Market Commentary - Housing, Infrastructure, Construction and Services 6th March 2017
Unusually there is no directly relevant news for the sector this morning. The Budget later this week will no doubt create some speculation about the impact of its measures on the sector. The main story on Friday was Berendsen, down 11.4% to 823p by close of play, having been down some 17% at one stage. The profit warning for 2017 was unexpected and what it termed “legacy” issues were blamed; the meaning of legacy in the sector is bad stuff emerging now that has nothing to do with current management.
Unusually there is no directly relevant news for the sector this morning. The Budget later this week will no doubt create some speculation about the impact of its measures on the sector. There are still a substantial number of companies to report either full or half year numbers in the coming weeks.
New news later this week comes with Ashtead’s interims tomorrow and finals from Grafton and Ibstock. On Wednesday G4S and Breedon tell us of 2016 progress with their finals. Thursday sees finals from Cairn Homes and Countrywide and the sector goes quiet on Friday with no planned news.
The main story on Friday was Berendsen, down 11.4% to 823p by close of play, having been down some 17% at one stage. The profit warning for 2017 was unexpected and what it termed “legacy” issues were blamed; the meaning of legacy in the sector is bad stuff emerging now that has nothing to do with current management. Notwithstanding any view on the so called legacy issues at Berendsen investors have to decide whether the substantial programme of change and investment outlined on Friday by Berendsen is likely to succeed. So far the top team has presided over two profit warnings and seen the share price fall from a peak of 1337p in late July last year to 823p as earnings slipped last year and are expected to be below 2016 levels this year, based on guidance. The results outlined a substantial programme of investment in capital and people in a business that seemed to be performing pretty well, enough to be valued at 20x prospective p/e. So far shareholders in BRSN have lost out and head hunters, change management consultants and strategy experts have gained; £11m has been spent on strategic changes so far.
Berendsen’s plans for expansion and improvement look sensible on paper. It has £1bn of annual sales in an addressable market valued at £6.8bn. The plan to invest £450m over the next three years, retrain or replace the workforce and subject more decisions to scrutiny by committees sound like it might work. But it depends crucially on sales being increased from current levels, outsourcing rising in the £3.1bn pa part of the market that is currently house and competitors either standing still or accepting lower levels of returns on sales. The point is that Berendsen’s plans are quite risky and all investors have seen to date is extensive change, especially in the UK and an inability to adapt successfully to short term fluctuations in its market. Stock market forecasts for earnings in the current year have not yet adapted to the guidance provided Friday last but are likely to settle at between 55p and 60p, with a bias to the bottom of that range. The 63p of EPS reported in 2016 was boosted by FX and adjustments, without which the figure would have been lower than 2015’s 60p. Trading Friday last at 14-15x 2017 prospective p/e is good enough for now for many investors, especially given the scale of changes proposed.
Interserve and Carillion were the best performers on Friday, rising 2.0% and 1.4% respectively on what was a poor day for the markets. We have talked a great deal about these two stocks in recent weeks so it may be best to move on swiftly.
Having expressed concern about accounting in the sector for many years we are always on the lookout for the next one to fall. The issues at Mitie and Capita have yet to play out in full of course. It has taken two years for Serco to rid itself of its final factoring arrangements and bizarrely Rentokil boasted a year ago about having entered such arrangements in its French operations. Serco’s accounts are now as clean as any investor would like to see but the price being paid is a slight delay in getting to industry average margins. There are two small companies that are sailing very close to the wind, Bilby and T Clarke; the latter has seen an inexplicable rise in its share price recently despite its weak profitability and, we suspect, alarming rise in its pension deficit. Among the larger stocks Homeserve stands out to us as having the most unobserved red flags. The business model relies on revenue growth in our view and the lack of transparency between revenue and operating profit, with substantial elements of the operations being re-insured, are concerns. Add to that the very mild winter to date which might have caused renewals and additional revenue from uninsured household items to dry up and we may see some backtracking on earnings guidance as it approaches the year end.
Moves last week
The sector grew slightly faster than the market last week with construction and building materials showing strongly, based in part on CRH’s performance. The house builders also did well. But the services sector suffered from the news coming from Travis Perkins, Capita and Berendsen. The sector is up 6% YTD versus the markets rise of 3.4%; the house builders are leading the way, up 9% with Construction and materials and services performing slightly better than the overall market.
The largest losers were Capita down 8.2% and Berendsen down 9.6. These two were discussed at length last week. Both stocks have much ground to make up which is possible, but investors will want to see evidence of success first and in the case of Capita, the identity of the new CEO.
Morgan Sindall gave the best performance last week, up 6.5% to 1046p, 38% YTD, as investors are getting to realise that the worst is well behind the company and there is plenty of evidence of high levels of demand and a well-managed balance sheet. The mathematics for earnings to get to the 150p per share level by 2020 is not difficult to construct, achievable just by the company performing at industry average levels. The stock is thinly traded so progress share price progress may be erratic.
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