Market Commentary - Housing, Infrastructure, Construction and Services - 9th December 2016
Marshalls and Waterman have provided trading updates this morning and Berendsen has announced a Competition and Markets Authority (CMA) investigation into a small part of its operations that is now discontinued.In the Capita “hiatus” yesterday the news that G4S and Serco had the extensions granted to the infamous Compass asylum seeker contracts to 2019. Is Capita worth buying at 485p with a dividend of 31.7p, a yield of 6.5%?
Marshalls and Waterman have provided trading updates this morning and Berendsen has announced a Competition and Markets Authority (CMA) investigation into a small part of its operations that is now discontinued. Marshalls delivered 3% revenue growth in the eleven months to end November and it was up 4% in the most reason five month period. Such growth is consistent with what we are hearing elsewhere in the market and, while not fast, is in the right direction. It will permit some earnings growth, probably at a slightly faster rate than revenue increases but the statement provides no indications on profits and cash.
Waterman’s statement is similar to that of Marshalls insofar as it points to modest growth in revenue in recent months and an amount of self help and improvement that should show through in earnings. The company has won a number of good projects recently (Army Basing project, Brent Cross) that should underpin another good performance in the UK this year. The news from waterman is not as positive as that of Atkins but its supports the view that the UK provides a good base for work at present and any adverse Brexit effects are not showing through.
The Berendsen announcement appears to be about storms and teacups. The CMA is to investigate allegations in relation to a JV which ceased to operate in February 2016, in a part of Berendsen that had £7m revenue in 2015. The investigation is confined to this small part of the company. While it cannot be disregarded this seems to be immaterial to the group in financial terms. It is not what is needed at this juncture but arguably it is not going to deflect the organisation from its main purposes.
In the Capita “hiatus” yesterday the news that G4S and Serco had the extensions granted to the infamous Compass asylum seeker contracts to 2019. The announcements came at around mid-day. The statements from government and the companies indicate that new terms in the extension might improve the financial out-turn to August 2019 but both Serco and G4S state that there is not enough evidence that causes them to change the existing onerous contract provision plans. In the case of Serco that was £112m, assuming the extension and for G4S £31m has been provided and further £57m has been announced as needed if the extension was granted. The news was in line with expectations and the price of both stocks rose yesterday, Serco by 1.4% and G4S by 0.9%. The government’s “concessions” may reduce some of the losses but it’s too soon to tell and as Serco tell us the contracts will still be loss makers.
There were some substantial moves yesterday up and down. Capita provided the largest fall with a 14% reduction on the day to close at 485p, which oddly is the same level it was at in late March 2006 when Rod Aldridge departed. We reflected a few weeks ago that strategically the business has not matured in the last ten years. So, logically enough, neither has the share price, even though the revenue has more than doubled. We reflected that Capita had endured a “lost” decade just doing more of the same. And that is the strategy outlined today in the conference call, albeit with some intelligent adaptations of generally available technology.
The rhetoric used today of “fully aligned divisions”, “a more resilient business”, “...these actions will create a leaner Capita, focused on its core strengths and with a much stronger balance sheet” are a bit of a technocrat’s solution to a business problem, dressed in business jargon. Completely absent is any mention of people, culture, training and leadership, recruitment and retention and commitment to customers. No regret is expressed about the uncertainty created among employees of the announcement that most of the Asset Services operation is to be sold, just a few weeks before Xmas. The only relevant aspect for customers and employees is that there is a cost reduction programme which may affect them adversely and there is no upside. And if they get no benefit then ultimately neither will shareholders. The statement is supposed to reassure investors but by ignoring completely the impact of the changes on the employees and, how they might become better able to their jobs and succeed in satisfying customers if changes are made, it’s a case of the plot being a little bit lost. We expect it’s an oversight at a difficult time but it may indicate management’s thinking and that is instructive.
Is Capita worth buying at 485p with a dividend of 31.7p, a yield of 6.5%? Our thought is that it will get followers at that level and up to 550p. The business has many good contracts and strong positions in some sectors. Despite the forced nature of the sale of the Asset Services operations a decent price that restores balance sheet strength is likely. Much of the awful jargon that is in the statement should be ignored. And investors will set aside the dreadful behaviour of Parking Eye, capita’s car parking operation that fine everyone it can. While much further change is needed we suspect Capita’s worst moment has been reached but new thinking is needed at the top.
The troubles at G4S, Serco and Capita beg the questions of the validity of outsourcers as an investment proposition and why does it seem to go wrong so often. On the first issue, the main point is that when it works well outsourcing provides good long term revenue streams and solid ROCE. There are many examples of good, long term outsourcing contracts that have been successful. And while too many companies have warned on UK activities its notable that Carillion, Compass and Sodexo, three of the largest in the segment have not warned. So it is possible to provide outsourced facilities and not hot the buffers every so often. On the second issue, many companies have sought to achieve faster than average revenue growth and increased margins at a time when the opportunity to do so was low. That resulted in companies taking undue contract risk and making assumptions about access to additional work within contracts that is discretionary. Slow and steady is best right now in UK Outsourcing as several companies have shown and many that sought a different outcome have floundered. There is no sense in which we see outsourcing reducing in the UK so its here to stay but requires a sensible approach from all parties involved and developments in technology and innovation are the ways in which companies can compete effectively.
The main move up yesterday was Berendsen which rose 8.4% to 840p. Favourable big broker comment and a recognition that it has not suddenly become a bad business were behind the move, we believe. Target prices are probably around the 1000p level and that is realistic. The CMA investigation may hold back some of the restoration of the valuation but not for long.
It was also interesting yesterday to see SIG rise again, up 1.6% to 97.2p; it is 8% higher now than its close on Monday 5th. In recent years management has arguably not made the most of the opportunities. But the opportunities to improve performance still exist and while there may at present be hope value in the shares at 97p there is some good an experienced management team can do with a business trading at 35p EV for every 100p of sales. Target prices of 120p are realistic on a six month view.
We attended the MJ Gleeson AGM yesterday. This has been a very interesting situation for some time and in our view remains so. We believe from what we have seen and heard that it could build over 1,000 new dwellings this year and with seven divisions has the capacity easily to stretch to 1,400 units. Beyond that a doubling of size of annual completions from here is possible, assuming current conditions are not altered substantially, including mortgage availability, good levels of employment and relatively low interest rates. Several more new divisions may be needed to double output, which is possible, without impacting adversely on margins. Looking at the strategic land operations we gained confidence, in discussions, from the willingness of land agents to use Gleeson in the South East, based on previous good experiences. The demand for land that can be put to use swiftly remains high among the top 25 housebuilders, by volume. The big housebuilders boast of large land banks and they are right to do so. But having a piece of land that can be used immediately, with detailed permissions is valuable and that is a big part of the gap that Gleeson’s land operations can often fill. The shares closed down a tad at 570p yesterday. The management is highly incentivised to get to a TSR of 1000p and, given it has succeeded at every previous target that has been set, we have a feeling it will not miss that one.
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