Market Commentary - Housing, Infrastructure, Construction and Services - 2nd December 2016
The main item this morning is the half year results from Berkeley Holdings. They are important as a candid view on the UK Housing market from Tony Pidgeley is a valuable guide to what is really happening on the ground. The Serco CMD yesterday was a very good opportunity to get to know better the range of the operations and the top team below Rupert and Angus that make things happen. What is increasingly clear from the data provided and discussed is that while Serco operates with five Divisions each with five strands of activity (Defence, Justice and Immigration, Transport, Health and Citizen Services) it is in fact a collection of around 600 contracts each of which has its own risk and reward characteristics. The glue that binds the business is a shared set of values and organising principles that indicate how it will deliver services on behalf of public sector entities.
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Market Commentary - Housing, Infrastructure, Construction and Services
Friday, 02 December 2016
The main item this morning is the half year results from Berkeley Holdings. They are important as a candid view on the UK Housing market from Tony Pidgeley is a valuable guide to what is really happening on the ground. The news this morning is that the business has had a very strong six months to end October 2016 with PBT up 33% to £393m and NAV per share up 8% to 1,418p. But reservations are down 20% as a result of Brexit and stamp duty changes (and the company’s move to slow its rate of forward sales). As a result of recent volatility and the impact on Berkeley’s share price balanced by its own resilience the company has announced that the proposed return of cash will be made but it will not be all in dividends and share buy-backs will be part of the mix. The amount of cash returned will be unchanged, a further £2.2bn or £10 a share at the current number of shares. Clearly with the share price at 2450p and with 226p of EPS at the half way stage and forecasts likely to rise from the previous level; of 400p for the year management is saying that it sees its own shares as very good value. It’s a smart move and tells us that underlying market conditions are probably better than the headlines suggest . More below.
G4S has announced that it has reached an agreement to sell its Secure Solutions business in Israel for £88m. This is one of the c £400m of expected disposals announced in the spring that will help reduce the net debt burden and improve the focus of the operations. It will be seen as good news in our view.
The Serco CMD yesterday was a very good opportunity to get to know better the range of the operations and the top team below Rupert and Angus that make things happen. What is increasingly clear from the data provided and discussed is that while Serco operates with five Divisions each with five strands of activity (Defence, Justice and Immigration, Transport, Health and Citizen Services) it is in fact a collection of around 600 contracts each of which has its own risk and reward characteristics. The glue that binds the business is a shared set of values and organising principles that indicate how it will deliver services on behalf of public sector entities.
One of the unmentioned elephants in the room was the issue of the resumption of dividend payments. Our view is that the board will get out the cheque book for shareholders some time in 2018, when it is clear that the scale of the last of the five large Onerous Contract Provisions (OCPs) is known and the cash cost is affordable. The announcement of resumed dividends may come much earlier. The values applied to the customers (Pride, Innovation, Care and Trust (PICT) might be equally applied to shareholder and we expect they will be and the trust shown to those who bought shares at 101p will be rewarded.
We have been positive about the top team at Serco since appointment as they seemed very genuinely committed to Corporate Renewal and importantly for investors, clear and transparent reporting. There were few doubts that a positive market environment exists for outsourcers but too many had bid low to win work and expected to wing it; or as recent phrases go they wanted to “have their cake and eat it”. But in services to both public and private sectors today the clients have got much more savvy. And the Serco top team, from what we can tell, had no intention from the outset of doing anything else but fulfilling all of its obligations for a fair reward. The message was provide by the company sticking with existing contracts which may have cost shareholders some £450m in OCPs but we suspect that will be seen in the long term as a small price to pay for creating a climate of trust with all customers. We suspect that while 135p may seem expensive in terms of the short term earnings outlook on a three year view it will seem cheap
Compass was the main faller yesterday, down 3% to 1329p as the improved value of Sterling was incorporated into earnings expectations. Other fallers at the bottom of the league table included Rentokil (down 2%) and G4S (down 1%) also affected by sterling strength. The odd one out was Berendsen which fell 3% to 859p as it struggles to get any sort of traction with investors. We were concerned from the outset regarding new management which seemed overly focussed on the mechanics of the business and not the human elements of its operations. The profit warning was based on a misunderstanding of the way the business works and its demand patterns allied with machinery failure. So having relied on effective operation of the business as the main source of credibility it’s no surprise that when flaws were shown the “approval “ rating, which is what short term share price movements amount to, plummeted. With EPS this year of around 63p its likely that support will emerge soon at the price at COP last night of 860p; the warning was not that bad and the underlying business is still in good shape. Improving on what Peter Ventress and Kevin Quinn achieved was always going to be a hard act to follow.
Interserve found some support yesterday though it was modest, rising just 2.4% to 306p. While we believe that the underlying trading situation is still positive at the company the management situation is unworkable. Adrian Ringrose is standing in until his successor is found. That will make the position of CEO impossible both internally and externally, in our view. It might work in the public sector but not in the private one. And as Serco’s presentations showed yesterday thrust is a key issue in winning large scale contracts. Adrian had always played a strong personal role with the large customers so what are they to think when awarding contracts about who they will trust in the future at Interserve? And that thought applies equally to investors.
One aspect of the market UK services that may have gone unnoticed is that Amey is potentially imploding. This may leave work packages for others to pick up. The third quarter report from its owner, Ferrovial, indicated that 828 employees had left the business YTD and the restructure cost was €19m to end September. Highways England has asked the company to stand down from its roles on Areas 6&8 and it will be replaced early next year. It is involved in substantial litigation on contracts for Sheffield and Birmingham City Councils. And its work for TfL on Tubelines was taken back in-house earlier this year. And it has lost work, deliberately or otherwise with several Local Authorities, such as Liverpool. CEO of 13 years Mel Ewell was replaced by an internal appointee Andy Milner at the start of this year. To an outsider it appears that Amey has continuing substantial issues which if it were separately quoted would have created a number of warnings. The opportunity for rivals is most likely to be in taking its contracts either at renewal or earlier if they fail.
Back briefly to Berkeley. The company is clear that the market is in a state of flux in its geographies triggered by stamp duty changes, Brexit and the normal cycle in the sector. However it is able to continue to grow the business due to its landholding and flexibility across several parts of the market and geographies around London and the South East. The company sold 2,076 dwellings in the six month period in question, down 1%, at an ASP of £655,000, up 29% due to mix and a larger proportion of Central London completions. The GM rose to 36% and the net margin to 28%, up from 26% last year. The number of plots fell by 733 to 42,125 which is not significant as it still has 10 years supply at current output and the reduced land spend allowed net cash to double to £208m. The company re-iterated it view that it is well positioned to deliver its three years guidance numbers to April 2018 of £2bn pre tax profit. And barring even more government inflicted wounds to the London housing market we suspect Pidge is right.
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