Market Commentary - Housing, Infrastructure, Construction and Services 3rd October 2016
It promises to be a quiet week but today Renew Holdings has issued an update, Interserve has told us of a £7.5m contract win and Morgan Sindall has got a new Chairman. Travis Perkins was the leader on Friday last, rising 1.8% to 1543p. It was a positive move but not enough to lift it from the bottom of the FTSE100 table of companies by market capitalisation. We attended the Atkins CMD on Friday. The technology presentation and the news of a $320m contract in nuclear in the US were impressive.
The Services sector fell 2.2% last week as Capita was smashed by the market and several stocks were hit with collateral damage.
It promises to be a quiet week but today Renew Holdings has issued an update, Interserve has told us of a £7.5m contract win and Morgan Sindall has got a new Chairman. Renew Holdings, formerly Montpellier is a remarkable story missed by many. We are informed today that it traded in line in the financial year ended Friday last and that the business has moved to a net cash position, which is better than expected. The text reminds us that Friday was Brian May’s last official day as CEO, Paul Scott, in internal appointee is now CEO and that under Brian’s leadership the market capitalisation grew from £17m to £229m without additional equity funding. What the release does not say is that he joined in June 2005 so the 11 year run is remarkable given movements in other stocks which, at the time he joined, were also in property, construction and services. The business is now mainly engineering services focussed on the utilities (especially water) rail and nuclear. More below.
Interserve’s latest announcement is a bit baffling as the size of the contract is small (£7.5m/3 years) and the work is low grade cleaning services (windows, daily and periodic, we are informed) for SSE and SGN. A win is a win but for a group with annual revenue of over £3bn getting a contract with an annual value of £2.5m hardly seems price sensitive though the company has used to announcement to advertise that it supplies asbestos removal services to the same client. Morgan Sindall’s replacement for Adrian Martin starts today; Michael Findlay joins having retired recently from BAML and is also SID at UK Mail. CEO at Morgan Sindall John Morgan paid £3.2m for shares in the company in early August to take his holding over 10%; that stands in stark contrast to the amounts spent last week by three Capita Directors (£123,000 in total).
There are no planned statements this week for sector stocks, according to The Times. In the last two weeks Mitie and Capita kept us on our toes with substantial warnings. Homeserve and Babcock have March year ends and might be expected to have pre close statements soon but all we have on their respective websites is the intended release of half year results, both on 22nd November. Shall we get another substantial warning this week? We cannot see another large sector company running the same levels of financial and commercial risks as Mitie and Capita but the is clearly some potential for concern around Interserve and some of the smaller companies such as T Clarke look to be on a one way track to serious financial difficulties
Travis Perkins was the leader on Friday last, rising 1.8% to 1543p. It was a positive move but not enough to lift it from the bottom of the FTSE100 table of companies by market capitalisation. Demotion from the Index in early December is far from inevitable but it is in danger and that often becomes self-fulfilling. Mitie found some support as well rising 1.5% on the day. Perhaps some shorts are closing and there is a recognition also that it has some valuable contracts and all that may be needed is a little more transparency on numbers and much more realistic margin aspirations. Making the business a “pure” FM operation may now be seen as better strategic option than “dabbling” in Energy Services and Healthcare. Capita was the back marker on Friday, down a further 4% to 670p and we discuss it development below in our section on Moves Last Week
We attended the Atkins CMD on Friday. The technology presentation and the news of a $320m contract in nuclear in the US were impressive. Capita’s current prospective p/e of just under 14x compares unfavourably with other UK domiciled stocks with international exposure that have an arguably weaker base of Intellectual property. There is lots of management know-how and technology in Catering, Cleaning Linen and Workwear and Pest Control but not enough to justify the substantial difference in ratings between Compass, Berendsen and Rentokil when compared with Atkins, in our view. The technology and know-how shown to us on Friday was impressive and the company claims it has lead in many areas compared with rivals. As outsiders we have no real means of comparing other than to say the only company that has come close to showing similar stuff to the City is Costain, which also boasts its technology credentials. What we are talking about is advanced design and visualisation techniques to create plans and assessment tools for buildings and structures that extend not just into the building itself but into costs and returns.
