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Stephen Rawlinson
29 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 29th June 2017

Babcock has announced it has won a contract and Civitas has spent some more of its equity on social housing stock and Utilitywise has a new FD and an accounting issue has been identified. Kier was the best performer yesterday as its update was seen as reassuring.

Babcock has announced it has won a contract and Civitas has spent some more of its equity on social housing stock and Utilitywise has a new FD and an accounting issue has been identified.

Babcock has announced that it has won a contract potentially worth £500m if it is extended for the intended six year period after the initial five year term. The work will start in mid-2019 and it is to operate air ambulance support for the health service in Norway. The Avincis acquisition provided BAB with extensive experience in running air ambulance services and it now has a fleet of over 300 aircraft in this market segment. The company claims it shows good progress in building international presence, which is a strong claim; it demonstrates to us that it has enormous untapped potential to operate internationally and in civilian markets, that has yet to be exploited. Also winning one project in one country is not the same as winning work across many countries for one customer. While the project does not start for several years, a timescale that is not unusual for BAB this is good news for Babcock as it has been unfortunate with the Avincis deal timing. It is on the way to reducing dependence on the UK and the MoD which was always going to take time. At 895p at close last night the valuation looks harsh as 78p of EPS is expected this year and near 90p next year.

Civitas has announced one of its largest deals to date with the £22m acquisition of 16 supported living properties with 173 tenancies. The announcement is the usual one from the company which is still struggling to find stock and is focussed mainly on assisted living properties at present. The attraction to a registered Provider of a 22-25 year sale and leaseback is not that high, it would seem. Civitas will succeed, in our view and be able in due course to have enough stock to leverage the portfolio but it still has more than £150m of the £350m equity raised, based on our estimates, so it’s going to be some time before it can use its leverage. The company has also made an odd statement about Grenfell tower.

Utilitywise has found a black hole in its numbers. The company had expected to be paid commission based on the energy usage of some of its customers. The company’s business is to act as an intermediary between the wholesaler and the customer offering lower costs to the user and high take off for the wholesaler. But it’s all come a bit unstuck as the customers are not using enough energy so the expected commission level has not been and is likely not to be as high as expected to the tune of £11.2m for the period to 2020. The company receives 80% of the expected fee upfront, based on consumption, subject to claw back if consumption is materially lower than expected. The recent evidence shows the likely levels of consumption to be such that a claw back is likely. The hit to the P&L will be taken this year. The current annual revenue run rate is around £45m. The company is keen to point out that its net debt guidance is unchanged. Whoops.

Kier was the best performer yesterday as its update was seen as reassuring. It certainly helps when you have a number of projects with cost overruns to have some large chunks of cash to cover the problems. The exceptional P&L hit is £135m over the three years 15/6 to 17/18 but the net cash impact is positive £45m over the same period. The important element yesterday was that progress in the mainstream operations in the UK is positive. Importantly the two current elephant project Mersey gateway and Hinkley are progressing well and there are new ones on the horizon that should replace them, such as HS2. Progress on getting 10% CAGR earnings growth to 2020 is more erratic than expected but we are told is still on track and evidenced by the expected returns on investment made in the last 12 months. The shares were 1.9% higher at 1241p with 108p expected in EPS this year and given the current macro environment further gains will be tentative, we expect but are more than likely.

Homeserve was the main loser yesterday, down 2.5% to 727p. The shares have had a good run in recent months so we see this as probably no more than a little bit of profit taking in the most highly valued stock in our universe. The market is looking for 31p of EPS in the year to end March 2018 and 23.5x prospective p/e is at the top end of the valuation range.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
28 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 28th June 2017

Kier’s trading year end update ahead of a CMD tomorrow is the main news this morning. The one-offs will attract attention but should not be allowed to overshadow what appear to be positive results to come in most areas of the operations. The moves yesterday were almost all downwards. The reality that interest rates are going up at some point, the UK economy is slowing and that political uncertainty is creating delays is starting to be realised.

