Market Commentary - Housing, Infrastructure, Construction and Services 27th February 2017
Persimmon, Gleeson and Keller opening the batting today in what promises to be a very busy week for the sector. The Berkshire Hathaway/Warren Buffet annual letter to investors, published late last week, puts accounting adjustments, a very common feature of UK HICS stocks into a managerial context. The results round so far has been one of virtually two opposites.
Persimmon, Gleeson and Keller opening the batting today in what promises to be a very busy week for the sector. Persimmon and Keller report full year outcomes, MJ Gleeson half year numbers. The housebuilders shares should see further gains today based not just on the good conditions reported but also on Persimmon raising its return of cash to shareholders by 25p to 925p a share, the new payment to be made on 31st March and Gleeson raising its dividend by 44%. The index for UK housebuilders shares is up 7% YTD and further gains seem likely as most key metrics in the sector, company and market, seem to remain very positive. Persimmon’s revenue in 2016 rose by 8% to £3.1bn split roughly equally between volume and price improvements. Net margin rose to near 26% in 2H with 25% the average for the full year. Year end net cash was £913m which was after acquiring 18,709 plots (of which 11,268 were from the strategic land bank) versus completions of 15,171. The company reports no shortage of demand. MJ Gleeson reports a similarly robust situation in its markets and has performed as expected. The headline numbers are not as strong as some rivals due to the timing of sales in its strategic land operations but in the mainstream housebuilding segment the volume of sales rose by 12.8% to 451 units and operating profit was 10.4% higher at £8.5m. While the headline profit numbers in Strategic land was a tad lower than last year the segment contributed significantly in terms cash inflow. The trading numbers are expected to be in line for the full year with the consensus at 45p of EPS. The increase in the dividend at the halfway stage points to a 19p pay out for the year versus 16p as the current consensus. The key attractions of Gleeson at present are partly that it has further substantial growth potential in its mainstream housebuilding operations and that its product is made for a part of the market that should remain highly robust. The news from the housebuilders remains very positive.
Keller is always worth a look for read across and because it operates at an early stage in the construction process. It has no direct UK quoted competitors and so suffers from some lack of attention. Revenue rose last year by 3% at constant currency and as expected underlying EBITDA fell by 9%, underlying PBT was down 18%. While the results were disappointing, according to the company, the levels of demand remain positive overall with the order book at a record level of over £1bn, roughly seven months of forward work. The underperformance last year was caused mainly by issues in the Asia and Australia operations and overshadowed good progress in Europe and the USA. The company highlights the steps it is taking to get back on track in the releases, including cost reduction projects which should bring a £50m annual improvement by 2020 of which half will drop through into earnings
The Berkshire Hathaway/Warren Buffet annual letter to investors, published late last week, puts accounting adjustments, a very common feature of UK HICS stocks into a managerial context “...But a management that regularly attempts to wave away very real costs by highlighting “adjusted per-share earnings” makes us nervous. That’s because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” as well. .....” The frequent use of accounting adjustments in the sector often boosted EPS measures that determine executive pay, has created distortions in the sector regarding impressions of performance. Those impressions can last several years but eventually unravel to the substantial disadvantage of shareholders. We have highlighted the use of adjustments many times; placing them in the context of their use driving bad behaviours throughout a business is relatively new.
This week promises to be the busiest for some time in the broader HICS space with Persimmon, Keller and Gleeson opening the batting today.
Tuesday – Interserve and Taylor Wimpey– All Finals & Babcock trading update
Wednesday – Carillion, Costain and CRH – All Finals
Thursday - Capita, Travis Perkins – All Finals
Friday- Berendsen - Finals
The results round so far has been one of virtually two opposites.
At one end we have companies that have come through a bad part of a corporate and economic cycle of events and are showing good performances, such as Kingspan, Morgan Sindall and Rentokil. Although Serco has dipped since its numbers the out-turn was in line with expectations; we suspect the share price was ahead of events.
At the opposite end of the spectrum we have companies that have bad stuff to get out of their history before they move on. Interserve and Capita have needed to get some of that out of the way ahead of the numbers as the Audit committees we assume did not like some aspects of the first view of the results and needed to ‘fess up before the board meeting hat approves them.
Looking ahead to the rest of this week we expect most stocks to report good numbers. Costain in particular might stand out with a very positive picture. Capita and Interserve will be providing more data on their updates which we suspect will not be helpful for their share prices. Carillion will be the one to watch most closely as the share price has been signalling that the new FD will take a different approach to net debt than his predecessor. That might be shown through an equity issue and certainly we expect the text to reveal a much greater commitment to debt reduction than in recent years. The stock is down 12% YTD on no new news so the market is telling us something. We have believed all along that the company can trade through its balance sheet issues but the five year charts showing net debt and the pension deficit cannot continue on current trajectories and leave the mainstream operations unaffected.
Interserve was the best performer on Friday last, rising 1.1% to 228p. This stock should be avoided in our view. The risks inherent in getting the gasification energy to waste plants yet to be completed performing at rated levels are so substantial that management has no appreciation of what it may cost. The technology at the Glasgow plant, the cause of most of the losses to date, is we understand, far simpler than the gasification plants in other locations. In our view the mainstream operations of IRV are threatened by the cash needs of the EfW in many ways. The company needs to seek an approach that might ring fence in a formal manner the EfW projects so the main operations can be preserved. Without that the consequence will be highly unfortunate, in our view.
The back marker on Friday was Carillion, down a further 2.3% to 208p. We have discussed this stock above and several times in recent weeks. It can continue in our view though recovery will take some time. From what we can see it has substantial balance sheet issues that will take some time to resolve but operationally is performing well, albeit that growth is slow, perhaps in part due to a cautious approach, triggered by the delicately balanced balance sheet. Stocks that have a p/e of 5.7x and a yield of 9% are unusual and the situations are normally very difficult. It may be that the company will reduce the dividend to preserve cash as part of a “cure” process but, in doing so, we are sure it will also be looking at the £50m a year of cash that is paid to the pension funds as a deficit payment.
Moves last week
The sector is still outperforming the market, a normal feature in the first quarter of the year going back decades. The market is up 1.5% YTD with the domestically biased FTSE250 doing a little better than the FTSE100. The HICS sector strength has been mainly in the Housing and Services companies with the Construction and Building Materials area lagging a little. It may be that the latter started the year with high expectations. It certainly appears to us that the housebuilders have been ahead of expectations and the encouragement for building new homes from government.
The largest losers last week were both stocks that fessed up to the numbers being less good than might be expected when reported fully this week. Interserve fell 32% last week after telling us that the cost of the Waste to Energy plants would be of the order of £160m and not the £70m previously stated; worse still the management tell us that the new number is not the worst case but the one it regards as most likely at present. Given that the main loss is at the Glasgow plant from which the company has now withdrawn the situation could be dire. The Glasgow plant is more or less an incinerator, we understand, so it’s quite simple technology. The other plants are gasification ones which have altogether more complex technology.
The other large faller last week, Serco, down 22% was due almost entirely to the share price getting too far ahead of events, in our view.
Morgan Sindall was the best riser last week, up 1.3% and up 30% YTD. It was one of our five best picks for this year. The numbers for last year were ahead of expectations, the company increased its guidance for this year and by simply maintaining revenue at or near current levels and getting industry average margins in all areas it can near double earnings. At 983p it may still have substantial upside.
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