Market Commentary - Housing, Infrastructure, Construction and Services - 22nd November 2016
So much news today we shall need to be brief. Compass, and Renew Holdings delivered finals to end September 2016, Severfield, Babcock and Homeserve their half year numbers to end September.
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Market Commentary - Housing, Infrastructure, Construction and Services
Tuesday, 22 November 2016
So much news today we shall need to be brief. Compass, and Renew Holdings delivered finals to end September 2016, Severfield, Babcock and Homeserve their half year numbers to end September. And we note that Phil Bentley has not messed about and weighed in yesterday with a substantial £3.6m purchase of Mitie shares at 194.3p. Shame his broker did not act earlier yesterday when the price was much lower but investors will note he has an even bigger incentive to make Mitie successful now than he did Friday last.
Compass showed revenue up by 5 % at CER to £19.9bn and operating profit (adjusted) was up 5.6% at £1.4bn, thereby delivering a slightly better margin at 7.2% but still a little short of the 8% target so there is room for more progress. The geographic spread of progress is familiar with the US showing “excellent” development, Euroland moderate and the RoW quite mixed. If it reads like the Shipping Forecast don’t blame us we did not organise five results announcements on one day. Compass state that 2017 is expected to be positive for the business and it sees plenty of growth opportunities for revenue and margin.
Homeserve has done what is said it would do and expanded strongly in the USA where revenue in the period grew 29% in US$ terms and the operating loss reduced to $1.6m from $2.2m last year. UK revenue grew 9%, boosted by the acquisition of HSEL and the adjusted operating profit rose by only 2% as operating costs rose by 10%. The danger for Homeserve is it rising debt and the possibility that growth will slow. Net debt rose to £253m at the end of the period versus £202m last year, 1.9x pro forma EBITDA. That leaves little room for error. The dividend is increased by 8% and the possibility of another special payment seems remote. We were sceptical about Homeserve and remain so.
Babcock is starting to get back on track after the disruption of the Avincis deal. Revenue in the first half was up 6% to £2.5bn and the operating profit by 7%. Clearly the ability to shift revenue and cost can help management achieve closely matched progress butthe underlying message is that the business is stable and now growing. The order book of £20bn provides good visibility of future revenue of which 93% is covered already for this year versus expectations. The board expects to perform in line for the full year which is for around 80p of EPS which makes the price of 991p at close last night look a tad harsh
Severfield’s progress continued in the first half of 20016/17 with revenue roughly flat at £118.2m versus £117.1m this time last year but operating profit was up 64% to £8.2m which is clearly a very substantial improvement. Net cash at the period end was £24m and shareholders can celebrate this morning with a 40% rise in the dividend. The performance was achieved by greater contract selectivity and in particular much improved risk management, in a reasonably favourable market of course. The company has indicated that the performance in the first half of the year has continued into the second so far. Management has been bold enough to tell us that full year performance will be comfortably ahead of expectations which were for 4.6p of earnings and 5.6p for next year also looks to be subject to upwards adjustment. The share price of 62p at close last night might rise today and targets of 80p look possible.
Renew Holdings has long been a favourite , since the shares were 31p some ten years ago. They closed at 412p last night and there are good reasons why they may progress further today. In the 12 months to end September the company produced revenue growth of 1% to £526m and adjusted operating of £22.0m; PBT was up 14% at £22.3m. At the year end the net cash position was £4.8m and as it has done before it has made the balance sheet work for shareholders; since the year end it has acquired Giffen Holdings which isa specialist rail sector supplier with revenue of around £22m in its last full year and PBT of £0.7m. The consideration totalled £7m including loan redemptions. Renew has increased its dividend by 14%. The prospects for the operations are positive in our view under as the comapny works mainly on essential infrastructure maintenance and has an order book of £516m, 3% higher than at this time last year. EPS for 15/16 were 27.4p and over 29p is expected this year so the share price is not stretching
We attended the Mitie results meeting yesterday. Predictably the stock was the largest loser, down 9.5% on the day, having opened near 20% down. It was difficult for all concerned. On the one hand a business that is good in parts has been created over the last ten years and, on the other, whatever the statements might be about the Mitie workforce, many thousands more people as investors, customers and suppliers were wrong footed by some accounting interpretations and that should not be ignored. The half year results were probably not a large enough kitchen sink, yet, in our view. And the share price may have benefitted yesterday from a bit of short covering with 15m traded.
The “blame” for Mitie’s current position lies not just with a few in the company but with many, including lawyers, uditors and advisers, who “played the game” with Mitie in a calculated manner. The change at the top signals that all of that is now history and more changes in the internal and external cast are needed. And while the inevitable review of existing contracts takes place we sense there is likely to be a write-off of a few, overly onerous liabilities, mostly non cash in 2017.
Some views have been expressed that outsourcing is the issue. We do not share that view. Several outs outsourcing companies failed to recognise and adapt when the market altered in around 2005 to one of relatively slow growth and margins of around 5% in most areas, a tad more in others. Carillion and Compass have come through the last ten years with no warnings in their UK services operations and new entrants such as Emcor along with small c £300-500m annual revenue companies, such as Norland, Cordant and Servest have done well. Sodexo has grown its UK presence very well in recent years. The number of quoted companies that chased growth and g higher margins and along the way invented a narrative that was not justified by the numbers, for a while, is larger than it should be and that is impacting on valuations.
We stand by the view that from here Mitie’s top team can create a business that should deliver 15-20p of EPS by 2018, while retaining a healthy ‘ish balance sheet and net debt. That is a realistic expectation. Thereafter growth depends on many factors, most of which are hard to determine yet as the availability of the right people and the cash needed to grow are not known. And, rightly, market opportunities are competitive. In terms of share price its hard to see how a rating in excess of 10x prospective earnings can be justified at present for Mitie which points to a price of 175p as the likely target level.
Just as Mitie bemoaned conditions in UK Domiciliary Health Care the best riser yesterday was the only other UK quoted company with Dom Care exposure, Mears. It rose 1.2p to 454p as perhaps news of Mitie’s position bolstered that of Mears. It highlighted that Mears has found ways to accommodate the inevitable restrictions in LA expenditure and focus on outcomes and partnerships with clients. And that applies to Dom care and Social Housing
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