Market Commentary - Housing, Infrastructure, Construction and Services
Kingfisher, owners of B&Q, have released half year financial statements this morning. The important issue Brexit impact, is dealt with early and the news is that despite creating uncertainty there has been no clear evidence of an impact on the business. Mitie’s 28.6% decline is the story that caught the eye of most of the market yesterday. We may see a bounce today as the reaction to this unexpected statement was strong and the likely downgrades at 10-15% for earning this year are much lower than the share price move yesterday. Kier had the biggest increase yesterday, just a few days prior to its Finals for 15/16 to be released on 22nd September.
Kingfisher, owners of B&Q, have released half year financial statements this morning. The important issue Brexit impact, is dealt with early and the news is that despite creating uncertainty there has been no clear evidence of an impact on the business. Kingfisher is going through a transformation project at present, not unlike other suppliers of building materials and the process seems to be working. Sales rose 6.7% L4L in the UK and Ireland in the period (3.3% at the reported level) with 4.6% L4L growth in B&Q and a substantial 14.7% L4L growth in Screwfix. Earnings grew at a faster rate (8.8%) in “Retail Profit” to generate a margin of 8.1%. The closure of some B&Q stores as part of the restructure contributed to part of the small decline in GM but clearly that was more than balanced by the improvement in net margin. More below
Mitie’s 28.6% decline is the story that caught the eye of most of the market yesterday. At the close of the session it was at its lowest level since early 2011. The stock closed at 192p in the middle after a chunky 766,904 shares (a third of the day’s volume) were reported traded at 16.35 at 191.3p.
We may see a bounce today as the reaction to this unexpected statement was strong and the likely downgrades at 10-15% for earning this year are much lower than the share price move yesterday. The NPV of Mitie is probably not near 30% lower than it was Friday last on this news; of course that depends on whether the starting point was “correct” and whether expectations are reset at a realistic level. The volume of trade was not high yesterday so clearly investors are not fully convinced the company is all bad; that is a valid view we believe as it has some good contracts and longevity with many customers. Mitie described the reasons for its earnings warning yesterday but did not really explain the corrective measures that have been taken. The two key issues are what happens next and who else might be affected?
What usually happens next, following a substantial warning of this nature is aftershock, sometimes there is more than one. The earliest impact is usually that management changes are made, more issues are discovered (swiftly if there is a moratorium) and in Mitie’s case in particular, customers and employees get very nervous. But in Mitie’s case we expect the damage should be at a low level as the core FM operations are not in crisis. Our sense is that expectations of what can be achieved need to be at a lower level as the margins were not sustainable at near 6%, given Mitie’s mix of activities. The largest concern we have for investors in Mitie is that resources are taken out of development roles now (IT, Marketing, People) so that short term profitability is improved. The delayed impact of such measures might damage future earnings.
The indication that the Healthcare business could possibly be sold, closed or substantially restructured is a little more concerning as it creates unnecessary stress for the people involved, employees, clients and customers. The company said it is “reviewing the long term plan and related options” for the healthcare operations. That implies to us that a full range of options will be examined, including sale or closure. Shareholders may appreciate the approach to the segment but may also be reflecting on the start being a bit late and perhaps still puzzled why it was bought in the first place. Healthcare will emerge as a good business at some point, in our view, given the population dynamics in the UK but at present the structure and funding of care is in flux.
We are sceptical there is any read across from Mitie. While market factors are cited as the reasons our sense is that so far its more about Mitie misreading the situation and possibly failing to act in a timely and appropriate way. Brexit was known at the time of the AGM (12th July) as were many of the market factors cited yesterday but the company made no comment.
The only quoted rival in Social Housing and Care, Mears, has seen its share price rise 22% since 24 June so it does not seem to have experienced the issues Mitie has encountered but also it has had a very different response to them. Mears anticipated the emerging issues in Social Housing and Healthcare several years ago and has made several key strategic adjustments to manage the situation which are benefitting the business. It trades on prospective p/e of 12.5x, which is not stretched in our view. Rivals to Mitie in FM have confirmed that they have seen little post Brexit impact.
The focus on Mitie has detracted a little from the 1.1% rise in Kier, the biggest increase yesterday, just a few days prior to its Finals for 15/16 to be released on 22 September. The shares closed at 1276p on an unusually large volume of 621,293 shares traded. Kier’s view on UK outsourcing will provide a cross check on Mitie’s thoughts in some areas. However, Kier’s scope is much wider than Mitie’s and its issues, to the extent it has any, will be around the property segment, we expect. Based on news from elsewhere Kier is likely to be quite positive about its property and housing operations, in our view. And of course it will benefit from infrastructure expansion not the least of which will be at Hinkley Point and it is advancing strongly with the Mersey Gateway project. The market is expecting EPS of 103-105p for the year ended June 2016 and 114-116p for the current year just started, in line with the promise of 10% CAGR to 2020. The earnings growth “promise” was made prior to Brexit but so far there seems to be no obvious reason to change it although clearly the risks have risen, which is not down to the company.
Our interest in Kingfisher is purely from a viewpoint of read across and that is mainly in the UK to the Merchants. The data suggests that the market is holding up very well in terms of demand which is good news for Travis Perkins and Grafton. SIG is in a slightly different position as it sales are into a market that relies more on specifiers and it less dependent on immediate availability. The pattern of the larger companies taking share from the smaller operators is the main characteristic of current developments. That is happening via normal marketing and sales promotion but more significantly through modern IT. The Merchants still need to have big sheds but at B&Q in the first six months of the year Click and Collect revenues rose substantially as total online sales increased by 39%. Both Grafton and Travis Perkins have seen their share prices decline due to market uncertainties, the news today from Kingfisher should reassure on several fronts
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