Market Commentary - Housing, Infrastructure, Construction and Services 4th May 2017
Morgan Sindall and G4S have updated this morning and made very positives starts to 2017; the former indicating that its earnings out-turn this year will be slightly ahead of previous expectations. Morgan Sindall is going through its best period of trading for several years. G4S has issued a short statement but when revenue is up 8.9% in Q1 on the same period in the prior year the numbers are doing the talking!
Morgan Sindall and G4S have updated this morning and made very positives starts to 2017; the former indicating that its earnings out-turn this year will be slightly ahead of previous expectations. So how come there is such a contrast with the news yesterday? The answer really lies in today’s releases coming from companies that have been through their bad patches and are now trading with clean accounts and conservative assessments of revenues and costs on work that straddles more than a few years. The issues that arise in the sector are nearly always down to management assessment of revenue and cost, as accounting rules allow such leeway and companies are not as transparent as they might be over their assessments. Some of the caution may arise from commercial confidentiality but clearly a lot is due to management incentives being geared to financial numbers that are based on management judgement. It begs question in many areas, including audit committees and external research.
The emerging situation in third party, independent analysis of companies arising from MiFiD II will not improve either the amount or quality of research. What is also clear from recent updates is that it is possible to create sustainable and profitable operations in Construction, Infrastructure and Services if risk is managed well and accounting treatments are cautious. Investors require a bit more exposure to management and a range of views on the numbers to get an understanding of those issues.
Morgan Sindall is going through its best period of trading for several years. The company tell us today that in all areas of the it is trading well, including Fit Out which has had a very good 12 months in 2016 that continued into the first four months of this year. The prospect of doubling earnings over the next few years from the 80p achieved in 2016 is very real. The signal this morning is that EPS this year might be near to the 100p level, based on PBT of £52-54m versus £44m last year. The company points to its net cash of £115m at end March 0217 and the average daily cash in the first three months of £154m; it starts to beg the question of what it might do with the money as clearly the balance sheet might be “more efficient”. Our sense is that having been through a bad period in 2012-2014 the management will want to pause for a while longer on making commitments. Thereafter we suspect its will see opportunities in regeneration and partnership housing as well as perhaps returning any surplus cash to investors. That is probably an issue to be resolved later in the year/early 2018 and it’s a very high quality one. The company has been strong in its commitment that it will avoid acquisitions. So expect to see MGNS shares perform well today and in the mid-term as 160p of EPS is possible and if it gets near that level the price at 1043p at close last night looks wrong.
G4S has issued a short statement but when revenue is up 8.9% in Q1 on the same period in the prior year the numbers are doing the talking! A few more numbers on comparisons on a L4L basis and at constant FX rates would help. But the indication that organic revenue growth was in excess of 10% in developed markets and stable in the emerging ones tells us much of what which is reasonable in the UK context, less so for US investors. The other important way of looking at the statement is that the company has not highlighted any issues to worry investors and is now moving forward solidly and sustainably. The increased revenue should allow margins to improve, as promised previously as overhead absorption increases. We are also told today that the disposal programme has led to the sale of Youth Services in the US realising $57m of cash so the trend to having net debt/EBITDA below 2.5x by the end of the year continues. The market expectation for EPS this year is 18.5p and taht will rise in 2018 to just over 20p. At 314p at close last night G4S looks cheap, based on progress YTD.
No prizes for guessing that Mitie topped the table in our universe and Galliford Try was the largest loser. There is much chatter in the press on these two today so further comment on the obvious is avoided here. Mitie’s 9.3% rise to 231.1p came after it cleared out all of the history and can now show a clean set of numbers; the issue for investors is whether at this level much of the upside is already in the price. That may be the case for now as proof that the changes made to the operations and management is delivering results is needed. Butte long term nature of its contracts and the essential nature of its work suggests that in the mid-term the rating will improve.
Galliford Try’s unscheduled update did not help the price, it fell 10.5% to 1308p, and almost exactly £100m was wiped off the market capitalisation which matches the c £100m of reduced Enterprise Value from the cost of the write-offs on the Forth Bridge and the Aberdeen roads. Clearly the recovery in Construction margins in 2018 and beyond will now be more certain but the performance in recent years begs the question of why continue in this space. Part of the answer is that pulling out is very difficult and the part ids that ROCE can be very good when things go well. The company assured us that it is trading well apart from on these two large projects so we can expect the share price to pick up a little from the close past night but it will take time and some ”selling” to get back to previous peaks.
The other comment that is not covered in the press relates to the collateral damage suffered yesterday by GFRD’s partners on Aberdeen, Balfour Beatty and Carillion, both of which fell, 5.1% and 2.1% respectively. It is possible that both could be trading through the known issues on that project and the absence of specific comment from them suggests that they are. But the market will remain cautious as it may take a view that GFRD is being more reasonable than the others. It depends on the work packages in which each is involved, of course. The answer may lie in GFRD having taken a very cautious view on contract out-turns and the others being more optimistic. Both BBY and CLLN know the rules of engagement in the quoted space so if they have known problems of a substantial nature they would have told us by now. The issue therefore is about accounting and contract assessment which is where we started!
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