Edison Investment Research

Market commentary - housing, infrastructure, construction and services

This morning Homeserve did not miss the opportunity to issue another trading statement.Given the wide variations in price of recent weeks the HICS sector was benign yesterday, despite the news on interest rates. In the absence of new news it’s worth a quick look at where we are ytd based on closing prices last night. The key question is whether the stocks that have been shunned in recent weeks have better recovery potential than current valuations imply; conversely, the other issue is whether the “safe havens” can maintain current outperformance.

This morning Homeserve did not miss the opportunity to issue another trading statement, this time to coincide with its AGM. We are told that trading is in line with expectations and reminded of some recent new affinity relationship, and also that the results are usually second-half weighted, implying that investors should not lose faith on 22 November when the first half results are announced. The number of potential points of growth is increased versus last year, which is good news for investors and, with the new affinity relationship with Dee Valley Water, it may be that the UK is not at steady state with 2.1m customers but may grow again. Earnings this year will show good growth, we are told, and compared with last year’s 21.8p EPS that means it will be nearer 25-26p and, with the tailwind of currency, should present FX rates persist, a higher level of earnings is possible, all of which could be said to justify the current 547p share price.

Given the wide variations in price of recent weeks, the HICS sector was benign yesterday, despite the news on interest rates. Grafton was the leader with a 2% rise to 542p and Polypipe the laggard with a 2% fall to 234p. In between, the story was one of resumed support for stocks with market demand that is either geographically widespread or essential or driven by legislation. Capita, Serco, G4S and Rentokil were well supported and rose. By contrast, the more interest rate-sensitive stocks fell a little, Carillion, Atkins SIG and Wolseley among the losers. There is no stand-out reason to trade at present save that some stocks have more robust earnings than the market seems to think, based on their low current valuations; Carillion and Atkins stand out in that regard.

In the absence of new news it’s worth a quick look at where we are ytd based on closing prices last night. The key question is whether the stocks that have been shunned in recent weeks have better recovery potential than current valuations imply; conversely, the other issue is whether the “safe havens” can maintain current outperformance.

The sector divides into two groups: stocks that have fallen 15% or more as they are interest rate sensitive and those that have risen by 15% or more as they are “safe havens”. There are few stocks in the middle ground with only Babcock (down 6.8% ytd) and Wolseley (up 9.9%) in that space.

Many of the losers were past their peak levels before the EU referendum, so we should not ascribe the whole of Galliford’s 37% fall or Interserve’s 46% drop to Brexit fever. Equally, the 28% rise in Rentokil had momentum before 23 June, as did Homeserve (up 32%), Compass (up 23%) and Serco (up 24%). Arguably, therefore, the referendum merely provided a catalyst for a more rapid acceleration of existing trends rather than the main cause of them.

Potential catalysts, one way or the other, which may influence events over the next few months include:

• some breakthrough in EU discussions that changes events (in that context, events overnight in Nice and the impact on security might be relevant);
• US election progress, which will obviously drive sentiment;
• in the UK, commitments to spending on infrastructure and the government finally taking fuller advantage of low interest rates to fund investment;
• allied to the infrastructure argument above, housing has received very strong support under Cameron and it’s hard to believe that will be withdrawn; and
• the possibility of a UK general election providing further short-term uncertainty.

The macro background remains uncertain, so the overall stock trends affecting the HICS sector seem unlikely to alter over the summer. The noises so far seem to indicate that the authorities will take measures to attempt to avoid a slowdown or at least mitigate its worst effects. On the monetary side, it’s easier to argue that there is not much ammunition left - rather the opposite - and on the fiscal side the new UK government seems prepared to loosen some of the spending constraints, at least in the short/mid-term.

Against that background the following stocks seem to have greater than average potential for changes in the next few months,

Grafton, down 27% ytd to 542p – the 25% of its revenue that arises from euroland (especially Ireland) seems to be being ignored, along with the enduring success of its Selco format in the UK, especially south England.
SIG, down 24% ytd to 110p – its valuation relative to its peers is very low and it has near 50% of revenue from euroland, although trading there may also suffer a little due to Brexit translation effects. Its efforts in cost reduction, improved efficiencies and new segments (eg modular housing) are positive for the stock. Credibility is low for good reasons, but it is delivering on its self-help plans so far.
Galliford Try, down 37% ytd to 959p - the market has called GFRD in the same way it has called the housebuilders in general, ignoring the company’s exposure to construction (especially public sector and utilities) and social housing construction. Even in its housing operations it has higher exposure to developments outside London and the South East where house prices in many areas are still at 2007 levels.
G4S, down 18% ytd to 180p – since it stopped doing swanky deals, G4S has struggled to get support from some brokers. The company has not helped itself in some ways by sustaining a high level of net debt. But in a world where security is heightened and knowledge of protecting assets is at a premium, G4S has a core market and an undeniably history of achievement. Greater clarity is needed, but the valuation at c 12x earnings is too far below its peers. 
Rentokil, Serco, Berendsen and Compass are all up around 20% ytd. It’s hard to find an argument that says these levels of valuation cannot be sustained, given the uncertainties that exist. There may be some reduction in support through normal trading ebb and flow, which could provide helpful entry points.

So there we are at present. There are good reasons to add Balfour, Kier, Carillion and Atkins at current levels, but few to say that investors should get highly enthusiastic, save perhaps in the case of Atkins as, if the infrastructure ideas become reality, its UK operations will be inundated with enquiries and orders.

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