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Stephen Rawlinson
13 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 13th June 2017

Capita, Crest Nicholson and Ashtead all have news for us today. Mitie’s results meeting yesterday was over in an hour, much earlier than expected.  The interesting elements from yesterday are the ideas about using technology and the admission that the Property Management operation is potentially up for sale.

Capita, Crest Nicholson and Ashtead all have news for us today. Capita has come out today with a trading update that is upbeat on the surface but within contains a few areas of concern. The release is made to coincide with the AGM. The company states that it is trading in line with expectations and that the turnaround of the IT Services business is ahead of expectations. The Euroland customer services operation are improving but some parts of the UK operations have yet to improve (property, employee benefits and learning services are mentioned). The search for a new CEO continues.  The DIO contract, heavily criticised by the NAO, is likely to be retendered in 2019 as the client refines its needs and will be much less profitable for Capita this year and in the future as it is “reshaped”; Capita expects to be part of any retender process. The first half of this year will have a similar out-turn as 2H ’16 and there will be an improvement in 2H’17, we are told. The market expects 60p of EPS this year and shares closed last night at 550p; our sense is that the company is still in transformation and without a long term CEO is in some difficulties but the risk/reward is attractive and an equity fund raising seems unlikely.

Crest Nicholson has delivered a good out-turn for the first half of its financial year to end April 2017. Revenue is up 3% to £420m and operating profit by the same percentage to £80m, an operating margin of 19.1%. The company reiterates that it is on track for the 2019 targets of £1.4bn revenue and 4,000 units completed. In the first half of 2017 it sold 1,021 units excluding PRS, compared with 1,033 last year and the ASP on private sales, again excluding PRS, was up 12%. The sales per site per week at 0.81 is well up there with the industry norms, if not a tad above them though down from 0.87 achieved in 1H ‘16. The move to get more units in the Midlands is proceeding, driven by weakening market conditions in the London/M25 area and good opportunities emerging in accessible areas outside the South East. Crest is one of the favourites of many commentators, given its experience top team and growth plans. There is nothing in these numbers to raise new concerns; the clear issue is the macro one around demand and that means Brexit outcomes.

Ashtead’s full year numbers show group rental revenue growth of 13% and EBITDA growth of 12%. We look at the business for read across to UK situations. A Plant, the Ashtead UK operation, saw revenue rise 15% on it rental revenue reflecting increase fleet investment in earlier years and of course good demand levels. Overall revenue at A Plant rose 15% to £418m and EBITDA was up 12% to £153m; the small fall in EBITDA margin from 38% in 15/16 to 37% last year is not that meaningful and margins remain well above the industry average. The read across to the other relevant hirers, Speedy and VP and the construction sector in general remains positive.

Serco announced yesterday a new $101m contract to manage hazardous materials for the US Defense Logistics Agency if it proceeds for the full five years; there are annual options after the first year. Handling hazardous materials is not a mainstream service for FM companies but it is something Serco has done for a number of years. Of course, in the UK it handles domestic and trade waste. The size of this new contract does not move the dial much but it demonstrates its ability to win work and perform complex tasks for customers. 

The road to redemption is being travelled well by Serco, albeit a long one. Investors should watch closely, in our view as the new wins are mounting up and the resolution of long standing issues, the Onerous Contracts, are proceeding with few setbacks. The shares closed last night at 116p, a level justified by 2019 expected earnings rather than this year or next. But the surprises so far have been on the upside and time flies so best not to miss the chance to get on board.

Serco’s contract in hazardous waste handling reminds us of Augean. Labels stick in the markets and this company is historically associated with landfill. However, it has transformed into a services company in the waste sector in the last five years. It is quite a different organisation than the one that came to the market well over ten years ago. The results for 2016 were released in late March and were positive with revenue up 25% to £76m and adjusted EBITDA rose by 17% to £14.1m. EPS this tear will be around 6.2p and 7.2p next year, according to market estimates so the shares at 61p at close last night do not look overvalued and some might say with that growth record they are cheap.

Mitie’s results meeting yesterday was over in an hour, much earlier than expected. There was much to digest in the numbers which we shall look at in detail in slower time. The KPMG Review has identified the issues and the company has dealt with them. There will be an amount of judgement applied to revenues and costs on long term contracts, as required by accounting standards but the approach will be much more prudent, that is clear.

The interesting elements from yesterday are the ideas about using technology and the admission that the Property Management operation is potentially up for sale; “we have had several expressions of interest” we were told. On the former we had a long chat with CIO David Cooper, ex Centrica. The focus of the work is on the use of big data as well as project specific monitoring and control. The conversation was mainly about applications in offices and commercial and offices premises. The applications will include facial recognition for building control, space monitoring for more efficient usage and energy management tools, some of which came with the Utiliyx acquisition but were not exploited. It may be for example that facial recognition might be used in conjunction with public data to monitor in retail environments where Mitie already has, say, a cleaning contract and it can cross sell that type of service. Our sense is that Mitie is not using new technologies and taking any risks but is seeking applications of existing technologies and using advanced data analytics to reach meaningful conclusions that might save customers cash and improve efficiency. The clue is of course in the words “connected workspace”.

The other point about Property Management is that a large part of the activity is in Social Housing and the whole focus of Mitie’s effort in the connected workspace seem to be in B2B applications. Part of the reason for entertaining disposal was stated to be that in social housing maintenance and management the customer is not the client, meaning that the work is done in dwellings for tenants, the customers, who are not paying for it themselves. The use of analytics in Social Housing is much greater than investors realise as data on repairs frequency and the characteristics are well documented, analysed and used in bids and everyday workloads. But Mitie’s approach to the connected workspace by definition is angled toward B2B, the cost of which can be spread across the near £2bn of revenue in that area. The technology investment needed to cover the £250m of revenue in Property Management, which will fall this year based on contract progress, may not be large enough to justify the level of technology spend needed in that area.

The other element in the mix is that while Mitie’s net debt at the year-end fell there was a strong year end push on working capital that aided the number. The company passed on the year-end dividend. We are confident that Mitie has no real issues with its debt and unlike Serco has few residual issues with contracts that require cash to resolve. But an injection of cash from the disposal of Property Management might be helpful and deliver greater comfort to the banks, depending on the size of any consideration.

Mitie was of course the biggest riser in our universe yesterday, up 11.1% at close of play to 274p. Some of that might be shorts closing out positions as they were 12% of the shares issued, as of Friday last. What is clear is that there may be a squeeze as there are few if any reasons to continue to be cautious about the accounting or the ability to earn margins of at least 4% in the future on revenue of £2bn a year. The valuation may be a tad ahead of events but increased confidence in the core business, an improved balance sheet and a bear squeeze suggest that there may be a floor in trading of around 220p and upside towards 300p, depending on sentiment, in the coming months.

The largest loser yesterday was G4S which fell 2.0% to 331p. We read little into that shift as it was likely to be just ebb and flow of trade on the day in a stock that has seen a strong improvement YTD, up over 40%. The story remains intact and the valuation not stretching.

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