Kier’s trading year end update ahead of a CMD tomorrow is the main news this morning. The company indicates that it is trading in line with expectations, which we believe are for EPS of 108p in the year about to end and for PBT of £129m, a 3.3% rise versus last year. But attention in the 8.00 am conference call will be on the increased provisions and cash costs associated with the withdrawal from the Caribbean operations and the news that there are substantial other exceptional P&L costs to be booked in 2H’16 that were not previously known and some have cash implications. In total these amount to £75m of additional exceptional P&L hits in the second half of the year. The largest hits to the P&L are an additional £23m in the Caribbean operation (making the three year total exceptional in that area £79m) and £23m provision for work in Hong Kong. On the latter the projects were known to be ending but the prospect of a large one-off loss was not mentioned. The other P&L “damage” is from HSE fines (£8m), the sale of a renewable energy operation (£9m) and reduced recyclate income and contract closures in the environmental services area (£4m).

There is a reasonable case to make that the cash impact is offset by gains from the sale of Mouchel Consulting, the release of cash from setting up the JV with Cross Keys Housing and a £17m payment from Hong Kong due next year. The exceptional cash costs of £107 for the three year period is mitigated by £152m of one-off gains. The industry is it must be said one of risk and the fact that there are assets that can be traded to offset situations in which undue risk was taken (with hindsight) is a good thing. It does however make investors nervous. Kier has always had such “reserves” to draw on which have helped in the past and this is another phase. Out snatched conversation this morning with the company points to the exceptional now being fully completed and signed off.

The one-offs will attract attention but should not be allowed to overshadow what appear to be positive results to come in most areas of the operations. The cash created from the disposal of Mouchel Consulting was swiftly used up on projects in Residential and Property (£81m of new investment in these areas in 16/17 that should deliver returns at least in line with the Group’s 15% hurdle rate. In residential demand remains strong in the geographic areas and market segments in which the group operates. In the Services area the sluggish first half bounced back in 2H, based not just on government spending the budget before the year end of March. The company points out that its net debt will around £150m at the year-end which is below expectations and the £30m lower than the half year situation.  There are many good things happening in the business and demand for its services in the UK does not appear to be an issue. The share price will probably take a hit this morning after closing last night at 1220p, down 0.4% on the day; the price has been winking at us for a few months. Any decline creates an opportunity as company gets back on track to achieve its 2020 vision goal of 10% CAGR in earnings.

The moves yesterday were almost all downwards. The reality that interest rates are going up at some point, the UK economy is slowing and that political uncertainty is creating delays is starting to be realised. We are moving to risk-off. However, the 6.1% fall in Mears to 451p yesterday had little to do with macro factors. The trading update was positive but contained enough elements of doubt to suggest that the risks were tending towards down not up. They included revenue being a tad lower than expected in 1H and the contract attrition in Care being slightly more than expected. Our sense is that these are just blips and that the strategy is intact and will deliver this year and into the mid-term in two areas of essential service provision. The selling yesterday was, in our view, overdone.

Breedon was the best performer with a 2.8% rise to 88.8p. The market likes its combination of exceeding expectations, entrepreneurial approach to marketing and selling and assets that are very difficult to replace.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
23 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 23rd June 2017

Workspace has the floor to itself this morning with its £159m acquisition of Salisbury House in Finsbury Circus. Moves yesterday were in a tight range with Grafton leading the way rising just 1% to 733.0p and Balfour Beatty suffering a little, along with other contractors, down 1.6% to 277.8p.

Workspace has the floor to itself this morning with its £159m acquisition of Salisbury House in Finsbury Circus. This is a much bigger than average deal for the company. It is interesting for the sector as it is a pretty bold statement by a very experienced organisation. It has been bought with an initial yield of 5% based on a rent at present of £41.50p per sq ft and 90% occupancy. There is therefore some scope to upgrade the space and charge a much higher rental, in a very good location. We look at it for read across and there are few signs of Brexit nerves shown with this deal. Also it has positive read across, albeit that it’s just one building, for fit-out specialists such as Morgan Sindall, which is already faced with unprecedented high levels of orders.

Moves yesterday were in a tight range with Grafton leading the way rising just 1% to 733.0p and Balfour Beatty suffering a little, along with other contractors, down 1.6% to 277.8p. This is telling us that investors are wary of both buying and selling at present, save on specific company news, good or bad. The reporting for December and June year ends starts in August but we will see some pre close updates in the next two weeks. If there are surprises we believe they are likely to come from Balfour Beatty, which has been modest in claiming progress to date but may have some better than expected news and Serco. The latter provided a reality check at the 2016 full year results in late February but has since won the £1.5bn detention centre project in Australia and may have made progress with its OCPs and the other “elephant” projects.

