Market Commentary - Housing, Infrastructure, Construction and Services - 21st November 2016
Mitie provides the main newsThe substantive issues for investors are whether the company has the markets, money and people to achieve turnaround. Our sense is the Mitie can become a business with £2bn annual revenue growing at 3-5% a year and with operating margins of 4-5% in the mid term. today. The key issue for Mitie is whether the announced measures announced this morning are large enough to “clear the decks” and create a stronger FM business.
Mitie provides the main news today. The key issue for Mitie is whether the announced measures announced this morning are large enough to “clear the decks” and create a stronger FM business. The management has today said it will withdraw from domiciliary care and it writing off its previous investment (cost announced today of £128m, of which around £10m will be cash this year, the remainder being cash spent several years ago and is now gone) and that trading in the FM operations has been weaker than expected, as outlined in September. The company points to cost reduction programmes, technology innovations and breadth of services as reasons to expect a better performance in FM in future years but not in 2016 or 2017.
Revenue to end September 2016 was down 2.9% to £1.1bn but adjusted operating profit fell by 39% to £35m as the FM business was hit by rising costs and reduced in-contract revenues and the healthcare operations doubled the loss to £4m on revenues slightly higher at £41m versus £39m last year. The dividend has been reduced to 4p at the interim stage, 1.4p lower than last year and there is no indication of what may happen at the full year. The long term receivables included in the balance sheet remain high at £84m and that may require further write-offs but that is not a new issue and was not capable of swift resolution.
The doubts over future funding remain a concern but we suspect it will not need new equity. Cash conversion was 108% in the six month period and the good parts of the group are capable of strong cash generation. Net debt at the period end was £232m and the available facilities at present are £527m. The company states it operated within the covenants (net debt/EBITDA and EBITDA/interest cost) but does not reveal what they are which will be a questions this morning. The group’s pension deficit rose to £85m at September from £36m in March due to changes in rates of return on bonds; though that creates another potential drain on cash resources we suspect the Trustees will wait for a while to press for deficit funding. There is of course the possibility that the company might receive a positive consideration for its Domiciliary care assets but we suspect its more likely that we shall see further closure costs, the amount is not calculable at present
The substantive issues for investors are whether the company has the markets, money and people to achieve turnaround. Our sense is the Mitie can become a business with £2bn annual revenue growing at 3-5% a year and with operating margins of 4-5% in the mid term. The markets while tough and possibly getting tougher are sustainable and the services provide are often essential ones. We have covered the issues of cash and future obligations and while these are onerous they should not prevent trading and can be extinguished over time, based on expected cashflows. And with a refreshed top team which we expect Phil Bentley, the new CEO, will introduce Mitie has a very good chance of turnaround and being able to deliver 15-20p of EPS by 2018. That along with the company continuing to pay a dividend should provide a firm floor to the price in the coming weeks as the new team is tested in front of Institutions.
Mitie’s withdrawal from Domiciliary Care is unlikely to have much impact on other quoted companies. Mears is the only other entity with a quoted share price that operates in the field and it is in the process of recalibrating its relationships with its customers. Mears expects to lose around 20% of its revenue in the area. For those who have not followed the Dom Care story in detail the key issue is that the way in which work is awarded by many Local Authorities is on a cascade system based on current prices. That system does not necessarily lead to reliable workflow and does not suit quoted entities, that usually have relatively high overheads due to the need to maintain high standards of H&S and employee training and development.
Investors will note that Mitie also highlights that it is not alone in having tough trading in FM markets. The sense we get is that FM has become tougher but peers are not as badly affected. Many rivals are performing much higher quality work than Mitie on long term contracts. Historically Mitie has had a bias towards work with lower paid operatives using limited “know-how” and with little scope for innovation, such as cleaning and painting and decorating and has few PPP/PFI type arrangements. It was therefore always likely to be affected disproportionately badly by the Minimum Wage changes. We see some but limited read across in FM.
Tomorrow we have Super Tuesday with Compass and Renew Holdings producing their full year numbers to end September and Homeserve, Severfield and Babcock their half year results. We keep Compass in this review as its competitors are support services operations and it seems to us to be in segment of the indices. HSS Hire reports its progress in the first nine months of the year on Thursday and Victoria plc reports its interims on Friday
Polypipe’s revival continued on Friday last and it closed at 306p, up 2.0%, the best riser on the day and the first time it has closed with a “3” in front since 23rd June. The sustained level of new housing demand is good for PLP and modest growth in RMI is a good environment for Polypipe. It may be that the best of the bounce back has happened but on a mid term view the stock remains good value. Interserve also found support rising 2.0% to 299p; its not clear how a considered decision to buy the stock can be made as management is not able to guide accurately as yet. It may be some shorts covering their positions.
Post its results release we said that Atkins might drift and that has been the case. It dipped 2.6% Friday last, closing at 1571p as its words of caution on the Trump Bump for Infrastructure spend were heeded, along with real concerns about trading in some parts of the business. The company can rarely be accused of not being candid with investors. There should also be understandable concern about the rising pension deficit and the fact that under the current arrangements the everyone in the company works until the end of March each year just to fund the pension deficit and will do so until 2025 at today’s £33m plus 2.5% extra each year. While the pension is a burden it should not detract from the good and improving operating performance in the UK and the USA
Moves Last Week
The sector did a little better than the market last week rising around 1.0% versus the 0.7% market increase. The housebuilders saw some support as trading updates were reassuring but the segment remains down by around 4% YTD against the All Share increase of 7.2%. The substantial moves in three stocks last week masked a generally positive performance by moist companies, the the data show.
The three big movers were Interserve, Polypipe and Atkins. Interserve was the main loser, down 16.7% as it lost its CEO and credibility and Polypipe the main gainer as the market finally became alert once to its strengths and, we suspect a confusion over the possible downsides. Atkins we have also discussed above and our sense is that the market got a bit overoptimistic about the impact a Trump driven boost to infrastructure might have.
From the moves in stocks with no news last week the main one to attract our attention is Berendsen. Its 4.9% decline last week to 903p is part of a pattern since its results. It has had a steep decline since its peak close of 1337p in late July 2016. It is not a stock anyone really needs to own. The latest forecasts show EPS this year to end January of 65p (including FX tailwind) so it is now trading on a prospective p/e of 13.9x. The track record of the management indicates that it may be starting to look oversold.
Balfour Beatty, like Atkins, saw the share price race ahead after the Trump victory only to retrace to the 280p level. Our sense is that BBY is substantially undervalued at the current level on a 2-3 year view.
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