Market Commentary - Housing, Infrastructure, Construction and Services - 2nd November 2016
G4S and Persimmon have issued updates this morning.Persimmon’s statement tells us that the housing market remains strong but the company is acting in a cautious manner. Persimmon’s statement reflects the longer term concerns about UK housing given the “euphoria” that seems to exist currently, especially outside the M25. The sector moves yesterday were in a narrow band with the best riser, Travis Perkins, up by 2.9% and the largest loser, Interserve down 2.1% to 331.5p.
G4S and Persimmon have issued updates this morning. G4S is doing so ahead of a series of investor conferences. The message from G4S is that the business is performing very well and that there is much more to come. The evidence for the first part of the statement arises from a 5.7% rise in revenue in the first nine months, at CER, and double digit percentage growth in earnings and operating cashflow. The second part of the statement is more difficult to evidence of course but the current improvement will aid the funding of future growth and development. No sign yet of disposals being completed but the commitment to reduce net debt/EBITDA is longer term and there are two sides to the equation. More below
Persimmon’s statement tells us that the housing market remains strong but the company is acting in a cautious manner. The evidence for the former is provided by a high sales rate, up 19% on last year since 23rd August and forward sales for next year are up 4%. The company indicate that while the planning regime is improved they are concerned about the impact of Brexit in the longer term and have become cautious about land buying. The company reference regional hose prices as remaining firm, making no comment about London. Reading between the lines the company shows concern that the current level of demand is boosted by the high availability of cheap mortgages and government schemes that may not be sustained. Persimmon is moving further into its supply chain and has announced to day that it is to build a brick factory in Doncaster to supply its own requirements, to be commissioned early next year. That is in addition of course to its Space4 modular component factory to which there is a site visit tomorrow. Other housebuilders have taken a view that capital is best allocated to house building so in teh 9am call this morning it will be interesting to understand Persimmon’s rationale. More below
The sector moves yesterday were in a narrow band with the best riser, Travis Perkins, up by 2.9% and the largest loser, Interserve down 2.1% to 331.5p. The move in Travis is in our view part of the ebb and flow of trade and not a signifier of any change of view; it is however at one of it lowest levels of valuation in recent years and on a long term view at a favourable entry point. Interserve seems to be unable to please investors in any way at present. It is due to update the market in mid November, the precise date is not on its website. The decline in the price in recent weeks, following a period of strength post the interims is odd as there is no new news. We can only surmise that news of performance is circulating, leaking from debt or other markets as can happen when companies are in difficulties. There is an expectation that the Glasgow project might see a further provision, above the £70m indicated earlier this year; balancing that is the indication that Kwikform is trading in line with expectations.
Back to G4S, the statement is short but contains enough to tell us that progress is being made. Access to the slides that will be used in the investor meetings would be useful for all parties to see. Our sense has been for some time that G4S is in a stronger position than teh market recognised an as such has been undervalued. It was always going to take a long time to achieve turnaround in a 620,000 employee global operation. The signal this morning is that the elements are in place and performance has improved. Two paragraphs out of the seven are focussed on handling objections to the attractiveness of the business, the net debt and the pension deficit. On the former the company indicates that it is on track for net debt to be below 2.5x EBITDA by the end of next year. On the pension the Trustees have agreed to a lower annual deficit payment at £39m due to improved investment performance in the fund. In our view the attractiveness is based on the company operating in growth market providing an essential service and its own development of efficient techniques for cost efficiency and operational performance. The stock closed at 220p last night which given EPS of around 15-16p this year seems to be a low valuation compared with rivals.
Persimmon’s statement reflects the longer term concerns about UK housing given the “euphoria” that seems to exist currently, especially outside the M25. Current market conditions thrive on cheap money, high employment, population growth and government support. Its not clear that all of those conditions will be sustained, especially the first three, in an aggressive Brexit environment. Add to that the company indicating skills shortages in vital site trades, the impact of which it is investing to mitigate via investment in manufacturing capability which is unlikely to yield the same ROCE as housebuilding, in our view. The telling statistic is that the company has bought just 7,580 new plots of land YTD at a cost of £116m; arguably it has enough land to satisfy it growth targets but that caution is at a high level. We will attend the conference call at 9.00 and report as appropriate.
Hot items of news Sent yesterday, 1st November 2016
Carillion, Bilby and T Clarke
Carillion announced at 13.50 today that JVs of which it is a 50% partner (with KBR) has won contracts worth a total of £1.1bn to deliver part of the Army Rebasing programme. The whole project is to repatriate around 20,000 soldiers and their families from Germany back to the UK. It has started on a low key basis and is now expected to accelerate. Carillion has won the work to be done in around the Salisbury Plain area, which is the patch it has covered or many years through the Allenby/Connaught project, Aspire Defence Services,
Carillion will get around £340m of construction work between now and 2020 and £215m of support services work, via the JV for the next 25 years. The issue will of course be how much it can self deliver to gain very good margins. Arguably Carillion was always going to get the work because as the incumbent it had such advanced knowledge of the area and the assets. But nothing can be taken for granted and it is good news that it has been won. The values imply it is not a game changer but it is good revenue usually at good margin and reinforces the company’s position. The form of the contract for the new work appears to be as a variation to the existing 35 year contract started in 2006. The work is performed by the Carillion/KBR JV on behalf of Aspire Defence Limited which is a subsidiary of Aspire Defence Holdings which is owned by HICL, Innisfree and KBR.
