Market Commentary - Housing, Infrastructure, Construction and Services 9th February 2017
There is no formal news this morning from sector companies. The item to which we draw attention is a short thought piece sent by Balfour Beatty, the latest in a number of documents in which the company uses its place in the UK industry to attempt to drive broader agendas. The document is worth a read because it applies not just to Network Rail. It also tells us something about Balfour Beatty, as you might expect.
There is no formal news this morning from sector companies. The item to which we draw attention is a short thought piece sent by Balfour Beatty, the latest in a number of documents in which the company uses it place in the UK industry to attempt to drive broader agendas. In the document we received today the company’s theme is the need for continuity of funding in the rail sector. The thread is that with known and continuous funding companies and network rail can make the investment needed in people, skills, equipment and technology to improve project performance and delivery. Taking Network Rail under direct government control, thereby putting its debt on HMG’s balance sheet is positioned as a potential negative for consistent funding. So BBY is making a very public plea that funding is consistent and is in the national interest to be so. The document is short enough to be read. It does not propose solutions but highlights the issues that have emerged and will emerge if funding does not match the basic requirements to achieve the outcomes needed.
The document is worth a read because it applies not just to Network Rail. It highlights significant issues that are emerging in construction generally due to an aging workforce; Brexit leading to a loss of available labour; increased use of technology; and large emerging pipeline of infrastructure projects. Plus, we also observe, a “demand” from government to increase housing supply which adds strain that sector that struggles sometimes to get the labour to achieve current output levels.
It also tells us something about Balfour Beatty, as you might expect. The projects it highlights in the document are large scale specialist ones in power and electrification. One of our key observations about BBY has been that its heartland remains the power projects for which it was established when it was the construction arm of British Insulated Callendar’s Cables (BICC). The parent morphed into Balfour Beatty following disastrous investments in optical fibre in the 1990s. BICC’s need for cash caused BBY to take on projects outside its mainstream and that continued after 2000, when BICC disappeared from view and it became a habit. Our sense is that the recovery in BBY’s performance will be swifter and better if we see it take on more large scale power work. The size and scale of the company means it will need to continue with much of the more general construction work that has become part of its skills sets. Straying too far from what was its best skill, especially into UK regional construction, was a blow for the from which it is some way through recovering, in our view. We believe that BBY is very much aware of its strengths now and is playing to them.
At 268p at close last night and we expect near 30p of EPS in 2018 it is starting too cheap. Valuation of BBY is of course more subtle as it is a mix of capital value and annuity style incomes in the PPP/PFI portfolio and cash creation in the contracting businesses. Valuation will always be impaired in our view given the two very different streams of shareholder value in each part of the business. Bilfinger’s demerger in 2012 was highly beneficial for shareholders and we maintain it is the best way forward for BBY. In the longer term that truth will play out to the benefit of shareholder, we believe and that is another good reason to buy now.
The moves yesterday saw Capita regain a bit of support raising the most, up 3.4% to 515p. It is trading between 480p and 530p and it is likely to continue to do so until it opens up on its strategy and funding needs. The company is still in issue identification mode we suspect but the City seems to have decided that a fundraising is needed. Grafton was the second best riser, up 2.6% to 614p; it has climbed steadily and quietly from a low of 489p in late September which followed its small earnings warning. That was a great buying opportunity in our view and while the rating at near 15x p/e, historic for 2016, is high versus peers the market, we believe, underestimated the company’s growth potential in Europe and the appeal of its Selco trade format, especially in SE England.
The main loser was Berendsen, it fell 1.7% to 889p. That was a simple retrace of the previous days near 7% gain and nothing of importance, in our view. The pressure remains on Babcock and will continue, we suspect until it shows greater resolve to reduce its debt. It fell a further 1.1% yesterday to 878p the lowest level since the post Brexit hiatus. At this level it is starting to look cheap but fears about the B/S remain. The succession to Pete Rogers has left it with a board of insiders at a time when fresh ideas are needed.
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