with SIG the timing could have been better as the year end is being tidied and budgets agreed for next year. The IRV and SIG CEO departures seem hurried which is unsettling for investors. Our sense is that at Atkins, Grafton, Mears, G4S, Serco, Kier, Balfour Beatty, Morgan Sindall and Carillion (and others) the leadership is strong and authority is intact so its not as widespread as two departures in two working days might suggest.
The more general issue is why FM companies are over-promising and under delivering continually, save for a few obvious “beacons”. The very short answer is that they are taking undue contract risk, often promising delivery in areas over which they do not have total control. There are other related issues (IT, Relationships, bloated overheads) which have lead to rosier pictures of the finances than were realistic
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