Market Commentary - Housing, Infrastructure, Construction and Services
There is no directly relevant sector news this morning from HICS companies but Kingfisher makes a contribution to our considerations with its Q2 trading update. Items of real relevance from the company include that Brexit has had no real impact on trading from its experience. Balfour Beatty was the biggest riser yesterday, up 3.2% at close having been up over 7% in early trading. The restoration of the dividend will have been discussed extensively at the board, we are certain. While that action was the headline grabber, our view is that it detracts a little from several other considerations.
There is no directly relevant sector news this morning from HICS companies but Kingfisher makes a contribution to our considerations with its Q2 trading update. Items of real relevance from the company include that Brexit has had no real impact on trading from its experience. B&Q showed a sector leading L4L sales increase of 5.6% (allowing 2% benefit from store closures) and Screwfix had sales up 13.3% L4L and 25% at headline level. Having improved sales at a rate much faster than the market there is a price to be paid which is a 100bp reduction in the gross margin in the UK reflecting mix effects from products and sales channels. The read across in France and from other euroland operations at Kingfisher is not substantial for UK quoted stocks. The UK performance is strong and the sense we have is that it is the smaller operators who are yielding share not Travis Perkins and Grafton. But the market clearly remains highly competitive and new formats, such as Toolstation and Trademate from Travis Perkins and Selco from Grafton are essential for growth in a market where underlying market developments are slow.
Balfour Beatty (BBY) was the biggest riser yesterday, up 3.2% at close having been up over 7% in early trading. The restoration of the dividend will have been discussed extensively at the board, we are certain. While that action was the headline grabber, our view is that it detracts a little from several other considerations.
• First, the company is by no means free from the occasional difficulties that beset its past trading. But it may avoid the worst of them and/or have them less frequently such that overall trading is in the 2-3% margin band.
• Second, that the PPP/PFI portfolio and the management of that side of the business has been very well managed. The existence of the portfolio has provided the balance sheet strength to sustain assurance to investors of a “backstop”. Our belief is that the pipeline is much stronger than the company is prepared to declare at this stage
• Third, the US operations are going to become more important in the absence of any leadership on investment in UK infrastructure. The order book shown in the data supplied yesterday shows a distinct bias to the US and that excluded the Caltrans project ($700m) which was won after the end of the half year. The margin potential is higher in the US than the UK, in our view.
• Fourth, the pension deficit has been quietly eliminated as an issue for the investors. It will cost shareholders an average of just over £20m a year for the next eight years but that has only a marginal impact on the company’s growth capacity.
The stock closed at 252p last night so it may appear to be well valued as earnings of 20p are about the best that might be achieved by 2017, depending on disposal gains. But the growth prospects beyond 2017 are excellent, in earnings terms and revenue as well if suitable projects are available. Balfour Beatty has also created options for its structure and thereby value creation as the core business balance sheet will soon be strong enough for a de-merger of the PPP/PFI portfolio to be viable.
Absent from the presentation yesterday were references to elements that will make BBY differentiated in the future, other than through its operational scale; innovation and use of technology in its operations were missing. It emphasised its renewed level of employment of apprentices and graduates and we hope at future presentations their contribution can be shown. Having faced a near death experience in 2014 it is perhaps too early to show that there is anything more than just getting the basics right. But in terms of earnings growth and enhancement we suspect the company has much more up its sleeve to show investors at future presentations. While 252p may be enough for now, the prospect of the stock moving to near 400p in the medium term will be a topic for investors over the next six months.
Other notable moves yesterday include Mears gaining further support rising 1.4% to 422p as it proceeds with its post results presentations to investors. The strengths of Mears are often underestimated, in our view.
The largest decline yesterday was at Polypipe which fell a further 4.1% to 268p following what can only be regarded as very good results. As outsiders we suspect that one of several things might be happening. It may be that a large chunk of stock is being placed perhaps, an overhang from its days of being in private equity ownership. Or it may be that the company’s comments about being late cycle in the building process and therefore unlikely to get strong signals of a dip in demand for some time did not aid sentiment. There could of course be other factors at work, but certainly Polypipe is better protected than most materials rivals by its relatively flexible cost base, new product innovation and expansion overseas into the Middle East. At 268p and with 23-24p of EPS likely this year and growth thereafter, the stock looks to be at a low point in terms of valuation.
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