Edison Investment Research

Market Commentary - Housing, Infrastructure, Construction and Services

What a difference a May makes

Grafton and Galliford Try have updated, the former at its half year and the letter at the full year. What a difference a May makes. FTSE 250 up by 3.3% yesterday and the sector up by 3.0%. Brexit may mean Brexit but nobody has defined what the “B” word means. Galliford report in the early part of the conference call that the impact so far of the Referendum has been quite resilient and calcellation rates are unchanged.

Grafton and Galliford Try have updated, the former at its half year and the letter at the full year. Grafton is still down 27% from its pre Referendum closing price and Galliford is 33% down despite strong rises yesterday. For Grafton the half year showed 4.2% L4L revenue growth at constant currency, 13.3% in reported terms in sterling. The important pointer is that the RMI market fell away in June and was negative; second quarter revenue rose 1.6% compared with 5.3% in the first quarter in UK Merchanting despite a positive performance at Selco, Grafton’s unique format for jobbing builders. Appropriately the company makes no comment about expected performance versus consensus for the full year.

Galliford Try has not just the update but also news that Greg Fitzgerald will leave the group at the AGM in November and that Peter Ventress will take over as non-exec Chairman, all is as expected. Galliford as with many in the sector are mightily disappointed as the numbers for last year that can be revealed in an update, are excellent and in line with the expectation of EPS of 130p. But the company, as with all peers can only tell us that the uncertainty is greater and that no pattern has yet emerged. More Below.

What a difference a May makes. FTSE 250 up by 3.3% yesterday and the sector up by 3.0%. Brexit may mean Brexit but nobody has defined what the “B” word means. All the people who proposed it seem to have left the pitch so it’s left to others to define it and the market seems to think it might be better than expected a few days ago.

Yesterday we saw the interest rate sensitive stocks storm ahead. Travis Perkins up 7.9%, Balfour Beatty up 6.6%, Galliford Try up 6.3% and Interserve and Grafton up 5.8%. All of these stocks are still well short of their six month peaks and based on the rate of improvement in sentiment further gains are likely. It all depends on events, to paraphrase Macmillan. The fact is though that even the Leave voters have realised that economically we were doing pretty well out of the failed European Project and have had a great fright. Make your own call, as we all shall but the odds on a General Election in the Autumn, which translates Brexit as a better level of “sovereignty “ for Member States, free movement remaining but the timing of moves being controlled and 28 countries agreeing to the UK remaining might work. Comments about a Prime Minister needing the legitimacy an Election provides and labour movement being about quantities and timing have already v been made

The point is that we believe the sector could now be faced with a positive environment. Its the Macro Call that counts for the cyclical stocks in the sector and the mandate of a HICS observer is valid only in that context. The scare has been quite severe and HICS stocks remain 10-40% lower than their pre Referendum based price. The pace at which they will catch up will vary of course but the scene is set for there being a possibility that they can make up some more ground.

Grafton’s revenue numbers for the first half are generally very positive and the good news outweighs the not so good in the period. Most segments showed slower growth in the second half which was probably more than just weak trading in the UK in the last week of June. Weather conditions might also be a factor as they were wetter than usual and that could have delayed projects in the UK. Ireland’s recovery was strong in the period with merchanting sales up by 11.7% L4L and retail up 6.4% L4L though in the latter second quarter growth was just 4.2%. The main disappointment was in Belgium where sales fell 7.4% L4L and the rate of decline accelerated in Q2 to 9.5% decline.

In terms of looking forward the big unknowns are of course the UK RMI and new build markets. Long term demographics indicate that many more new houses are needed and the age of the current stock points to a continued need for RMI spend at higher levels than currently obtain. The company do not refer to any actions taken so far or that are intended to adapt the cost base or alter its previously intended actions to adjust. Instead management point to the resilience of its Selco brand sales and positive progress in Ireland and teh Netherlands (currently c 20% of revenue). We were expecting 47p of EPS this year which must be in doubt given all circumstances though of course the € earnings translation will make up for some of any dip in the underlying UK performance. We expect that management will behave very cautiously with regard to costs and expansion in the coming months but the operational gearing in the sector is such that it will be hard not to take a meaningful hit to earnings this year.

Galliford’s Housebuilding business showed increased completions, up 11% to 3,078 units and the ASP was up 2%. It would have been helpful to know how many were from newly acquired Shepherd Homes but that will be asked in the 8am conference call. The forward sales position is up 27% at £380m and there is no comment on any changes in cancellation rates. The Partnerships operation has not grown quite as fast as was hoped a year ago, due to rent reforms announced in the June 2015 budget. But the segment is picking up and the landbank has grown to 2,700 plots, up 23%. And in Construction revenue grew strongly last year and the order book is maintained at £3.5bn, around 1.7 years of revenue which is high for the sector and much of it is in regulated and public sector areas. The company comments on margins in housebuilding (in line with expected progress) but not on earnings levels in Partnerships and Construction both of which are more important now than they were on 23rd June. Net debt at £2m at the year end in line with expectations but with £160m net cash in Construction the housebuilding operations show a broadly unchanged level of working capital lock up and at a higher level than many peers.

Galliford reports its Prelims on 14th September and the company hopes that by then the picture will be clearer. What is clear is that the first six months of the new financial year will probably show a weaker performance than last year and that the 143p of EPS we were expecting, versus 130p in the year just ended, in unlikely to be achieved. The NPV of Galliford has not however fallen by 35% in our view so the share price is too low.

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