Market Commentary - Serco, Kier, Mitie, Carillion, Interserve
There is no new news this morning in the sector though the announcement at 11am yesterday from Serco is worth mentioning. Kier’s results meeting was uneventful save that the company is clearly going to be pushing more capital into its property operations. It has also signalled that it believes 10% growth in earnings will not happen this year. Kier commented on its work in Housing maintenance which provided some read across to Mitie and Mears. Kier’s experience of the market echoed the statements from others that it has become more challenging but the impact has been managed. Mitie seems to be an outlier in terms of the difficulties it has faced suggesting the issues are company specific rather than market ones.
There is no new news this morning in the sector though the announcement at 11am yesterday from Serco is worth mentioning. It has been awarded preferred bidder status on a £600m/10-year contract at Barts Hospital to provide soft FM services (ie cleaning, catering, pest control). The appointment is clearly good news for Serco though it hardly caused a flicker to the share price. The Barts news comes a day after Serco issued a press release indicating that it is in talks to obtain the transfer of parts of its subcontractor on the Compass contract, Orchard and Shipman (O&S), into Serco. The contract has been loss making for all suppliers since it started in 2012 as a five-year project with a two-year extension. O&S operates the housing service for asylum seekers in Scotland and Northern Ireland on behalf of Serco at present. The discussions are about the transfer of 60 employees who are responsible for 4,700 asylum seekers. Serco is determined to see out this contract and we suspect it wants to continue on better terms. We think the company’s approach of standing by its customers should benefit all concerned in the medium term.
The other issue worthy of some attention from yesterday’s news is that the Bank of England has said that the Help to Buy (HTB) Mortgage Guarantee Scheme is no longer needed. We view this as a move designed to influence the Chancellor’s thinking ahead of the autumn statement due on 23 November. The argument is based on the scheme accounting for only 3% of all mortgage lending in Q116. This part of HTB allowed people to borrow to buy with a deposit of 5% with the government providing a guarantee on part of the loan. As the scheme in question was due to end this year and other parts of HTB did not receive BoE comment, we sense it will not have a significant impact. But clearly the Chancellor will be making changes to encourage housebuilding and the public soundings which usually precede such news have not yet started.
Kier’s results meeting was uneventful save that the company is clearly going to be pushing more capital into its property operations. It has also signalled that it believes 10% growth in earnings will not happen this year. The company promised 10% CAGR in earnings to 2020 in July 2014; it achieved 11% EPS growth last year. But the timing of certain projects in Property allied to the expected slow rate of growth in services and construction earnings means that earnings growth in 2016/17 will be nearer 5% than 10%. The company increased some of its exceptional costs relating to Mouchel and other restructuring such that the synergy benefit in 2016/17 will be £11m, £5m more than previously expected. It is not known how much of that will drop through to earnings, but that should provide a big chunk of the 5% earnings growth alone. Valuations are softening in property so we think it is realistic to flag that market conditions are tougher. The company has stuck with its 10% CAGR to 2020 target, but flagged that it will not be a straight line. We suggested yesterday that 117p of EPS was possible in 2016/17, but we think consensus will emerge around 111-112p.
Kier commented on its work in Housing maintenance yesterday which provided some read across to Mitie and Mears. Kier’s experience of the market echoed the statements from others that it has become more challenging but the impact has been managed. Mitie seems to be an outlier in terms of the difficulties it has faced, suggesting the issues are company specific rather than market ones. Kier expects a positive trend in Housing maintenance in the future in both public and private sectors. Mitie continues to struggle in terms of its share price with a small 0.5% fall yesterday to 186.5p; there is evidence of some Institutional buying but as with Brexit, it is too early to tell and there are probably changes on the way.
Carillion was the best performer yesterday rising 1.6% to 261p. There was no specific news to drive the price. The stock is lowly valued at present along with several of its peers. Carillion is playing a long game in terms of working its way through its debt and pension deficit issues. We would not be surprised to learn that the company was exploring potential deals, as it did with the proposed merger with Balfours, and such possibilities are available. It is trading at 7.5x prospective P/E and yielding just over 7%. The old adage that stocks should be bought when the P/E and the yield crossover in our view may apply in this case.
Interserve was the back marker again, down 1.2% to 392p. The news of a few small contract wins this week was not enough to boost the share price and offset the loss of some work. The rating at 6.1x prospective P/E looks attractive (assuming Equipment services as a continuing operation) as does the yield at 6.4%. But this is a case where the yield:P/E crossover may not work as there are still too many uncertainties and debt is rising, which makes the yield vulnerable.
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