Market Commentary - Housing, Infrastructure, Construction and Services 2nd February 2017
Compass and Carillion have news this morning, the former an AGM update and the latter has extended the duration of its contract with Openreach. Compass has its AGM today and a conference call at 8am. Interserve was the main mover yesterday, it rose 3.1% to 334p. It remains on a low valuation with a p/e of 5.4x 2016 expected earnings and has a yield of 7.3%. Carillion’s new FD has wasted little time in ensuring the operations have the funding needed and getting the Openreach contract agreed.
Compass and Carillion have news this morning, the former an AGM update and the latter has extended the duration of its contract with Openreach. Compass has its AGM today and a conference call at 8am. The news from Compass is as expected, trading is in line, organic revenue growth was 2.8% in the first three months of the year to end December 2016 and operating margins are up a tad as operational gains offset cost increase and new investment. The performance of Compass in the last ten years has been excellent so any expression of concern is like having a go at your granny and we would not do that. Investors will however, be aware that operating margins have been stuck at group level at around 7.1-7.2% for some four years and that the US, which contributed 7% revenue organic growth in Q1 of CPG’s financial year remains the main engine of growth. We shall listen to the call as the company refers to being excited about significant structural growth opportunities as its those that will provide most of the earnings growth we suspect. More below.
Carillion, fresh from announcing on Monday afternoon that it has refinanced over £100m of maturing loans at sub 3% coupon has today provided some of the means of paying off the loans with the extension of its 60/40 JV with Telent on Openreach. For Carillion the work is likely to provide revenue of some £500m between 2018 and 2021 within the framework and if further extended to 2023 that could rise to £900m. The statement is indicates that the geographic areas covered are North East, Midlands and Wales, South West and London and the North Home Counties. Our understanding is that the geographic area is reduced now compared with the national coverage that existed when the contract first started and we will contact the company to confirm. That does not mean that revenue is lower than it was and certainly does not indicate that profitability is changed one way or another. This is good news for Carillion as it provides secure work through to 2023 when all extensions are taken into account. More below.
Interserve was the main mover yesterday, it rose 3.1% to 334p. It remains on a low valuation with a p/e of 5.4x 2016 expected earnings and has a yield of 7.3%. The market clearly has grave doubts about trading and net debt, despite management reassurances in recent updates. The new CEO will be announced soon we expect and that may reassure investors. Serco was the backmarker, down 1.1% to 142p. The share price is well ahead of the expected improvement in earnings and the company has provided no encouragement to outsiders seeking a rapid change in earnings. It has consistently beaten the expectations based on its guidance but they remain at a low level and 2018 is the first year in which there is a good chance of getting near to industry operating margins. So a small retracement is not a surprise given a market forecast of EPS for the year just ended of 4.5p and 3-4p for this year. When the legacy contracts are ended and the new ones kick in then EPS of nearer to 10p (based on the current number of shares) would be a reasonable expectation.
The news today from Compass may bring some relief for investors who might have been concerned about Richard Cousin’s unexpected resignation as a NED at Tesco. We expect that realistically it will not have much effect. The impact of FX on reported earnings is interesting as Q1 16/17 shows revenue higher by £924m due to FX and operating profit up by £74m (8% operating margin). Those are big deltas increasing revenue by c 20% on FX alone. The full year impact is slightly less due to FX in the final quarter of last year. That of course affects reported earnings positively and makes forecasting a little tricky! EPS for this year should be around 72p, boosted by FX and 79p the following year based on current exchange rates. The rating at 20x p/e for this year is much in line with where it has been for the last few years and of course is also likely to be a little higher if the share buy-back programme continues. The conference call may provide some clues on that because if the opportunities to which the company alludes are numerous enough it may re-invest in the business a little more.
Carillion’s new FD has wasted little time in ensuring the operations have the funding needed and getting the Openreach contract agreed. The balance sheet issues are well rehearsed and its those that hold back the rating. Earnings of around 35p for last year will be reported on 1st March, a level broadly unchanged for the last four years. Given the hiatus we have seen at other companies Carillion’s lack of a substantial profit warning gets little mention and no credit from investors! The shares closed at 221p last night, an historic p/e of 6.3x which is surely overly harsh.
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