Market Commentary - Housing, Infrastructure, Construction and Services 9th January 2017
Directly relevant news this morning from sector companies includes an update from MJ Gleeson, the unexpected departure of Bovis Homes CEO David Ritchie and contractor Styles and Wood (S&W) acquiring a small consultancy for £4m. Announcements on trading come fast this week with Galliford Try tomorrow, Taylor Wimpey on Wednesday, Barratt Developments on Thursday and SIG and Grafton on Friday; all according to The Times.
Directly relevant news this morning from sector companies includes an update from MJ Gleeson, the unexpected departure of Bovis Homes CEO David Ritchie and contractor Styles and Wood (S&W) acquiring a small consultancy for £4m. Regarding Gleeson the messages are that demand levels remain strong and that it is on track for 1,000 completions that year and is trading in line with expectations. The departure of David Ritchie at Bovis comes after a surprise profit warning around Xmas which indicated that its completions in the year to end December were 3-4% lower than the guidance provided just a few weeks earlier, 180 units. The company had been struggling to keep pace with the leaders on certain key measures for some time so it may be no surprise that change is being made but it looks somewhat harsh. S&W is mentioned not just because the company acquiring signals the long road to recovery is advanced but also as with Costain and Renew Holdings it is finding higher added value services to be a useful addition to its core contracting operations. Rivals are perhaps a tad less obvious in their approaches to having in-house advisory capacity but there is a trend in some areas towards an integrated offering. More Below.
Announcements on trading come fast this week with Galliford Try tomorrow, Taylor Wimpey on Wednesday, Barratt Developments on Thursday and SIG and Grafton on Friday; all according to The Times.
Friday last saw the sector perform weakly against the market with the best riser up just 1.0% (Polypipe, closed at 332p). The main action was at the other end with Interserve down 8.3% as optimists were undone by negative broker comment. Comments on trading from the company in recent months have been positive but the problems in waste to energy will not have improved, the debt burden will have risen and getting a new permanent CEO is likely to be work in progress. It’s too early to be supportive of Interserve, in our view; it has some good contracts and industry comment is not unfavourable. But the sense is that it has fallen behind in a number of ways (eg IT, risk management) and needs a fresh approach.
We picked out MJ Gleeson last week as one of five stocks in the broader HICS sector that might show strong outperformance this year. The announcement this morning is positive about progress and confirms the message provided pre Xmas at the AGM. The completion of 451 units in 1H 16/17 is bang in line with the promised level of output increase of just over 10%; the company completed 504 units in 2H last year. The company also reports good demand in the South East for its strategic land development. With EPS of 45p expected this year and 50p at least next year the company is more highly rated than its peers but its growth trajectory is more assured, in our view. We have yet to see enough data from government to know whether the recent policy changes and what might be in the White Paper will affect MJ Gleeson. Its model in its housebuilding operations plays into building low price/cost affordable dwellings for sale. Its task might be made easier by government plans though it may also trigger the entry of rivals. Our sense is that Gleeson’s longevity and experience in the area will enable it to use changes to full advantage.
The news from Bovis was not expected at this time but it is clear that it is facing difficulties that its competition does not seem to have. Sales rates were substantially lower than the peer group level in 2016 at around 0.55 compared with 0.7 and better elsewhere. The growth strategy was delivering improved profits but margins were hindered by growth that was perhaps too fast. Certainly it seemed to be more affected by supply chain concerns taht rivals as it worked in newish geographic areas. The stock closed at around 800p on Friday and 100p of EPS is expected this year so the valuation is not overly stretching. In some parts of the market a small trip such as the one Bovis has shown might lead to consolidation talk. Among the housebuilders that seems unlikely right now especially for a business which is a mini-me of the larger players. There may be a case for certain specialists to be attractive (eg Gleeson, Telford, Inland) but not a standard builders, other than in the context of a merger with a similarly sized rival.
We mention S&W only in the context of a contractor buying a consultancy style operation. It has been a conundrum in contracting for many years that the businesses are ideally placed to provide a more integrated service but attempts to access such higher added value fees have not worked well. Balfour Beatty’s ill fated attempt to penetrate the market with Parsons failed, thiough in fairness it was not tested in good market conditions. Costain and Renew Holdings seem to be proving the approach can work and the common factor is that the company has a high level of repeat work with a limited number of “blue chip” customers. S&W is in the process of reinforcing its position with its main customers and has been so for several years. Its only our hypothesis at this stage but there seems to be some validity to the argument. Most of the contractors have some consultancy capacity but rarely showcase it and of course Kier has recently sold the Mouchel consultancy operations it acquired recently though it retains some advisory capacity. So it’s still horses for courses! But the trend seems to be towards supplying a tad more knowledge based input to clients in some parts of the market.
Moves last fortnight
There have been only four trading sessions so it’s a bit early to make bold assertions. The sector YTD has risen around 04% YTD versus the market up 1.0%. That is despite a strong performance from Persimmon and other housebuilders after the update. Relative performance is likely to be weaker than the market as long as £ is weakening and since the new year started sterling has fallen 2-3% against $ and the Euro; most HICS sector companies will not gain much from weaker sterling with a few notable exceptions (WOS, RTO, CPG, G4S, HSV & ATK)
Morgan Sindall outshone the rest in period rising 7.4% on the two weeks since the last session before Xmas and 5.4% YTD. We made our view clear that MGNS is one of the sector stocks most likely to outperform this year. Early form is not always a good guide but there is a lot happening that is positive for the company. 1000p is a realistic target for the next six months.
Interserve and Mitie are the weaker performers YTD as fears of more troubles to come hit the enthusiasm showed in recent weeks. We stated last week that IRV is vulnerable to substantial further accounting adjustments and we stick with that. At Mitie the news will depend on how much Phil Bentley wants to unravel previous accounting treatments. There is a judgement for all companies regarding the allocation of revenue and cost on long term projects and Mitie will now need to decide on how that might change for it in the future and what the cost is for past approaches. We believe the burden will not be unduly onerous in the case of MTO but IRV may have a large bill to pay..
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