SIG was well ahead in early moves yesterday though it retraced towards the end of the day, rising just 0.8% by close of play, having been up over 4% at one point in the trading session. A broker’s note was published yesterday, switching the recommendation from hold to buy with a TP of 170p and that boosted interest. We became very positive on the stock at 93p late last year. This broker’s recommendation was hold from 90p to 145p and has now become buy with just 17% upside. Work that one out! In fact we expect 200p+ to be achievable for SIG based on EPS of 15p and a 14x p/e ratio. We also expect its insulation consultancy services to be in greater demand henceforth, which have an above average margin. Its new commercial approaches and better accommodations with suppliers make improved earnings realistic, hence the move already to 145p.

Finally, many thanks to everyone who contributed to the Royal Marsden Charity Golf Day we were involved with that took place on Friday last. At both individual and company level you have been very generous. We are still getting money coming in and there is still time! The tally at present is over £7,500. https://www.justgiving.com/fundraising/CoombeWoodGolfCharity

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
22 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 22nd June 2017

James Latham, a £200m revenue a year timber merchant, reported its finals to end March 2017 this morning. Capita topped the leader board again yesterday with a 3.8% rise to 696p as big brokers start to change view. Are there other examples of stocks that are substantially out of favour but have strong market positions you may ask?

James Latham, a £200m revenue a year timber merchant, reported its finals to end March 2017 this morning. Its story is always interesting as it has read across to the main merchants. In the UK there are two companies in this space that have survived as independents, James Latham and Meyer International, now privately owned, the rump of what became Jewsons. They have similar levels of revenue. While James Latham is quoted it has a strong family ownership and Meyer is also, effectively, family run. James Latham reports that revenue rose near 7% last year to £199m and operating profit was 8% higher at £14.2m. The company was able to pass on a substantial portion of the price rises it faced on its imported products and had a small rise in volumes which aided performance. But the GM fell by 0.3% as a consequence of competitive pressures. The company had net cash of £17.2m at the year-end but also a pension deficit of £166m which has varied greatly with gilt yields. Read across from Latham suggests demand remains positive and price rises can be passed on in certain product areas.

Capita topped the leader board again yesterday with a 3.8% rise to 696p as big brokers start to change view. While nothing has altered much in the business the broking “herd” is starting to decide it was not so bad after all. We say starting, as the possibility of a 1000p share price is realistic with the right CEO appointment and adjustments to the strategy and operations, based on demand for what the company does and its existing contracts and market position. But we are not at that point yet and will not be so for some time. So entry at 696p is not without some short term risk. This is yet another example of investors selling on bad news causing a price to slip badly but remain there long after the selling has stopped. Capita’s operations are too important for many of its customers, at least in the short/mid-term so they were always bound to be supportive.

Are there other examples of stocks that are substantially out of favour but have strong market positions you may ask? Babcock, Carillion, Galliford Try and Interserve stand out, though of the four only the first two have really strong market positions and in both cases the main customer where they are strong is the MoD. Interserve also has good contracts with MoD but they are not as large a percentage of revenue as at BAB and CLLN. Babcock at 902p may not have the growth to justify its previously high rating and it has several issues to work through but with 78p of EPS expected this year and 89p in the year to March 2019 it may be the next stock that big brokers realise is potentially oversold. The data show only 0.5% of the stock shorted so there would appear to be few betting against it rising again, which is a good sign. We continue to believe that Carillion can trade through its problems, which are more balance sheet issues than trading ones, but it will be a long haul and the shorts are now over 24% according to Castellain.

The bottom end of our league table shows the Merchants facing a tough time. Grafton fell 2.7% to 727p and Travis Perkins fell again to 1469p, a 2.4% fall. While Berkeley was positive yesterday it is a company that is run quite differently from others. The news from the housebuilders has remained stronger for longer than expected so demand remains positive in that area albeit that it is subdued in RMI. But short term the Merchants are having to cope with inflation of input costs which is difficult to pass on in full. In the past inflation helped Merchants as the stuff in the yard became more valuable but with supply chains now much shorter and with the hedges that were in place expired rising prices are starting to hurt a little. As we mentioned yesterday, e-commerce and changing patterns of construction, more off-site, are also disruptive. We expect to see the merchants adapt, as they are doing, especially in plumbing and heating but that will not be without a cost as Wolseley showed on Tuesday. Travis Perkins as the pure UK play will take the brunt of any concerns while Grafton and SIG have substantial and growing Euroland operations that will off-set many UK concerns.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
21 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 21st June 2017

Berkeley’s finals for the year to end April are as candid as usual. The key message is that Berkeley is doing a good job of building new homes and making valuable contributions to society (e.g. apprenticeships, social housing units, taxes paid, charities to which the company has donated) despite the headwinds being created by the politicians (e.g. stamp duty, mortgage relief on BTL loans, Brexit, planning system). The moves yesterday included only small changes.

