Market Commentary - Housing, Infrastructure, Construction and Services 3rd November 2016
Plenty of new news this morning from Morgan Sindall and Howdens providing trading updates and Severfield announcing £72m of new orders. Evidence that the London housing market is “off the boil” came yesterday from Persimmon when it referenced regional pricing remaining strong but not around the M25. The 10.3% rise in G4S achieved yesterday is overdue, in our view, as its rating has lagged the peer group by some distance.Interserve and Capita were both among the main losers yesterday down 1.8% and 1.6% respectively as concerns remain about the need for an equity issue.
Plenty of new news this morning from Morgan Sindall and Howdens providing trading updates and Severfield announcing £72m of new orders. Morgan Sindall has prvided a strong positive statement which should almost conclude that it will be ahead of expectations but that temptation is resisted. The company has performed well in the YTD and order books are at high levels and cash is positive, which is much better than expectations. The company claims to be opportunity constrained at present, but it has become much better at selecting the right opportunities. Howdens will be relieved to have seen total revenue YTD rise by 6.6%, 4.0% on a L4L basis and gross margins are said to to have been in line with expectations. It has however indicated that trading conditions were softer in recent months, as highlighted by the Merchants so life might be getting tougher. It now has 639 depots in the UK, having opened 20 new ones YTD, which begs the real strategic issue for Howdens of what to do next, as a lot more depots is probably not the answer. Severfield has announced six new contracts worth £72m including 22 Broadgate for Multiplex; its looks like a good start to the month for Severs ahead of its results to be released on 22nd November. More below
Evidence that the London housing market is “off the boil” came yesterday from Persimmon when it referenced regional pricing remaining strong but not around the M25. If the quoted sector will not “Fess Up” then the social housing sector has with L&Q reducing its forecast surplus for this year by £11m due to the drop in the prime London market and post referendum delays on key sites. S&P has downgraded L&Q and Swan over sales risk and putting other Housing Associations on a negative outlook. Property sales are a key item of Housing Association profits as they recycle gains into new developments. All of that comes at a time when the first social housing REIT is intending to float and raise £250m. Timing of the float may not be ideal but that does not mean it will not happen.
Much of the Persimmon conference call was focussed on the decision to start making concrete bricks and spend £10m on factory in Doncaster to do so. The trading numbers for the mainstream operations were a tad better than expected and the reduction in land spend is well rehearsed. The company is preparing for tougher conditions in the housing market and the Nationwide’s data on prices revealed yesterday show that affordability limits might have been reached. Housing output grew in October as the main housebuildesr enter their financial period ends (mainly December) and were cranking up the volume before the weather turns; nothing new there. You can bet the ranch that build volumes will plummet in December!
Back to Persimmon’s bricks and vertical integration in house building. Persimmon is will make the lowest quality type of brick in concrete. This type of brick is not fired and therefore does not have the same colour retention and longevity of a kiln fired brick. But the capital investment needed at £10m is around a third of that required for “proper” bricks. In the call the company, by implication admitted that the investment will yield a lower ROCE than the current levels in housebuilding but it need to have supply security and certain pricing. The decision is curious as the three major UK brickmakers have all invested in new capacity in recent years and 2bn pa seems to be the optimium level of production capacity needed with imports providing some swing capacity. The move also which no other housebuilder has deemed necessary. Our sense is that Persimmon will be alone in this one with most other housebuilders having pulled out of integration (eg Taylor Wimpey and Prestoplan) or not bothered in the first place. The main UK brickmakers are unlikely to be phased by this development which adds around 4% to UK capacity and it is in the lowest value product.
The 10.3% rise in G4S achieved yesterday is overdue, in our view, as its rating has lagged the peer group by some distance. The update was short but reassuring on the main issues. We expect that the company will release the slides to be used in the forthcoming investor conferences coincidentally with the presentations. The peer group is trading on c 18-20x prospective p/e and save for its small balance sheet concerns G4S should be nearer Compass and Rentokil in valuation. Our sense is that target prices of 300p are not unreasonable given that logic described.
Interserve and Capita were both among the main losers yesterday down 1.8% and 1.6% respectively as concerns remain about the need for an equity issue. In the case of both companies we suspect that some investors might want management change and a clearer strategy before providing increased risk capital. Note our point is about investors possible views not ours. The issue now of course is whether it is too early to buy shares on the basis that an equity fund raising can be avoided. Our sense is that is a tricky game to play but the scope at current levels exists with both companies as interest cover is at high levels and there is ateh capacity to trade through the difficulties.
No problems with cash at Morgan Sindall which is the main topic of the update today. Effective collection of overdue sums on account and increased levels of forward payments on projects has helped the company to flip from net debt to net cash of £78m on 31st October and average daily cash of over £5m for the year with the 2H average much higher than that. So roll on the drinks session mentioned in today’s release, scheduled for 22nd November! On a serious note the board discussion around the dividend payment shall be an interesting one and we suspect that the company will exceed current expectations as our conversations with management suggest that the good performance outlined today is sustainable.
The good cash position is based on the hard slog over the last five years to get the business in better shape and it now seems to be firing well on most cylinders. The company claims that Brexit has had no impact on trading. Fit-Out would be the area most likely to see some impact but we understand that the order may been be a little stronger than the record level indicated in August at the interims. In Social Housing the new leadership team has a great opportunity to fulfil the potential created from acquisitions and the position the business was in five years ago; interest levels are said to be much higher now from all Registered Providers.
We were expecting EPS this year of around 78p (85p next year) and we sense the company might just beat that a little but not put everything in the shop window. It should and we suspect, will remain cautious. It may be that it will nudge up the dividend to a higher level than the 32p we have pencilled in for this year as getting back to 42p som e time soon is probably what John Morgan had in mind when he bought £3m worth of Morgan Sindall shares a few months ago. The shares will rise today of course but the trick will be in showing that the current performance is sustainable by having the broad mix of activity within the portfolio. We suspect that it will be.
Howdens announcement is positive for now but there are seeds of concern within the statement, especially around the softening of demand. RMI spend has not fully recovered post down turn so overall demand is under pressure. And Howden’s look-a-likes are improving and getting some share, eg Benchmarx. The company has moved into products other than kitchens and tried to go overseas (which is not mentioned today) but to all intents and purposes has reached saturation in the UK. The stock has been under pressure in recent months and the news today will not change that much. The announcement confirms that EPS this year wil be around 28.5p but an increase for next year has to be questioned right now should current trends persist. The stock closed at 382p last night and that looks good enough for now.
Severs announcement is excellent news for the company which has seen the price struggle for no obvious reason. It is well past recovery stage in many respects and now in the growth phase, market conditions permitting. The company expects to report near 5p of EPS in the year to end March 2017, we believe and 6p is in sight for 2017, especially given these new orders. So the shares at 58p look a little cheap, in our view. The keys have been much improved risk management and a positive market environment.
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