Market Commentary - Housing, Infrastructure, Construction and Services 27th March 2017
The only formal news this morning is that Babcock’s partnership working on the nuclear decommissioning project on 12 Magnox sites has reached agreement with the Nuclear Decommissioning Authority to end the contract in 2019. News later this week comes from Wolseley tomorrow with its interims and from T Clarke with its finals for 2016.
The only formal news this morning is that Babcock’s partnership working on the nuclear decommissioning project on 12 Magnox sites has reached agreement with the Nuclear Decommissioning Authority to end the contract in 2019. There has been an amount of turmoil over the award of the contract in any event but today Babcock has stated that the workload is different from that originally envisaged, opening up the possibility of a legal challenge. The impact on Babcock is not immediate in financial reporting terms, it will lose £100m pa of revenue from 2020/21 onwards and the order book will fall by £800m to £19bn and the pipeline will be £1bn lower at £10bn. The company is keen to emphasise that this will have no impact for some time and that its client is satisfied with the JVs performance. This is not good news for Babcock despite the lack of any real short term impact and the long period the company has to replace this work. This was billed as a £7bn/14 year project when it was first won two years ago in March 2014. The numbers released today do not quite square with the original figures but Babcock pulling out because the workload is not as originally expected may be only one of a number of factors.
News later this week comes from Wolseley tomorrow with its interims and from T Clarke with its finals for 2016. We get a day off from formal news on Wednesday, based on current plans and on Thursday Tribal and Polypipe report finals for 2016. Some news on the Bovis/Galliford/Redrow might be expected this week as it is over two weeks since the proposed bids were revealed and discussions started. What seems to be clear from the pattern of share price moves is that there is no viable alternative bidder to the two companies currently involved.
Capita was the leader on Friday last with a 3% increase to 576p. There is a two way pull; if there is an equity fund raise the stock is probably too expensive at present and if there is not and a credible CEO is appointed or there is predator interest the stock is probably too cheap. Our sense is that as with G4S and Serco a strong business will emerge at some point, probably with revenue of around £4bn and operating margins of 10% and organic revenue growth of 2-4%. The route from where we are today to that position, as with Serco and Mitie is unlikely to be smooth and may be long. We should add Rentokil to the list of services stocks that has regenerated itself, as it was trading as low as 33p in November 2008 and closed at 244p on Friday. The point we make is that we may not be at the bottom with Capita but if management takes the right decisions and, given it has substantial know-how and long term contracts in its markets, there is a good chance we should see a strong uplift longer term. But it’s not for widows and orphans at this stage!
Kier was the main faller on Friday, down 2.0% to 1473p and its fellow decliners were Galliford Try, down 1.5% to 1519p and Morgan Sindall down 1.7% to 998p. We missed the fact that Redrow, Bovis and Galliford Try all went XD on Thursday last which accounted for some of the slippage we saw. On Friday, however the dips in GFRD and Kier were probably echoing the general concerns about the housebuilders and the increased concern that while construction companies are well placed right now public sector funding is slow to emerge (other than the normal seasonal first quarter boost). Morgan Sindall has very limited exposure to housing sector risk. Macro issues and in the case of GFRD the Bovis bid are likely to be stronger drivers of sentiment on the largest fallers on Friday than stock specific issues in the coming months, in our view.
Moves last week
The sector’s performance last week was a little better than the markets 1.2% fall; the construction and materials stocks were broadly unchanged while the housebuilders and services stocks fell by around 0.8%. YTD the market is up around 3% and the sector by 5% with the housebuilders leading the way, up 10.7% so far. The first quarter bounce in the sector may fade as the year progresses in our view but much depends on the two way stretch in the short term of funding for projects being available and the emergence of price inflation in the sector. The latter has so far been suppressed by hedging last year and absorption of its effects into margin.
The largest decline last week was at Berendsen as the big brokers ganged up on the stock in a series of notes that cast doubts on future performance. It closed down 6.5% over the seven days at 793p while forecasts remain in the 60-65p for EPS this year. Our sense is that there is a good business at Berendsen and this may be a very good buying opportunity but to date the presentation of what is going on in the business is capable of better explanation and there does seem to be far too many “initiatives” going on.
The best performance was at Grafton which rose 4.1% to 680p and the shares are now up 23.5% YTD. The stock started the year in an oversold position, in our view. The increase in recent weeks is part of a growing recognition that the growth prospects in Ireland and Belgium are good and that in the UK its Selco format is performing very well. With EPS forecasts at 47p for this year and 52p for next year the stock is not cheap now but the business performance bears out that it has not lost touch with its core customer base.
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