This is good news for Carillion and emphasises that is predominatly about low risk work for blue chip customers combining construction and support services. The market is still classifying it as a construction company that takes on high risk projects at fixed prices. There is no doubt that its balance sheet is an issue but the long term nature of its contracts and the absence of substantial accounting blunders should provide investors with some confidence. The shares are trading at 255p and EPS this year will be around 36p, aided of course by contract wins such as the one announced today.
There are other elements of the Rebasing programme as Salisbury Plain is not the only area involved. Morgan Sindall recently completed 350 new housing units in Staffordshire as part of the project. And WYG is heavily involved in the planning programmes through its main stream operations and via two consultancies it purchased within the last 12 months. Carillion and Interserve will be involved in competing in those areas as well along with others. But Carillion, through this win has received the first major contract to be let.
Bilby
At just after 10.00 this morning Bilby joined the long list of shockers to hit the sector. This was a good little company based in Kent that that a great line of work in plumbing, gas and power related work in social housing, in particular it took advantage of the boiler replacement programmes in CERT, CESP and ECO and had an ongoing revenue stream from the annual gas certification required in all rented properties. Its operating margins were 10-12%. Then somebody persuaded it that the next stage was a Buy and Build in the space and an expansion into Building Services and that is were it went wrong. As a little local operation that knew its patch well the system was working but scaling up is a different management task altogether
The news today is that revenue will be 10% lower this year to end March 2017 than expected and EBITDA 25%. The issue is that a major customer has changed the way it buys services and taken some of them back in-house. The larger Housing Associations often run a mixed economy in terms of building services and the trend has been to take some back in in-house; the smaller ones are more inclined to outsource. The company also cites that loss of work as well as “certain other additional costs” as the reasons for the warning.
The statement today provides a lot of remarks about the company’s confidence in its growing range of services, customer relationships and comfort with the integration of recent acquisitions. But there is no data to support those views! Nor has the company addressed the implications for cash and dividends in the statement; it may be too early but it might have acknowledged the issues.
We can see no reason why Bilby should continue to earn operating margins of 10% in a sector were a consistent 5% is good. Revenue in the last full year was £32m and underlying profit was £3m. Among the £1.5m of adjustments from headline operating profit to underlying were £275,000 for establishing frameworks which look like normal bid costs to us and should have been taken over the duration of the frameworks or in the year of spending and around £0.4m of cost for the group’s BD and Managing Directorand a portion of the Deputy Chairman’s time. This is hardly best accounting practice signed off by RSM UK Audit LLP (Formerly Baker Tilly)
If Bilby is to have a future as a quoted entity it may need to consider getting more industry experience on the board (only one of the five Directors has industry experience), get real about its margins as 5-6% is the likely sustainable level, in our view and get right the acquisitions it has made before seeking new ones. Realistically adjusted EPS is nearer to 4p a share or less and not the 7.4p shown in the accounts for last year. Based on that 40p-50p might be a more appropriate level for the stock not the 70p at which it currently trades.
T Clarke
After close of play yesterday, at 16.37 to be precise, the well advised T Clarke, issued a warning to say that £2.8m has gone missing from its Essex subsidiary DG Robson Mechanical Services (DGR), The statement is reassuring as it appears to be in just one subsidiary and does not affect the group as a whole of reported results this year. The cash has gone and may never be recovered. Misappropriation of funds, as CTO states it, is a wide term open to misinterpretation so more data is needed before conclusions are reached. And the FD may need to think of the future a little differently.
As with Bilby, T Clarke has morphed from a specialist on top of its game and tried to enter the market for general building services. It has swapped the sanity of good work at good margins in specialist electrical work for the vanity of larger turnover and low margins in building services. T Clarke had a long history of being the best Electrical Contractor in London. It expanded in other regions in electrical work quite successfully and owned the properties from which it operated. Margins were 4.5% in 2005 on £194m of revenue compared with £4.4m last year on £244m revenue. And ten years ago the company had tangible fixed assets of £8.5m and a pension deficit of £4.3m. It now has tangible fixed assets of £0.3m and a pension deficit of £13.4m on a plan with assets of just £30m.
The key to assessing CTO is in Note 16 to its accounts. At end 2015 it had £182m on long term contracts on which it had recognised costs including net profit; against that sum it has received just £155m of progress payments. This situation is said by FDs not to be a concern but in our experience wrapped within these two big numbers that are several projects on which payment may never be made. It’s in the debtors numbers and those due for over one year have grown from £8.1m in 2014 to £9.8m in 2015.
Whoops, it slippery out there for firms that think Building Services and Regional Construction are easy games for quoted entities to play. The accounts can tell the management story for a while but it can, but not always, get ugly if growth rather than margin is the goal.
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