Berkeley’s finals for the year to end April are as candid as usual. We shall come to the numbers in a moment though as taster we can say they are ahead of expectations. The key message is that Berkeley is doing a good job of building new homes and making valuable contributions to society (e.g. apprenticeships, social housing units, taxes paid, charities to which the company has donated) despite the headwinds being created by the politicians (e.g. stamp duty, mortgage relief on BTL loans, Brexit, planning system). There is no plea as such to politicians to change their behaviour, these are results after all, but the upshot of the ”headwinds”, according to Berkeley, is that fewer dwellings are now being built in London than are needed. The company indicates that it believes the London market has now stabilised and its reservations in the capital are now back at 2015 levels. But, we are faced with a prolonged period of uncertainty. It’s all fair stuff and stops short of entering any political domain. In our view it expresses disappointment rather than frustration; the company is just getting on with conforming to its obligations set by politicians.

Onto the numbers, which are very positive. Revenue in the year rose 33% to £2.7bn and operating profit was up 51% at £756m. The company sold 3,905 new homes at an ASP of £675,000 compared with 3,776 units at an ASP of £515,000 in the prior year. The 3% rise in volumes and 31% rise in ASP were due to changing mix as 15/16 included 638 student apartments. The revenue number includes £27m from the sale of ground rents and £29m from commercial unit sales. The operating margin has risen to 27.8% from 24.5% in the prior year due to reductions in share scheme charges and some cost savings. EPS rose 58% due mainly to the increase in earnings but also due to the share buyback scheme; the market consensus was for 422p, a much lower number due we suspect to a miscalculation of shares in issue. PBT at £812m for 16/17 is £14m ahead of market expectations. The business consequence of the uncertainty is that Berkeley is maintaining a very strong balance sheet despite the costs of special dividends and share buybacks. The group ended the year with net cash of £286m, having made a £255m payment of special dividends and paid £65m to buy back shares. The short term landbank is stable at 33,771 units and there are a further 12,580 plots which are contracted but do not have planning or vacant possession. During 16/17 the company bought sites in the “shire” towns around London that are in high demand such as Tunbridge Wells, Leatherhead, Franham and Cranleigh as well as adding land within the M25 on its own account and through the JVs, St Edward and St William. The JV with Thames water, St James gets less prominence these days.

If the industry’s job is to work within the framework set by politicians than Berkeley is doing as great job, as evidence by these numbers. The progress seems likely to continue as the company adapts, though clearly the highly capital intensive nature of what it does, especially in apartment developments. Means it will be cautious. The returns from what Berkeley does are high and in the emotive world of housing policy, that does not help but it is a consequence of good management. The new build segment seems to have a relatively favourable platform at present and if the Governor of the Bank says there will be no interest rate rises before Brexit then the scene is still favourable, despite the headwinds. There is still much to do in UK Housing and it is significant to us that there is no mention of the Housing White Paper, released in February 2017, which is supposed to fix the broken market but has ended up as being substantially irrelevant, so far.

The moves yesterday included only small changes. Mears up 1.1% and Kier up 1.0% were the largest risers with Morgan Sindall not far behind suggesting some support for companies with relatively stable risk exposure in construction, services and maintenance. The moves were small so there is no real pattern. Kier has CMD next week which should help with understanding the business and getting the valuation back to earlier levels. Travis Perkins fell 2.1% to 1505p as Wolseley’s comments about the UK market were not altogether positive and veered towards the negative. RMI markets are now more competitive than they were and changing methods of construction and e-commerce are affecting supply chains which are disruptive for the mainstream Merchants; in some product areas there is higher added value from helping with specifications and SIG is the main one exposed to that opportunity. With 113p of EPS expected this year and the shares at 1505p Travis Perkins is not expensive compared with historic valuations but there are few compelling reasons to but in scale at present.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
20 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 20th June 2017

The moves yesterday saw G4S lead the table with a 4.6% rise to 336p. Homeserve was the worst performer, down 1.1% to 779p a move that is within the scope of trading on the day.