The route taken at Renew Holdings is one that many UK companies might have followed from it starting point in the early 2000s. The company was then the bombed out Montpellier Group which had a few valuable pieces of property (in the east side of the US, Lombard Street and in Chelsea) and some construction, engineering and housebuilding activities. The newly appointed Chairman at the time, Roy Harrison (who remains in that post) carefully steered the company away from activities in which it had few advantages and are low margin/high risk towards the 4-5% margin activities it has today. That was done by acquiring skills and customers in UK engineering activities at sensible considerations, having strong brands, being patient about disposals of certain businesses, managing risk well and keeping a very tidy balance sheet. I am sure there is lots more we can add and will if asked. The issue is whether it can improve further on the 27-28p of EPS expected for the year ended Friday last and the 31p expected this year and the answer is yes. There is still scope for revenue and margin improvement in our view. And when it has been in net cash before the company has usually made a bolt-on acquisition in a relevant area via it normal method of a term loan with fixed repayments so investors are never in doubt. The price closed at 367p last week so the shares are not cheap but the value is recognised and is improving, as might the share price.
Moves Last Week
The Services sector fell 2.2% last week as Capita was smashed by the market and several stocks were hit with collateral damage. The housing stocks rose a little and the sector index is now level YTD while the Construction and Materials segment rose 3.3% delivering an 18.8% rise YTD. Services stocks are up a short 3% YTD.
The big change was of course Capita. It signalled a 10-13% fall in PBT for this year and the stock fell 32% and is down 45% YTD. We covered what may be going wrong in our note on Thursday. The substantial price fall reflects the market suspecting that new equity may be needed to bolster the balance sheet. The company may also think it needs one but shareholders may not want to back the current top management. The Co-op Bank’s response to Capita’s view on the state of its contract with them, disputing strongly Capita’s claims hardly helped.
The Capita Chairman and CEO may have bought shares in the company on the day of the warning in an attempt to garner support and confidence; they paid around 700p and spent £14,000 and £99,000 respectively. The FD was a bit cannier and spent a short £10,000 on shares at 679p.
Top executives buying shares and mainstream brokers writing sell notes when the stock is already down 30% from their previous buy recommendation are two of the interesting aspects of warnings.
• On the first we just do not get it. OK, it may be seen as a vote of confidence but equally a long serving CEO such as Capita’s Andy Parker is already well stacked with shares and options. Making yourself even more dependent for future wealth on a company with a big problem is hardly likely to make clear-minded decisions easier.
• And in terms of Sell notes our view is that the arguments for a further fall in the stock need to be pretty clear. Admittedly there were some who saw that this as a potential buying opportunity, unusual but the severity of the fall made the reaction a little different
At 670p the prospective p/e at just over 10x Capita’s shares could be seen as very cheap as it still has substantial contracts and market presence. But they are not ones for widows and orphans as there is still some bad trading news to emerge, in our view and a sustainable level of operating margins is probably not the 14% boasted of by the company but nearer to 10% and a reliable set of forecasts has yet to emerge.
We were not surprised to see some collateral damage last week to stocks that also rely on UK government contracts, such as Carillion and Babcock, both of which fell by around 5%. We believe those moves are not justified. The MoD is the main customer in both cases and it is heavily dependent on long term suppliers of essential services such as CLLN and BAB. The MoD’s spend on outsourcers is 6x greater than any other government department (£20bn a year from a budget of c £35bn) and thes suppliers have well established levels of margin. Capita by contrast does some work for MoD (DIO contract) which was won around two years ago and is currently another loss maker, according to industry sources, unmentioned in the recent update
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