Market Commentary - Housing, Infrastructure, Construction and Services - 7th December 2016
Carillion has the floor more or less all to itself this morning with a positive trading update and the announcement that it has achieved preferred bidder status on a £120m high voltage power transmission project in Canada. There is a Carillion conference call at 8.30 that will enlighten us further. The statement today has some aspects that the bears a can point towards and sustain their positions and many elements that are positive and show that the business has good trading prospects, despite the balance sheet issue and can continue to trade through its difficulties. We said almost to itself as Redhall a perennial struggler has issued its Finals for the year to end September 2016. It continues to struggle but might have reached a point where its restructure efforts are proving effective.
Carillion has the floor more or less all to itself this morning with a positive trading update and the announcement that it has achieved preferred bidder status on a £120m high voltage power transmission project in Canada. The trading update from CLLN is significant in that it points strongly to the increased significance of services in the mix and the strategic developments that have been in train for the last few years. Carillion was always expected to morph into a mainly services operation at its formation in mid 1999 but some construction and many PPP/PFI projects were too attractive to resist; that remains the case to some extent but the number of projects with the right risk/reward characteristics is lower than it was. The company has said today that it is trading in line with expectations though, due to FX movements, average net debt will be higher than expected. The small dip in the order book to £16bn by the year end from £17.4bn last year might attract some attention but with revenue at a short £5bn the change is not significant and the pipeline remains at £41bn and 70% of 2017 expected revenue is already signed up. More below
We said almost to itself as Redhall a perennial struggler has issued its Finals for the year to end September 2016. It continues to struggle but might have reached a point where its restructure efforts are proving effective. Revenue in the year was down £1m at £44m but adjusted operating profit of £0.9m was achieved versus a loss of £0.7m last year. Redhall was intended to be a buy and build in engineering services centred on Booth Industries, as specialist business based on Bolton that made and still makes the bomb (and everything else) proof doors used in nuclear and other high security situations. Well, the buy bit happened but he build bit did not hindered by the recession, some bad judgement on acquisitions and litigation on several projects, including Vivergo. The news today is that he business is still in recovery mode. But the increased levels of activity in nuclear (new build and decommissioning), in food and pharmaceutical sector plant and in defence seem to be promising and the company may well be at a turning point.
The moves yesterday were for the most part in a narrow range and mainly upwards. Grafton with a 3.9% increase was the leader and it closed at 537p. In fact the three best performers were Grafton, Travis Perkins and SIG as the Merchants came back a little, all were up by more than 3%, buoyed no doubt the news from Wolseley. Valuations in the sub-sector remain low and in our view attractive for yesterday’s top three. At 4727p at close last night Wolseley is probably fully valued given EPS of around 300p this year; having said that the potential for improved performance on the operations outside the US provides some upside. The problem we see is that so far management has not been at its best in recent years in those areas. Berendsen was the largest loser (again) with a 7.2% fall to 786p and was the exception yesterday. We have consistently been correct that the stock was overvalued when it was on c 18-20x P/E earlier in the year but the extent of its fall since end October’s mild profit warning has exceeded our expectations. EPS of around 65p is likely this year, post warning, so the current valuation of 12x earnings seems harsh. Admittedly the company seems to have mishandled some operational issues that should have been second nature during last summer and it is under pressure in some markets and input costs for new rental product are higher due to FX but the current adverse reaction seems to be overdone, in our view.
Back to Carillion, there is a conference call at 8.30 that will enlighten us further. The statement today has some aspects that the bears a can point towards and sustain their positions and many elements that are positive and show that the business has good trading prospects, despite the balance sheet issue and can continue to trade through its difficulties. The shorts can point to the slow order intake in the second half of 2016, slow down in the Middle East and net debt position being broadly unchanged. Those who are positive on the stock at it current level will focus more on the increased quality of earnings from both the higher proportion of services revenue and the level of risk management in construction, the improvement in demand that will arise from increased infrastructure spend and the commitment to reduce borrowings. Our sense is that at the closing price last night of 256p and with c 35p of EPS expected this year (same as in 2015) the shares are very good value. There are good reasons to believe the company will pay a slightly improved dividend of around 18.9p for the full year which is a yield of 7.4% and over the next 18 months with two finals and an interim payment the dividend return will be over 10%. It will take time for the company to trade through its balance sheet issues but we believe that will happen and that the shorts will need to retreat at some time soon.
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