We have an early start for a site visit so no comment on Wolseley’s interims, apologies.

The moves yesterday saw G4S lead the table with a 4.6% rise to 336p. The market has taken a while to get to understand the story with this stock and in some areas not really understood its intent with technology developments, or not wanted to, perhaps. It no longer spends big bucks on M&A as it is growing well enough organically and via bolt-ons. It’s back in the FTSE100 which was never a target but is a positive outcome. Capita may also be FTSE100 bound as it was the second best riser yesterday, up 3.8% at 670p; it will need to get to 840p to gain entry at current share prices but with a new CEO and a clarification of its (his or her) strategy and who knows. Our view is that much work is needed to identify what makes Capita a better choice for customer’s than the alternative, given the technology disruption in its area and the company’s lack of investment in bespoke know-how and IP. The market certainly seems risk-off with CPI.

Homeserve was the worst performer, down 1.1% to 779p a move that is within the scope of trading on the day. Much as we have substantial concerns about HSV, especially at current valuations levels, the market want to buy the story right now. Galliford Try struggled to make progress, down just 0.6% yesterday to 1166p. The message seems not to be getting through to investors, institutional or retail; and the latter should be very attracted to the story of substantial growth and the 8% yield.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
19 June 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 19th June 2017

There is no substantive formal news on the day the negotiations to exit the EU begin. News expected this week includes interims from Wolseley tomorrow and finals from London housebuilder Berkeley Group on Wednesday. Friday saw some positive moves across all HICS stocks; among our 22 stocks only four declined, with the worst case, SIG, being 0.4% down.

There is no substantive formal news on the day the negotiations to exit the EU begin.

News expected this week includes interims from Wolseley tomorrow and finals from London housebuilder Berkeley Group on Wednesday. The latter are likely to be very interesting as Tony Pidgely is usually quite straightforward in his views on progress in the sector. Recent moves by Berkeley and London rival Crest Nicholson into the Birmingham market will be well read as this may be a signal that opportunities for their product are more restricted in the M25 area these days. 

Friday saw some positive moves across all HICS stocks; among our 22 stocks only four declined, with the worst case, SIG, being 0.4% down. Other than the positive treatment for the sector there was no real noticeable trend. Homeserve was the best riser, up 5% and closing at 786p is at a record level; with EPS forecast at around 30p for 17/18 management has a lot to do to sustain share price momentum, in our view. If interest rates really are on the up then valuations are full for stocks with UK earnings but, at present, the mood is that even if rates rise a little, it will not affect progress. Grafton also rose 2.1% the second best riser as it consolidates at around 750p.

Moves Last Week

The prospect of a rise in interest rates had little impact last week. The sector was down slightly, less than the market which fell 0.7%. The housebuilders remain up 17% YTD, versus the market 5.3% higher. M&A activity has helped the Services stocks rise 11% YTD as well as continued FX tailwinds. The Construction and Building stocks are up 4% YTD, slightly less than the market.

The best performer last week was Capita following its reassuring update, it was up 20%. That level may not be sustained in the short term but longer term the earnings point to further gains being possible. The need for more equity seems to be fading. But the technology advances in back office processing are something with which the new CEO will need to get to solve. That is the key issue, in our view. Mitie, up 17.3% over the week’s trading might also see some retracement though longer term picture is positive and, in our view it has more opportunities than threats, the reverse of Capita’s position.

G4S saw the largest loss over the week, down just 4.9% and still up 37% YTD. The move was just ebb and flow of trade, in our view. The Merchants all slipped backwards last week, in 2-3%, which may be indicative of some nerves about possible interest rate rises.  But as previously shown there were some gains on Friday in the sub-sector.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
16 June 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 16th June 2017

There is no directly relevant news this morning. Here is a lot of comment in the press on the prospect of a rate rise and it’s not the role of this note to predict interest rates or the political and economic issues behind rate setting. What is 100% clear is that 3%+ inflation and base rates at 0.25% is not a sustainable norm in any economy.

