Market Commentary - Housing, Infrastructure, Construction and Services 13th March 2017
Galliford, Redrow and Bovis have all made announcements this morning in a bid/merger battle that may take a while to play out. Our belief is that Bovis will be asked by shareholders to get back to the table with both parties as a deal will be the best and quickest way of restoring much eroded value in the shares. As both approaches are indicated to be mergers shareholders will have difficulty in choosing, if they wish to retain sector exposure in any combined entity.
Galliford, Redrow and Bovis have all made announcements this morning in a bid/merger battle that may take a while to play out. Bovis has rejected both potential merger approaches which were at 814p from Redrow (125p cash, 659p in new Redrow shares and 30p final dividend) and 886p in an all share merger bid from Galliford Try. Redrow’s proposal was made in late February and is based on an undisturbed price of 774p while GFRD’s approach is based on a more recent price, it quotes the 10th March price of 828p as the basis for its calculation of the bid. Bovis tell us that the conversations with Galliford Try continue but ceased with Redrow on 6th March.
Our belief is that Bovis will be asked by shareholders to get back to the table with both parties as a deal will be the best and quickest way of restoring much eroded value in the shares. As both approaches are indicated to be mergers, shareholders will have difficulty in choosing, if they wish to retain sector exposure in any combined entity.
Galliford and Try struggled after they “merged” in 2000. It took 18 months for the parties to realise that there are only takeovers and once the dominant party captured the reins the operations started to improve.
In our view there are economies of scale in housebuilding from which investors can gain benefits. These arise from common designs, procurement, technology and overhead absorption. The ability to procure well, often directly from manufacturers of components and assemblies, is rising rapidly in importance and should not be ignored. The scene in housebuilding is changing and whereas in the 2005/2007 merger wave it was about land and size alone now it is about design, strategic plots, technology, build efficiency and supply chains. There is no doubt that housing is a local operation in many ways as location trumps brand when customers make a buying decision and, its why the regional operations of the large housebuilders rarely exceed 1,000 units a year and most operate at 500 units or less.
So in our view combining Bovis with either Redrow or Galliford makes sense in simple operational terms. From a geographic perspective the evidence is that Bovis/Redrow provides a better fit as one the former provides the new entity with spread north and south whereas Bovis/Gallford Try does not give the new entity much new exposure up north. However it must be said that in both cases the new entity would not be so unwieldy in any one area that reducing scale is needed.
Some observers will see this as another stage in a repeat of 2005-07 when “mergers” where another stage towards the end of the Recovery phase of the Boom – Bust – Recovery cycle in the industry. News today from Countrywide that it believes that rents in the north will grow faster than rents in the south is another element of evidence for the cautious. Certainly rental demand has reduced in the south for some two years now as cutbacks in international transfers due to reduced energy prices and now added to by Brexit uncertainty hit demand. Are we the only observers who recognise that reduced migration of the nationalities that have high birth rates might just slow demand for housing and make a the shortage smaller. A rising population in the UK is taken for granted in most views about future growth; there are early signs in attitudes to immigration and rates of migrant retention that assumptions about population growth might be challenged.
In the context of Bovis merging soon the logic is clear and in our view is a positive development. It is not a repeat of the mergers of 2005-07, in our view. There are few signs of boom yet in housing outside the M25 area and even within the M25 there are areas that are only now seeing strong recovery. Who wins Bovis, if anyone does, will come down to price in the end. We doubt that another entity will enter the bidding at this stage.
Companies reporting this week include SIG with its finals for 2016 tomorrow; Safestyle, Forterra and Marshalls update on Wednesday all with Finals; followed by Balfour Beatty on Thursday with its report on 2016 and Berkeley Group will provide a trading statement on Friday. We are expecting positive progress in all cases with Forterra and Balfour’s the most likely to provide a surprise on the upside.
The moves on Friday last were mainly upwards with Berendsen at last getting some support, up 3.7% to 808p. It will take a set of good numbers to get BRSN back into investor’s good books and it has said already that some improvements will not kick in until 2H’17. With EPS of around 65-68p expected this year and 70-73p in 2018 the shares look cheap compared with historic valuations. But with so much change at the company the risk level is higher. Evidence that the changes are succeeding is needed now after two profit warnings. G4S was the second best performer on Friday, up 2.5% to 294.4p. It has taken some time for the company to achieve it turnaround but it will be seen to have been a swift process in a few years’ time, when we suspect the share price will be much higher; short term retracement after the recent swift rise would not be unusual or of concern.
Only four stocks slipped downwards on Friday last, Capita (0.9%), Mears (0.7%), Babcock (0.5%) and Homeserve (0.2%). Mears is the exception in this group and because the move is based on just 16,749 shares traded it is not representative. There are real reasons for concern at CPI, BAB and HSV, in our view. Homeserve has furthest to fall from current levels, in our view. It should be updating the market soon and while the revenue figures will be boosted at headline level by FX we expect the earnings will disappoint. The business model is built only for growth and the lack of news recently on new affinity partnerships, along with mild weather and fading growth in real incomes, we suspect that growth momentum has slowed.
Moves last week
The sector’s improvement YTD continued last week with a small 1% rise spread equally across Housebuilding, Services and Construction. The market fell slightly so the sector outperformed, and is now up 6% YTD compared with the market up by 3%.
The best riser was G4S up 11% last week as it bounced back after its results were greeted positively as well as its indications of much better to come. Grafton, Capita and Carillion also showed strength last week with rises of over 5%. The backmarker was Mitie which suffered from negative broker comment. There was no new data just a few brokers waking up to the fact that the company has yet to indicate the full depth of its accounting policies, or rather the impact of some fairly unusual approaches to calculating revenue and cost that need to be corrected. Unlike in the case of Serco the main difference will be that the cash costs are minimal, confined we suspect, mainly to restructuring; the previous regime at Serco had made promises and obligations that had a cash cost in the future. We understand that Mitie has made no similar commitments though we also believe that future profits will be diminished by some promises made regarding performance benefits for customers that are due in the next few years.
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