Market Commentary - Housing, Infrastructure, Construction and Services 21st February 2017
Interserve was the back marker yesterday, quite predictably as the warning was a bit of a shocker. Balfour Beatty has unexpectedly announced that it has sold its Middle East JV to its partner for £11m; Capita has announced that it will take £90m, non-cash, asset impairment to its P&L for last year; Wolseley has announced that it is to merge its Swiss operations with a locally based business, Walter Meier and Galliford Try has announced some solid numbers at the halfway stage of its financial year.
Balfour Beatty has unexpectedly announced that it has sold its Middle East JV to its partner for £11m; Capita has announced that it will take £90m, non-cash, asset impairment to its P&L for last year; Wolseley has announced that it is to merge its Swiss operations with a locally based business, Walter Meier and Galliford Try has announced some solid numbers at the halfway stage of its financial year. More Below
Interserve was the back marker yesterday, quite predictably as the warning was a bit of a shocker. The stock fell 32% to 228p and based on the lack of hard data it was fortunate to stop there. We thought 250p might be the level based on the release but the conference call only served to show that management simply has no idea what the right number might be for its contribution to other organisations waste to energy plants and £160m is the best it can calculate at present. Indeed the duration of the warranties, said to be up to a couple of years, is such that it may be 2020 before definitive answer can even be properly guesstimated, especially if litigation processes get sticky and prolonged. In the meantime the top team, which is on the way out, is having to manage the difficulties it created with its venture into Waste to Energy.
The story next week at the results meeting should be about how the other operations in the group might progress sensibly in the circumstances. It will need to be pretty convincing. It is not wholly credible to believe that some £60-80m of working capital and development spend can be squeezed from the businesses, as it was last year and there will be no impact on the business. Management will need to convince investors that employees, customers and suppliers will remain patient; we doubt that will happen in all cases. Suppliers in particular should want payment early, customers will be slow to pay, employees will be looking for new roles and that estimate of net debt at £450m will soon look pretty rocky if it is based on business as usual. New work is likely to dry up for a while or be acquired on poor terms. There will almost certainly need to be disposals for the core business just to survive, from what we can tell. Some of the existing operations are in less than rude health. Most rivals will have been running a slide rule over Interserve’s existing contracts we suspect; if they have not we should want to know why. The business has some very good contracts and performs well in some areas so it not all bad.
Most of the information points to the company being on the early stages of the Spiral of Corporate Death that has seen so many companies in this space fail. It is easy for outsiders to comment when there are many facts unknown and the issues seem so obvious. But what is clear is that firstly, the issues were probably known a long while ago but avoided, in the hope that “something will turn up”. Secondly, there is no basis for buying Interserve shares at this stage, as even management has limited confidence in the outcome of its disputes over Waste to Energy obligations.
The results next week are in our mind probably the first stage of an emergency equity fundraising. The narrative must be related to that so the business can arrest the inevitable pressure that a very heavy debt burden and falling profits will create. But who will invest in a business with an unknown level of obligations for some poorly constructed contracts and a poor choice of main subcontractor? No, we do not know either. Of course it may trade through the issues but the facts at present point to an investment at this level as still being very high risk.
Morgan Sindall and SIG topped the table, two of our favoured stocks for 2017. The former was up 3.7% to 896p so no pressure on Thursday when the 2016 results are released! MGNS has had problems as well but traded through them and they are history. Of course contracting is fraught with potential pitfalls but MGNS’s risk management seems today to be up with the very best in the industry. Expect EPS of 80p for last year when the numbers come out and the guidance will be for 90p or more for this year, we believe.
Our fondness for SIG at 103p at the start of the year remains unchanged even though at close last night it was up just a measly 8% YTD, well measly alongside MGNS. We remain of the view that the stock is still substantially undervalued at this level. The opportunity to improve margins in the core distribution business and exploit new markets, in modular housing components and assemblies and air handling are quite achievable, in our view. So focus not on the 10p of earnings that the impaired business will earn this year and next but the 13-15p that should be attainable in 2018. Raising the output of dwellings built by 60% to 5,000 pa, doubling the number of units in Partnerships to 4,200 and year and raising annual revenue in Construction by 20% to £1.8bn, with margins of >2% all sound possible but need further understanding and testing that a brief morning note cannot provide.
