MITIE CONFERENCE CALL FEEDBACK 18th January 2017
The main talking point in the call was about accounting Rinky Dinkies that few knew about. We discuss those below but first the main substantive points.
Our contention that within Mitie there exists a business capable of £2bn+ a year revenue, 5% margins and 3-5% pa growth is unchanged
MITIE CONFERENCE CALL FEEDBACK
The main talking point in the call was about accounting Rinky Dinkies that few knew about. We discuss those below but first the main substantive points.
• Our contention that within Mitie there exists a business capable of £2bn+ a year revenue, 5% margins and 3-5% pa growth is unchanged
• The path to getting there may be a bit longer and more expensive than expected but 2018 is a reasonable target to reach that cruising altitude
• It may take longer because contracts have been delayed as stated today and there are management and operational changes to make that will be needed to get to c 5% margins on a sustainable basis. From the call many of the changes mentioned are just adequate practice rather than anything else.
• It might be more expensive because bringing in new people always is and there will be more moves than previously outlined (eg taking out layers management that were adding limited value) and the extent of the changes is larger than expected
• The reduction in operating profit expectations from £129m in 2015 to the most recent consensus of £90m (year to march 2017) to the new figure of £65m comprises several elements. The most recent £25m reduction is £14m of one-offs and the rest is mainly deferrals and delays of work that will not happen.
• Several parts of the business are performing really well, Security was described as going gangbusters, a pun to which even we might not stoop. Specialist services and catering were also described as doing well.
• There are still outstanding potential adjustments to come from accounting treatment described below and the c £30m of capitalised mobilisation costs according to management. There will be little certainty on these issues until March at the earliest, we expect. Small amounts of fraud are a possibility of course which will have a newsflow effect if announced but there is no evidence of systemic fraud.
The main discussion was about an accounting treatment they have been using that has boosted reported profit in recent years.
Percentage of Completion Accounting (POC) applied to Mitie Services
On 18 current contracts, covering 35% of 2016 revenue, Mitie has been pulling forward expected future improvements in profit to the current year. That was based on assumptions about future revenue increases and cost improvements that may or may not happen. The POC method is normal on construction and similar long term projects of course and in some other areas but the application to services revenue and cost at Mitie was more extensive than we had expected and could have been quite optimistic but shareholders had no means of knowing the detail of the assumptions.
The 2016 B/S had a figure on long term receivables that was rising but was widely assumed to be relating to historic events and quarrels about payment. It amounted to around £85m.
It now turns out to comprise mainly expected revenue on contracts where the profit has already been booked. The POC method is allowed under accounting rules as it is a smoothing of the numbers to prevent distortions in any one year. It may even be OK under IFRS 15 which deals with revenue recognition and is to be introduced soon.
This type of approach especially for PPP/PFI valuations is a Tom Jones job, It’s Not Unusual. Indeed when valuing such contracts its essential to make a long term assumptions about revenue and costs. So its not new, it is used in many areas but not usually as extensively nor are contracts deliberately extended for what now appears, potentially, to be a means of boosting current earnings.
The link of this treatment with the extension of a contract with Lloyds Bank around two years ago now becomes clear. Mitie won a five year contract from Lloyds worth around £175m a year in 2012. It was extended for a further eight years in 2014, quite out of the blue and for no obvious reason. It now becomes clear that by extending it allowed many more years of expected future profit to be pulled forward! The Lloyds contract was one of the 18 subject to this accounting approach.
This treatment is clearly the logical flipside of making provisions for expected future losses. But while those are usually identified and often regarded as exceptional the expected future profits were booked as normal trading.
The lines will be hot in the next few days as analysts adjust for this in companies such as Babcock and Capita in particular. We will make our enquiries.
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