Market Commentary - Housing, Infrastructure, Construction and Services 23rd January 2017
Berkeley Group gets in the news twice today. Once for the article you will all have read about the company being encouraged to take a close look at Bovis as an M&A target and secondly for its progress in modular house construction methods. The sector performed roughly in line with the market’s 1.8% fall last week. We are expecting in-line performance this year and so far the sector is slightly ahead YTD. But the housebuilders have lost some of their early pace, triggered by positive market updates from Persimmon and TW as interest rate and Brexit fears creep back in.
Berkeley Group gets in the news twice today. Once for the article you will all have read about the company being encouraged to take a close look at Bovis as an M&A target and secondly for its progress in modular house construction methods. On the former we are with the sceptics that a Bovis/Berkely tie up makes the most sense in the housebuilding sector and about the validity of sector consolidation when land and money are cheap for quoted entities. We can see a logic for adding two businesses together to save overheads and refresh the Bovis top team swiftly. And there are others for whom a combination with Bovis makes very good sense.The gross development value of the Bovis consented land bank is around £1bn, assuming 20% margins and £250,000 ASP (The margin is a slight stretch from the current levels and the consented landbank at end June was 19,477, ASP is slightly below 2016 actual). The market capitalisation at Friday close was £1.07bn. So for anyone looking at the company from the uplift in value will arise from the 25,000+ plots in strategic land, cost improvements that take the margin to nearer 25% and site planning gains that may be available.
There are several organisation with whom Bovis might combine, possibly at a premium to current value, though Berkeley would not have been top of most lists. Berkeley has been developing its JVs with Thames Water and National Grid as well as buying up plots in the shire towns around the M25, especially those with Grammar Schools to provide a buffer against an increasingly tricky Central London market; Bovis fits in that regard but its also fits well with several others.
Is seeking a tie up the right way forward for Bovis? Nobody really knows the answer but it is clear that 10,000+ units a year provides economies of scale and better firepower and with just over 4,000 units Bovis is not in the best place. It margins were once among the best in the sector due to its early adoption of using strategic land. That is no longer the case. So a tie up with naother organisation of similar size or being used by a privately owned rival for them to get a quote makes great sense.
On modular Berkeley, we believe, has used Metsec’s light gauge steel frame (LGSF) product to build a small development at Kidbroke Village. A Times article today indicates that Berkeley may develop its own dedicated factory. When Berkeley highlighted its use in a recent update it pointed to build times reducing from 40 weeks to 10. In the current market in Central London that timescale is getting more critical for meeting market demand. Traditional methods on a 15-20 story block mean a 150 week construction period, minimum. Modular can reduce that timescale to less than 100 weeks. A saving of over a year does not mean much in terms of working capital tie up when money is cheap but hose builders are avoiding debt like the plague and two years build provides a better chance of getting the market right than over three years, which is what Nine Elms is taking. Modular is coming and by the end of this year annual production capacity could be well over 10,000 units a year with more factories in the pipeline.
News this week is provided by Augean today with an update, Lakehouse and Crest Nicholson report finals tomorrow, Renew Holdings has its AGM on Wednesday, Countryside has its AGM on Thursday and Kier is due a trading update. T lalrke provides an update on Friday. Our understanding of the timetable ahead for the sector is shown below.
Augean’s share price has been soft in the last week but the update contains no reasons to explain that. The company performed in line with expectations in 2016 despite some market challenges, as it calls them. The shares closed at 51p on Friday last despite the expectation of 5.5p of EPS for last year and 6.5p for this year, which we are told has started well. The net debt at near £11m is better than guidance and at around 1.5x EBITDA is not stretching. The business is not well understood. It is largely a services company in the waste sector rather than a landfill operator with it is more commonly associated with being. There are clear opportunities for further earnings improvement, in particular from getting the incinerator in Kent up to profitability and from North Sea decommissioning. The p/e valuation will look attractive for many investors we suspect; there seems to be a determined seller at present which will clear the market in due course.
What does “America First” mean for UK owned entities in the USA in this sector? We suspect not much but as with Brexit we just do not know about the detail. It would be wrong to completely discount the notion that US owned competitors to Atkins, Balfours, Babcock, G4S, Wolseley, Rentokil, Compass, Serco, may use the sentiment of the moment to highlight their situation and use it to advantage. It is possible to say that “America First” does not improve the outlook for these UK based companies but too early to say whether it makes things worse. Trump inspired infrastructure investment may improve the market prospects for some of them so things could get better for Atkins and Balfour. But, you know what, when an American owned company is competing for a US public sector contract against a UK domiciled one, mentioning the ownership structure in the conversation might be high on the To Do list. What would you do in their shoes?
Capita was the best riser on Friday, up 2.4% to 514p on a generally weak day for the sector. To emphasise the point the next best riser was Interserve up just 0.5%. The sector is getting some sceptical treatment from investors right now as some sharp practices are making investors wary. These range from the attempts of Bovis to cover up its operational deficiencies by compensating customers with “market incentives” through to pulling forward unproven profit gains from future years, in a way that outsiders were hardly likely to notice, until the exceptionals piled up too high and no more hypothetical profits could be pulled from thin air. We think the sector’s main woes are nearly all out in the open now but there a few issues to conclude, some of which may be cloaked in IFRS 15 adjustments.
Berendsen was the worst performer Friday last, down 2.2% to 845p, down 2.2%. It had staged a recovery recently, hitting 888p in intraday trading at one point. But the new CEO is struggling to get to grips with a number of things, it would appear and/or convince investors. Peter Ventress was always going to be a tough act to follow. But it has been tougher than expected and remains so. The European market has altered with Rentokil and Haniel’s deal and it’s not certain where Berendsen will sit in the relevant markets, longer term. EPS at Berendsen will be around 64p for last year and 68p this year so a buy case is not hard to construct at the current level but its not necessarily compelling unless management has got a proven firm grip on the business, which it did not seem to have the last time it reported.
Moves last week.
The sector performed roughly in line with the market’s 1.8% fall last week. We are expecting in-line performance this year and so far the sector is slightly ahead YTD. But the housebuilders have lost some of their early pace, triggered by positive market updates from Persimmon and TW as interest rate and Brexit fears creep back in.
Mitie was the worst performer last week after its warning mid week. There was nothing unpredictable about the update, other than the accounting methodology used to boost stated profits. The 4.9% fall was arguably less than might have been expected in the circumstances and the 203p price at close on Friday sits alongside a dip to 170p at opening on Wednesday morning. The price might easily slip back to that level if the final kitchen sinking due in May is worse that thought likely. At present there is no guidance on that as there are too many unknowns in the numbers.
Mears, where there are very few, if any unknown in the numbers was the best performer in the week, up 4.9% to 476p. It remains a very solid investment with businesses in attractive areas. The valuation with 40p of EPS this year is not cheap but the prospects are good and getting better.
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