Galliford Try’s numbers for 2016 released this morning are very positive in the Housing and Partnerships areas and disappointing in Construction. Revenue at the group level in the period was up by 3% to £1.3bn and PBT was up 19% at £63m. The dividend has been raised 23% in line with the earlier plan on cover; the dividend was 32p on 61.9p of EPS. New targets have been announced for performance to 2021 as might be expected with a new CEO. We shall learn more about them this morning at the 11am strategy update. The strategy of 60% growth in PBT by 2021, 5% CAGR in dividend and a RONA of at least 25% show some ambition but comment is best left until there is more detail. Raising the output of private for sale dwellings built by 60% to 5,000 pa, doubling the number of units in Partnerships to 4,200 and year and raising annual revenue in Construction by 20% to £1.8bn, with margins of >2% all sound possible but need further understanding and testing that a brief morning note cannot provide.
In 2016 GFRD’s private for sale housing operations showed growth of 12% in revenue to just over £400m and operating margin rose by 120 bps to 18.2%. Unit sales rose by 10% to 1,491 and the ASP rose a little to provide the overall rate of revenue growth. There may be a few questions to be asked about the reduced size of the land bank which is 1,250 units lower at 14,250. But the pipeline of total sales is higher in value terms by 8% at £857m compared with last year and we are told that 72% of projected sales for 16/17 are either in the pipeline or completed. The partnerships operations are still in the relatively early stages of growth so the 4% fall in revenue should not alarm GFRD watchers and the operating profit rose 9% to a short £5m, 3.4% margin. This part of the business should see much further growth as Housing Associations, Local Authorities and others expand their build programmes. The margin in the business is constrained a little by the geographic expansion with a new office in Bristol and plans for further geographic range. The Construction operations saw revenue steady at £742m but the margin fell substantially from 1.2% to 0.4% and that is not really explained. The company refers to working out some legacy contracts but that is old news and the recent trend has been for the margin to improve.
Overall the numbers from GFRD see the business on track for 145-150p of earnings this year and will cause no alarm. The new targets need to be understood a little better and certainly the intention to slow the growth in the dividend from the pace achieved in recent years, seemingly reducing it in relation to EPS will cause some concern; the thought was put forward at the last results meeting so it’s not new. Trading at 1515p at close last night the shares are not out of line with the peer group and views on value will be guided as much by thoughts on progress in the housing market. At this level and with a positive view of the housing market GFRD should find support for the short term outlook and its new plans.
Capita’s intention to write down £90m of assets is not much more than a footnote. It is to be expected but it is indicative of the way in which it has been using accounting treatments to full advantage of short term profits. The release states that accrued income of £40m will be written down as a charge to underlying results. Quite right as this is money that the company expected to get at some point in the future so it was pulled forward and guess what it now expects it will not arrive after all. Doing this now is probably quite right in some senses but it also has the advantage of taking some of it out of the spotlight on 2nd March when the results are released. The company tell us that 2016 expectations are unchanged by this accounting manoeuvre and that there is no cash implication. We believe the content of the announcement is indicative of a lot of things that are wrong at Capita but is small in relation to the strategic, financial and management issues it faces.
The transactions at Balfour and Wolseley look to be no more than exercises in tidying the portfolio. Balfour’s exit from the Middle east should be no surprise as it has been pulling out for over 20 years since it sold Ducab. Its presence in the region may be retained in some large projects but strategically it is best focussed on the UK and the USA, with some ventures overseas in HK and Australia. The more interesting aspect of the announcement is the reminder that the company is entering Phase Two of its transformation and it will be interesting to know the new targets when announced, probably at the results in mid-March. Wolseley’s move is simply about consolidating the market in a country which is unlikely to be meaningful in revenue and profit terms in the future. The synergies across national borders in most building materials are few, except in manufacturing commodities such as glass and cement. The moves by these two companies announced today are unlikely to move the dial and should leave prices unchanged.
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