Market Commentary - Housing, Infrastructure, Construction and Services - 8th December 2016
Capita and MJ Gleeson tell us new information this morning. The former’s trading update outlines difficult trading circumstances in many areas and the intended sale of most of Capita Asset Services. Capita has not really surprised anyone today with its news. The need to bolster the balance sheet was clear so earnings were always likely to be diluted in some way either via the sale of a business or the creation of new equity
Capita and MJ Gleeson tell us new information this morning. The former’s trading update outlines difficult trading circumstances in many areas and the intended sale of most of Capita Asset Services. The company is not masking its intention to sell most of the Asset Services operation behind a “strategic review” cloak; it is going. While the certainty of the intention might not be the best way to maximise the consideration shareholders need to know the balance sheet is to get some support This part of the operation provides registrar and other services related to asset ownership and transfers and EBITDA of £70m is expected in 2016. The company expects the proceeds from the sale will reduce net debt/EBITDA to nearer 2x. Trading in many divisions is said to be difficult and is pointing now to revenue this year of £4.8bn and underlying PBT of £515m; those figures suggest that the Asset Services operation is still in continuing businesses but that is not explicit. Confirmation of the board’s intention to pay a dividend this year at the same level as last year and the news that the balance sheet restoration plan is underway should help sentiment this morning. Though eh news on trading in many of the continuing operations is not great, hence the second profit warning. This year released today and the plans to restructure and reduce costs. More below
MJ Gleeson is the exception among the housebuilders in its mainstream operations as it seeks to build volume and margin, while setting price levels according to affordability. The news this morning to accompany its AGM is that trading is as expected. The growth ambitions in the housing operations are being met with demand remaining strong and the company likely to complete over 1,000 dwelling this year. The new office in Nottingham will open soon. The strategic land operation has a lumpy trading profile as some plots are large in relation to total revenue. The company has flagged today that the results to June 2017 in this area will be similar to last year and second half weighted. EPS for this year is expected to be around 45p and over 50p in 17/18. The share price is starting to react as might be expected for the company’s low level of risk and not just respond to sentiment on the sector. It closed at 583p last night and is likely to rise further in the mid term as its operational growth and earnings increases continue.
The market and sector was Risk-Off yesterday so Mears, a safe stock in the current climate, was down 3% to 442p as a determined seller of 369,000 shares accepted 455p for them. Carillion was the other large loser as it fell 3.9% to 246p; the update was as expected apart from the £20m gain to the P&L and cash from selling its FM IT suite in countries in which it does not operate, via a third party. The item is a one-off this year. The gap next year should be filled mainly with higher revenue and earnings from support services contracts recently mobilised. The company stated it is committed to reducing it debt but no detail was provided how that might happen. The pension deficit is likely to remain a drag on valuation as the outgoing FD indicated it might be as high as £500m at the next valuation. Richard Adam alluded to a actuaries taking a longer term view on deficits as a likely development by 2018; but that is for the new FD Zafar Khan to resolve. We believe that there are ways out of the balance sheet “traps” that are available to the company.
The risk element was increased yesterday with Interserve rising 4.4% to 318p, Wolseley up 3.2% to 4879p and SIG up 3.2% to 95.5p. The weak industrial production data for the UK fuelled a view that interest rate increases were “off the table” and sterling declined accordingly. Our sense is that the buying of Interserve may have been a genuine interest in the stock and Carillion’s views on margins in FM in the UK might have helped, an argument that applies to Mitie as well which rose 2.9% yesterday. The positive performance of the two Merchants was probably boosted by the dip in Sterling as well as the expectation that interest rates may be low for a longer.
We warned a few weeks ago that Bilby was heading for a large bump in the road. It released a statement yesterday at 14.25 indicating that its reported PBT for the year to March 2016 is expected to be reported at around half of the previous level at £0.7m. In fact if the costs of business development that were capitalised are added to 2016 costs the business was at just a bit better that break even. In the case of Bilby we see a good business that was doing rather well in private ownership being brought to market on a “Buy and Build” story that is going sour very swiftly. The issues highlighted today are just the start of a process of unravelling, in our view, of what is a classic case of shifting revenue and cost between years top make adjusted numbers look good and making acquisitions that paper over cracks. Amey, Jarvis, Spice, Connaught, ROK, Erinaceous and counting.
The next situation likely to unravel at the smaller end is T Clarke. Recent adjusted profits have been due more to property disposals and exceptional charges flattering the numbers than genuine trading. The company is rapidly becoming a pension black hole rather than a building services business. The pension deficit at end June 2016 was £22m which is a serious issue for a company that had operating cashflow in 2015 of £2.7m, a £27m shortfall in its progress billings versus payments made and £5.1m of trade receivables over 12 months overdue. The pension deficit at end 2015 was £13m with £43m of obligations and £30m of assets at that point. Plan assets are said to be professionally managed but it’s rare to see a fund with 64% of its assets in equities of which 29% is with Hedge Funds and 21% in overseas equities. We are not being controversial to suggest that the pension fund investment profile seems ill suited to its obligations. The shareholders are probably not aware at present of the B/S issues and pension fund issues but are likely to be soon when the Trustees come knocking on their door as the latest valuation is produced. And, guess what, the earnings cupboard is pretty bare.
Capita has not really surprised anyone today with its news. The need to bolster the balance sheet was clear so earnings were always likely to be diluted in some way either via the sale of a business or the creation of new equity. We can only hope that the sale process has started in some way as the certainty that it will be sold and the need to complete a sale are 100% clear. The “New Capita” will have a clearer structure and be focussed on organic growth, we are told. But there will be little to cheer investors next year we suspect as the changes to the business and the market work their way through. It looks as though the Avocis acquisition has been a mistake and the company is working that through; the a focus in future is said to be on small bolt-on deals that add to existing operations. The concern today will be that no indicative numbers are provided on the restructure costs and expected savings so its all rather vague and seems hurried. The numbers on saving and costs will be revealed in the promised Capital markets day for which no date is provided. The news this morning is that Capita has realised there is a rather large problem and is taking the first real steps to solve it; the issue is whether they will be enough and whether the operations are in rather more difficult circumstances that revealed today. We expect the market will give the company the benefit of the doubt but as the renewal process is only just started and there are real questions about its ability to compete in some areas and the accounting treatments it’s too early to rush in.
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