There is no directly relevant news this morning. The key driver of the sector in the coming months will be macro issues, in our view. Uncertainty will be the most frequently used word in trading releases from UK biased companies in coming months. The voting split in the MPC interest rate decision yesterday is clearly not good for the sector, especially the housebuilders. There is a lot of comment in the press on the prospect of a rate rise and it’s not the role of this note to predict interest rates or the political and economic issues behind rate setting. What is 100% clear is that 3%+ inflation and base rates at 0.25% is not a sustainable norm in any economy.

The moves yesterday were nearly all downwards, only Mitie was in positive territory, up 0.6% to 285.5p. The main losers were the merchants with Travis Perkins down 4.8% to 1511p and Grafton down 3.7% to 734p. SIG also fell, down 3.4% after a strong recent run and despite around half of its operations being in Euroland. The operational gearing in that sub-sector always makes the shares react swiftly to the possibility that demand might be vulnerable. Travis Perkins has 113p of EPS expected this year so arguably the shares at 13.4x p/e are fairly priced, especially if 2018 growth looks to be under greater doubt now than it was a few days ago. The market forecast for 2018 EPS is 118p. The new housebuilders see no lack of demand but new build techniques and changing patterns of materials distribution are developing. Travis Perkins has been fully aware of these issues but that does not mean it can always adapt its business model swiftly or cheaply. In the retail area, Wickes, faces the challenges of B&Q and Homebase, where the new owners, Bunnings, are making improvements that might increase the competitive environment. So it is getting tougher generally for the Merchants and the TPK strategy of exploiting its strong market position is facing some tough hurdles at present.

Many thanks to those who have already donated to the Royal Marsden, the chosen charity for my golf day, which is today. Many of you have been very generous. The link is below for those who are still hesitating!  https://www.justgiving.com/fundraising/CoombeWoodGolfCharity

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
15 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 15th June 2017

Atkins has produced its final results this morning and abandoned the usual meeting in favour of a webcast. While the overall results are very positive the geographic split shows an exaggerated development of the trends seen for the last five years. Balfour Beatty has quietly risen in the last few days and we suspect will provide encouraging results at the interim stage.

Atkins has produced its final results this morning and abandoned the usual meeting in favour of a webcast. The recommended offer from SNC Lavalin is proceeding so the usual event is probably unnecessary. The numbers show why SNC Lavalin is interested. Revenue rose to £2.1bn from £1.9bn in the year to and March 2017, boosted by organic growth, FX and acquisitions; revenue grew by 4.3% at CER. Underlying operating profit was up 16% to £172m providing an operating margin of 8.2%, versus 8.0% in the prior year. Average staff numbers remained static. Net debt fell from £192m (post the PT&T acquisition) to a net cash position at the year-end of £6.1m. The pension deficit fell slightly to £259m from £286m following the latest triennial review as the longevity assumptions were changed (reducing life expectancy) and the rate of increase in salaries of scheme members were reduced. There are other moving parts as well but the outcome is the continuation of the c £35m pa shortfall recovery plan. We have looked at the pension issue for read across.

While the overall results are very positive the geographic split shows an exaggerated development of the trends seen for the last five years. The UK and the North American operations performed very well, Asia Pacific was OK but dull and the Middle East in poor shape. The UK operations saw revenue fall by 3% to £911m but operating profit rose 23% to £90m as cost efficiencies kicked in; revenue fell due mainly to reduced rail signalling work. In the North America operations revenue rose 33% to £481m and operating profit increased by 64% to £34m; revenue rose by 14% at CER.  The Middle East was in line with expectations but a 7% fall in revenue to £232m and a 26% fall in operating profit to £22m; this out-turn has interesting read across to other and explains the reduced level of interest from contractors. Atkins also points to cash collection issues which have been a constant theme. The Asia Pac operation saw revenue rise by 11% to £118m and operating profit rose by 9% to £9m; project delays affected the performance. The Energy division speedboat saw revenue rise by 62% due mainly to the PT&T acquisition which chipped in with revenue of £143m implying that the performance elsewhere was down, but we are told has now stabilised with a good 2H. So overall Atkins with the read across to others shows some interesting patterns that are not a surprise but emphasise findings of others.

