Stephen Rawlinson
20 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 20th March

News today comes from Michelmersh, the small UK brick maker, with its finals, JLIF, also with finals, Volution with its interims and Carillion with news of a £90m construction contract in Cyprus to build a communications centre for the MoD’s Defence Infrastructure Organisation (DIO). No news on the Bovis/Redrow/Galliford Try front.

News today comes from Michelmersh, the small UK brick maker, with its finals, JLIF, also with finals, Volution with its interims and Carillion with news of a £90m construction contract in Cyprus to build a communications centre for the MoD’s Defence Infrastructure Organisation (DIO). No news on the Bovis/Redrow/Galliford Try front. The key message from Michelmersh and Volution, both of which supply materials into the UK construction sector is that the new year has started well and while they keep expecting to see signs of Brexit uncertainty there are none yet evident in demand. Both companies have been able to date to mitigate much of the impact of FX changes since 23rd June.

Michelmersh had a revenue increase of 3% to £30m in 2016, PBT was stable at £4.5m and net cash rose £1.8m to £4.7m. The company had a wobble in production during 2016 so this represents good progress and the company seems to be in very confident mood, due to high order intake YTD, new plant performing well and the £2.7m sale of surplus land at Dunton. Average selling prices have been maintained. The read across to Ibstock and Forterra is positive, in our view. Michelmersh has quite specialised products but it still competes with the three mainstream companies that have 90% of the market capacity and needs good conditions in which it can thrive. The company lists some of its larger customers in the results update to show that it’s not just a small specialist of limited relevance. The company indicates that it is now ready to kick on from here, notwithstanding Brexit uncertainties, which it mentions. With £46m market capitalisation and because it is not set to grow substantially we have tended to give it limited attention.

The news from Carillion is interesting not just because it is a good contract to win but for two other reasons. Firstly, it signals that Carillion is still in favour with DIO despite some reports of difficulties in the early stages of the NGEC project and secondly, because Interserve does the FM for the MoD estate in Cyprus and might have regarded winning this capital project as a natural extension of its work. Clearly it is inappropriate to read too much into one contract but, it’s a collection of small signals, such as this, that tell us the sense of direction for a business. Our sense on IRV is that it is in a weak situation, which can only get worse as it waits until September for the new CEO to arrive. For Carillion this is small but clearly significant and it confirms the hints about future work awards provided at the recent results meeting.

Volution is a £365m market capitalisation company of which few people have ever heard. It is the leading supplier of ventilation products in the UK in residential and commercial. The numbers today are very positive with revenue up 19.3% at CER of which 2.3% was organic. Headline revenue at AER rose by 26% to £89m and adjusted operating profit was 7.7% higher at CER at £17m. The operating margin dipped as a result of recent acquisitions performing below the group average. Net debt was virtually unchanged, just £0.6m higher at £41m. We will not comment in depth on the business as we have not looked at it in depth. The read across to other companies in the materials area is the main reason to look at it and the news is positive. Its strategy of self-help and buying smaller rivals is producing good growth at a time when ventilation systems are becoming a much more important factor in building design. The company is expected to deliver 13p of EPS in the year to end July and the stock closed at 182p on Friday last; with 6.5p of EPS at the halfway stage the forecasts look credible.

We like to look at the Infra Cos as they provide a good steer on the long term value of many construction stocks and they are not widely covered. JLIF’s numbers today justify the recent strength shown in its share price. NAV was at 120p a share based on a portfolio value of £1.2bn at end 2016, up 40% on the prior year. As expected the dividend was raised a tad ahead of CPI, at 2%, for the six months to end December. During 2016 the company sold assets as well as acquired them where it can see better value from disposing. The company explains that there is a shortage of available projects in the UK both in terms of new ones coming to market and because many existing ones are in the hands of large, long term investment vehicles. It highlights its increased level of geographic diversity and in particular the opportunities in the US where it made its first investment last year. Whether the UK market for PF2 projects will emerge we shall need to wait and see. But clearly JLIF has taken action to ensure its own growth as have others in the space that are interested in both primary and secondary investment. The signal today from JLIF is that it will be taking a greater interest in some new geographies, especially the US as they provide a better risk/reward profile that some mature markets, in the mid-term. It has also announced a £90m equity fund raise to reduce debt and create firepower for more growth.

News later this week comes from Mears, Augean and Smart Metering (Finals) and Bellway (Interims) tomorrow. On Wednesday Kingfisher reports its finals which will have important read across. Thursday sees Kier provide its interims, and its Crest Nicolson’s AGM. On Friday Henry Boot provides its finals for 2016.

The moves Friday last saw Balfour Beatty take another small bashing for being a tad less positive about the next 12 months than it might have been, down 2.4% to 265p. The concern is always what lies beneath statements when they suggest caution. The mood at the meeting was quite upbeat. Forecasts for BBY have slipped downwards a little in the light of the underperformance in 2016. The value of the PPP/PFI portfolio at £1.2bn is sustained, despite distributions and disposals of £253m as the unwind of the NPV discount and expected operational improvements raised the value. As all recent sales have been at values in excess of Director’s valuation we are inclined to go along with the board’s view. Higher interest rates may change things but despite several rises in US rates the Infra co’s valuations are sustained. The news from JLIF today puts BBY’s portfolio of investments and its prospects for the future into a positive light. At 265p the shares look good value, in our view.

Homeserve got some support on Friday last, rising 5.2% to 554p. Optically the numbers for 2016/17 (March y/e) will look quite good due to FX but our doubts about the long term remain. The lack of transparency in the numbers and the need to replace nearly 20% of the customer base every year in the UK and the US make us concerned. The company is expected to update around its year end which is March. We are not optimistic about what it will say given market conditions.

Moves last week

The sector performed a tad ahead of the market last week rising 1.2% versus the markets 1.2% rise. The Construction and Materials segment fell a little last week as Balfour’s decline did not help. YTD the sector is still outperforming the market’s 4.2% rise with a 6% increase. But as we often remind investors Q1 Is always nearly good for the sector in relative terms and its exposure to risks arising from Brexit are not really yet apparent in demand or share prices.

Interserve was the main faller last week, down 7.7% and we fear for its long term capability to survive. Debt is too high, there is likely to be a vacuum at the top lasting well into 2018 as the new CEO finds her feet and appoints her team and customers, suppliers and employees will find more stable situations where they can trade. Balfour was the other large faller, down 6.7% on a knee jerk reaction to the trading numbers and the short term outlook.

Berendsen and Capita both rose by 5% last week as investors sought value in companies that have tarnished reputations. Both stocks remain well below historic valuations and it may be they will need to adjust to lower operating margin expectations in the future and that is part of what is happening to them. Capita has the most obvious attractions as a Special Situation recovery play and the prospect of the need for an equity fund raise is fading and in any event is not possible until a new CEO arrives. Capita would seem to have a ceiling of around 600p on the share price, in the short term, until key issues are resolved.

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