Market Commentary - Housing, Infrastructure, Construction and Services
News this morning is from Polypipe, Mears and Balfour Beatty; the former two have half year numbers released this morning and the latter has announced a $697m contract to undertake the electrification of 52 miles of railway track between San Francisco and San Jose. The HICS sector moves yesterday were much tighter than some of the “Cat and Mouse” style games in the Olympic Cycling events. Capita was the biggest riser, up 1.1% and Atkins the largest loser down 1.5%, so from the top to the bottom there was little movement and no new news guide us. The facts are that the” Phoney War” on Brexit continues, sterling remains weak, oil is stuck at c $50 a barrel and UK investors, even without Brexit, are seeking “safe” yield to get some at least some return when bonds offer so little and interest rates are stuck at near 0%.
News this morning is from Polypipe, Mears and Balfour Beatty; the former two have half year numbers released this morning and the latter has announced a $697m contract to undertake the electrification of 52 miles of railway track between San Francisco and San Jose. BBY has its half year results tomorrow. We see this as an excellent win for the company in what should be a heartland area of operations for it in the longer term, rather than general construction at which it is good (much of the time), but not great as it can be in power and transport. Polypipe has delivered a 31% rise in revenue on last year to £223m and a 47% increase in operating profit; the headline numbers are boosted by the acquisition of Nuaire last year but even so organic revenue growth was 8% at CER. With 12p of EPS at the halfway stage and the news on trading we suspect forecasts will nudge up slightly this morning. Mears results show an 8% rise in revenue and a 5% fall in adjusted operating profit; the dip in margin is due mainly to the impact of several new contracts in Social Housing being in the mobilisation phase and margins will be back to norm levels in 2H 16 at around 5.5%. The out-turn is in line and the company is on track to achieve full year expectations which we believe to be for around 35p of EPS. The comapny is still grappling with long term changes in its markets and making solid adjustments to its services but that will require some costs this year, especially in Care. More below.
Brexit watch. Polypipe tell us that order intake has not been affected so far and that it has heard encouraging signs from government about the need to stimulate construction. It will take a more measured approach to UK capex, we are told, in the light of Brexit. It is the many small decisions such as that of Polypipe that will impact negatively in the long term. Mears makes no mention of Brexit and that might be appropriate as its business should not be affected in the mid/long term by leaving the EU other than via GDP growth.
In the HICS sector Capita was the biggest riser, up 1.1% and Atkins the largest loser down 1.5%, so from the top to the bottom there was little movement and no news to guide us. The facts are that the” Phoney War” on Brexit continues, sterling remains weak, oil is stuck at c $50 a barrel and UK investors, even without Brexit, are seeking “safe” yield to get some at least some return when bonds offer so little and interest rates are stuck at near 0%. There is a significant amount of economic news to be released this week and the betting at present is that at least some of it will show the Brexit slowdown that Bovis hinted at yesterday. Our main concern is that employment intentions are much reduced and there is already much evidence of a slowing in recruitment, especially in the private sector.
We saw the share price sprints in early August from Serco and last week from G4S and Interserve, creating new levels which have been sustained. It may be that Carillion and Costain next week and especially Grafton the week after that could offer re-ratings, with new information or better interpretation of existing positions, that reassures investors.
In essence macro factors are driving the sector at present and fear is the main motivator at current levels. The fear factor was too big prior to the results of G4S and Interserve, as we saw last week but in most other cases its hard to see that big value gaps exist, other than perhaps with Carillion which is still heavily shorted and the Builders Merchants.
Polypipe has shown this morning that it is a very good business. In our opinion the diversification into the ventilation area via the Nuaire acquisition, done entirely with debt and the expansion into manufacturing in the Middle East will both be good for shareholders. Most encouraging is the 71% rise in cash generated from operations to £31m, a high level at this time of the year and it has helped to limit net debt which fell £3m to £191m. The Nuaire deal provides all the leverage for the shareholders but means that for a while net debt to EBITDA will be outside “norm” levels of 1.5x and at the halfway stage was 2.3x. The strong cash generation will reduce debt swiftly, we suspect. Looking through the numbers there are few stand out features; they are much as expected. The only change is that capital spending plans are reduced, in the light of Brexit, and guidance is now for £20m of spend this year. The company is strong on recognising greater uncertainty now but we believe the nature of its operations and the signs it sees of encouragement for construction will sustain its performance.
Mear’s has two stories today. The first is about its strong work winning contracts in Social Housing which came to fruition in the first half with the mobilisation of a larger number of contracts than usual. Revenue in the segment rose by 6.3% versus last year with growth coming mainly from Housing Management, following the acquisition of Omega and the increased level of demand in that area from a number of sources. The second is about the difficulties that persist in the Care market which is challenging due to lack of funding and more recently the impact of the living wage. Mears is restructuring the business and will exit up to 20% of its contracts by value. In the first half it reported margins in this segment of 1.3% versus 4.6% last year reflecting trading issues and the costs of exit. The care market remains one with positive long term characteristics, due mainly to demographics but is dragged back short term by several factors. Mears will persist with its efforts in the area, we suspect, but there is as yet no clear path to success.
The order book at Mears has increased to £3.5bn and the company won £420m of new work in the first six months. Operating cash from continuing operations was 91% of EBITDA which is positive and period end net debt was £14m, £10m higher than last year but still low by comparison with rivals. The increase in net debt was to support the mobilisations. In terms of revenue stability and certainty, 98% of the expected revenue for this year of £945m (consensus) is already secure as is 85% of 2017 revenue.
We expect that the numbers from Mears will take a little while to absorb as the company is quite complex for its size and its specialised market take some time to understand and are going through change. Share price performance in the short term may take a small hit but we expect longer term that the strengths of the company will show through. The stock has seen good support in recent weeks and closed last night at 412p; 35p of EPS is expected this year and a strong second half performance, which the company has indicated is being targeted, will be needed to reach that figure.
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