Market Commentary - Housing, Infrastructure, Construction and Services 2nd March 2017
Capita and Travis Perkins have reported their 2016 results this morning. Capita is to part company with CEO Andy Parker, which is no real surprise and he will leave when a successor is found, probably towards the year end. Travis Perkins has delivered results roughly in line with the expectations for 2016 which were reduced during the year as it became clearer that trading conditions were tougher than expected, especially in many plumbing and heating lines.
Capita and Travis Perkins have reported their 2016 results this morning. Capita is to part company with CEO Andy Parker, which is no real surprise and he will leave when a successor is found, probably towards the year end. The continuation of the CEO in that position is impossible, in our view and we are not sure why that approach has been adopted here or at Interserve. The CEO is gone, let them go and appoint an interim until a new permanent person is found; hanging on is not good for the company or the individual. Capita’s numbers are poor and as we discuss below the strategy is unclear so it’s no surprise the CEO is moving on. But it means a year of hiatus and uncertainty which is unnecessary. Revenue rose 1% in 2016 on an underlying basis and operating profit fell by 28% to £541m. The contracts won during the year worth £1.3bn are simply not enough to sustain the revenue run rate of near £5bn a year. It was not all bad as net debt fell by £60m but is still high at £1.8bn and operating cash conversion was 139% at £750m. There will be some relief that an equity issue has been averted for now and the dividend is maintained at 31.7p and that there will be a new CEO but more answers are needed to key questions. More below
Travis Perkins has delivered results in line with the expectations for 2016 which were reduced during the year as it became clearer that trading conditions were tougher than expected, especially in many plumbing and heating lines. Revenue rose in the year by 4.6% to £6.2bn (L4L rise was 2.7%) and adjusted operating profit, including property sale profits fell 1% to £409m. Cash generation at £503m during the year was positive, up 43% and net debt was reduced by £69m to £378m. There are two big exceptional, £235m on assets in plumbing and heating and £57m for other restructuring. In line with Buffet’s comment at the weekend it’s not clear what adjusted means. EPS were slightly below expectations at 120p, versus 122p that was expected. The trading results are hindered by challenges in some markets but we shall attend the meeting at 11am today to explore whether it’s that factor alone or whether the strategy to take full advantage of scale is working or not. More below
Predictably Carillion ended the day as the back marker, down 5.9% at 206p. The trading news showed the business to have performed very well in the core Support Services operation and in Construction (ex Middle East) but market issues meant Canada and Middle East Construction struggled. So trading, while mixed, was acceptable and the reasons for the performances understandable. Investor confidence is eroded because three key balance sheet items have had the wrong trend for the last five years; rising levels of net debt, pension deficit and early payment facility. The company knows that and says it will address the issues, which makes 100% sense but there is no proof it will happen, yet. There are cures, which new FD Zafar Khan intends to apply but there is no silver bullet. We have been supportive of Carillion and been wrong for shareholders, so far, based on last night’s close.
The deterioration in the balance sheet has been an act of neglect which the new FD is pledged to resolve; no pressure Zafar! We maintain the view that it can trade through but maintaining the dividend with a 9% yield is brave. Through a mixture of working capital improvement and other efforts it can reduce net debt. It can reduce the early payments facility, which cost £8m to the P&L last year, possibly offsetting the boost it provides to earnings and new ways to plug the pension deficit now exist. We think the company has more options that the shorts seem to believe, it’s a question of allowing the new FD some time and that option exists due to the trading position.
The question will always be asked whether Carillion should have had a profit warning four years ago when the full cost of the £400m acquisition of EAGA was evident. The answer is probably yes but that does not mean it should have one now at a time when markets are looking more positive in UK Infrastructure, when large contracts have been re-won (NGEC, Centrica, Nationwide) and when there are means of correcting balance sheet issues which seemed to elude the previous FD. The board had a tough decision to make and an equity “cure” may still be the best answer but having go this far management has stuck by its guns. With the share price at 206p equity is very expensive, far more so than the coupon on borrowing; while it may have a £1.5bn facility from the banks the equity market is saying that is too high.
Mitie topped the table rising 3.6% by the end of the day to close at 214p. The market liked the sale of the Dom Care operations as it cleans up the portfolio even if the venture wasted near £150m of shareholders’ funds. How Mitie got into the mess is not completely relevant right now but the lessons are important. Phil Bentley was not inclined to reverse the decision of his predecessors and make a success of Dom Care. Contrast that with Mears who have taken a new approach to the Dom Care area. They have created a better model for operating in the space that works for them, albeit at the cost of exiting some 20% of the previous level of work with customers who want to retain the traditional model of working. Essentially Mears has more influence over the use of the Dom Care budget and is therefore able to utilise the workforce more efficiently and effectively. The trading results for 2016 are due mid-March and we shall get a better understanding at that time of the success rate with the roll out of the new approach; the indications to date are that it is working well.
Regarding Capita, it clear to understand why Andy Parker has gone and we suspect that most of the Pindar “Old Guard” are likely to be elsewhere by the year end. As regular readers know we have been critical as the company did not really mature after Rod Aldridge departed in March 2005, it just did more of the same; it may have doubled in size but not in skills and capabilities. But Mr Parker’s departure does not address the issue of whether the company has a viable strategy. At the back end of last year structural reporting changes were made, disposals were announced (but are yet to conclude), cost reduction was introduced and management accountability increased. But all of that is about good operating procedure which should exist anyway. 2017 will be transitional year for Capita, we are told but it’s not clear what it will transition into. Last year EPS were 56.7p which justifies the closing price of 565p, some may say and there are good reasons to believe the company will achieve the same level this year, as the market expects. But in the absence of a sense of direction and with the possibility of an equity issue it’s a risky call to be positive right now.
Travis Perkins announced a bold strategy just over three years ago which involved, as it called it, using it’s scale to its advantage. The results appear to be mixed so far, derailed a little by weak conditions in plumbing and heating markets but also by the economic cycle, which features a great deal in the statement today. The entry of a new competitor, Bunnings who bought Homebase, has yet to have an impact. The headwind created by FX moves following Brexit were entirely unpredictable. The company is continuing with the strategy and has made more developments in the customer offering, attempted further changes to “optimise the network” and is “leveraging the group’s structural advantages”. It all sounds good stuff is a little MBA. The text reads as though the company is trying just a little too hard to please. EPS are expected to fall to around 115p for this year and there is not much in the text to cause forecasts to alter. Trading in the fourth quarter was good and there are many things the company can do to mitigate the impact of some headwinds; it may be trying to do too much. The shares closed last night at 1563p and we think the announcement today will not help the price in the short term.
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