Market Commentary - Housing, Infrastructure, Construction and Services
Carillion and Costain have announced very solid half year numbers this morning.
The Brexit Bounce was seen again yesterday and while many HICS stocks are still below their peak for this year 21 of 22 in our closely watched group are at a higher level than the were at close on 24th June. The exception is SIG which is down 4% and the best performer is Interserve which is up 44%
Carillion and Costain have announced very solid half year numbers this morning and Interserve has revealed a £17m design and build contract. Carillion also tell us that Richard Adam will retire soon and the Group Financial Controller, Zafar Khan will assume the CFO role at the end of this year. At both Carillion and Costain revenue rose in the period by double digit percentages (10% and 27% respectively) but again in both cases group operating margin dipped a little. Carillion’s fell from 5.1% this time last year to 4.9% and Costain’s from 2.1% to 2.0%. The margin dip is not overly significant at this stage and in both cases management expects to see progress for the full year, in line with expectations.
For Carillion the dip is due to a lower contribution from PPP/PFI sales after a strong performance last year and weak performance in the Middle East, as expected. The main reporting Divisions at Carillion recorded good progress and in Support Services operating profit rose by 30%. At Costain the Manchester waste project continues to blight the numbers as it is costing around £1m a month and in the first half recorded a £11.4m loss, against reported underlying operating profit of £15.8m. For both companies, performance in the main divisions was positive.
The Brexit Bounce was seen again yesterday and while many HICS stocks are still below their peak for this year 21 of 22 in our closely watched group are at a higher level than they were at close on 24th June. The exception is SIG which is down 4% and the best performer is Interserve which is up 44%; the mean average is a 14% increase. Given that the forecasts which have been altered recently have usually been only to accommodate FX, the bounce is a surprise. The data so far on the economy suggests that little has altered but that may just be temporary as we now expect that investment projects are on hold in IT, commercial property and in some manufacturing situations. It may be that the market is factoring a fiscal boost in the autumn, a thought not discouraged by government. And it may be that there is a race to get yield and this sector offers plenty of that compared with others. Some stocks have had surprise good news that has boosted the average (IRV,GFS, SRP and BBY) but that does not change the main argument that the sector in general is showing signs of being more robust than first expected on the morning of 24th June, so far.
The short term danger is that the fiscal boost fails to appear but in the meantime valuations are not stretched, especially among Builder Merchants which have performed poorly since 24th June (SIG down, Travis Perkins up 0.6% and Grafton up 4.1%) apart from Wolseley which as we know is US dependent.
The news from Persimmon yesterday was sufficient to trigger a wave of optimism in the sector in cyclicals. Kier was the main riser, up 4.9% to 1247p followed closely by Grafton, up 4.6% and Galliford Try up 3.7%. The story that footfall has remained solid on housing sites is encouraging and the lowest mortgage rates on record helps as well. Close attention will be needed as we know the market can be as fickle when bad news appears as it when good news happens. But for now we suspect that the news will be quite positive and recent gains will be sustained. The losers yesterday all were down by less than 1% and included the stocks that performed well post 24th June, G4S, Rentokil and Berendsen, as interest was focussed on the cyclicals and interest rate sensitive areas of the market.
Costain’s statement sticks with familiar themes of focus on large projects for blue chip customers, an integrated offering and innovation through technology and other means. The order book rose to £3.9bn and is unusually high for a company in the sector at well over two years’ revenue. Revenue in the first half at £791m is at a record level and will grow further in 2017 due to organic growth and the recent acquisition of SSL. The formula for success is clear and it is just highly frustrating for management and shareholders that Manchester is dragging back the out-turn and while it shows signs of ending a line cannot yet be drawn underneath it. The dividend has been raised by 15% which will be well received of course. The company is on track for EPS of 27p for this year and 30p for 2017 so the price at around 350p is not stretched, in our view, and once Manchester is concluded the stock will look very cheap indeed.
The story at Carillion is really about the very strong performance in Support Services, which has been trailed well by the company as it won much good work in 2014 and 2015 which is now in full swing. Revenue was up 8% to £1.3bn and operating profit up 30% to £76m. The progress in winning work continued in the first half of 2016 and £1.6bn of new contracts were won. The PPP/PFI performance is really about the timing of disposals rather than the lack of value in the projects; performance is always likely to be spiky in that area. The Middle East is a slight disappointment though well flagged beforehand; questions in the meeting this morning will be about long term operating margins in the region as the 3.7% level reached in 1H16 is below historic levels. Net debt remains high but is stable at £540m average for the period and the pension deficit rose to £402m from £318m due to bond yields falling. The company is on track for EPS of around 36p this year and will get a small tailwind from currency. At 296p the shares have risen strongly from the post Brexit low and the business will do well from the proposed UK Infrastructure programmes.
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