The main moves yesterday saw Capita rise further 3% to 653p; we believe that a strong move in CPI is premature but on a 2/3 year view there is no reason why, given the underlying business potential the price cannot get back towards 1000p. The real issues are the appointment of the new top team and the extent to which the company can adapt to new technology that will transform back office operations. Balfour Beatty has quietly risen in the last few days and we suspect will provide encouraging results at the interim stage. It increased 2.7% yesterday to close at 286p; it is still cheap at this level on a 2/3 year view given the PPP/PFI portfolio. Compare the price of BBY with the Infra Cos’ the latter have risen substantially in recent months but BBY has not. The implication therefore is that BBY’s contracting operations are less valuable which is not the case; they have improved as has the net debt/cash position. The Infrastructure investments in BBY will remain undervalued as long as they are not separately quoted.

The main loser yesterday were few and bottom of the pile was Berendsen, down 1.3% to 1194p which will be affected by FX (as part of the Elis consideration is in € denominated shares) and there is still some execution risk. The other fallers were down just on ebb and flow of trading.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
14 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 14th June 2017

Severfield, Norcros and Bellway attract attention this morning with releases to the market. The moves yesterday saw Capita storm ahead with a 15.2% increase to 634p as the trading update restored investor confidence and the previous valuation was too low by some distance if the business is stable.

Severfield, Norcros and Bellway attract attention this morning with releases to the market. Severfield’s continued progress is shown today with revenue up 10% in the year to end March 2017 to £262m and underlying PBT up 50% to £19.8m. The company describes the year just ended as excellent and the numbers indicate the management may be right. The fact that the Indian JV kicked in with a £0.2m operating profit share, compared with a £0.3m loss last year says it was very good. The key was some large projects such as Number One court at Wimbledon, Spurs new ground and 22 Bishopsgate and of course completing Anfield. Cash conversion was 112% which aided year end net cash to reach £32.6m. Quite rightly the dividend is doubled to 2.3p a share with the final pay out at 1.6p a share. The question today will be whether the progress can continue and the company indicates that it can. The order book is lower but said to be at a more normal level of £229m in the UK, compared with £315m in November last year and at £73m in India. There seems to be no shortage of projects on which to bid. The company continues to make operational improvements which should help to sustain margins. So at Severfield the scene is set for EPS of 6.0p this year after achieving 5.5p in 16/17. The shares closed last night at 84p.

Norcros seems to have performed well in 16/17 though margins fell a little operating cash flow was very positive and net debt was reduced. Revenue rose by 11% at CER in the year and 15% at the reported level. Underlying operating profit was up 12% at AER. Net debt was down to 23m from £33m last year. Revenue and earnings were boosted by acquisitions which distorts the picture, L4L sales were up 8.8% in 2H 16/17 in the UK compared with a 5% reduction in 1H. The company points to the Referendum affecting sales in the first half last year as the key reason. Norcros refers to its markets as challenging and difficult but they do not seem to be more so than in other years or for other companies; selling is never easy, especially via retail style outlets! UK retail buyers are probably some of the best on Planet Earth. So the read across is positive.

Bellway had a trading update today for the period from 1st Feb to 4th June. The company reports that demand has remained strong evidenced by a 13% rise in reservations in the period and the order book higher at £900m compared with £846m last year. Looking through the statement there is a good pricing environment at present, despite some concerns in the press. The company has continued to add to its landbank so no signs of flinching in the growth objectives at Bellway! The company reports no impact from the General Election but perhaps having had a major election in each of the last four years the public is not accustomed to them and the outcome being that not much changes. The new build segment is really the only substantial source of stock available to the homebuyers so aside from some developments in London the climate remains positive.

The moves yesterday saw Capita storm ahead with a 15.2% increase to 634p as the trading update restored investor confidence and the previous valuation was too low by some distance if the business is stable. The disposals will reduce earnings but create a more cohesive business in the future and a credible balance sheet. We suspect there is still a long way for the price to go. There were few losers yesterday with Berendsen falling a tad to 1212p as the worst faller.

The large rises in Mitie and Capita in the last two trading sessions beg the question whether there is a third we should be looking for. The two main candidates are Interserve and Carillion of course as both have low valuations and difficult balance sheets. The potential is present and for choice we think that CLLN might move first if it can show its balance sheet issues can be resolved. There is confidence that it is trading well in most parts of the operations. Interserve has yet to see officially its new CEO. No doubt there is work behind the scenes. But the problems in construction and energy from waste are difficult to bottom out, especially as outsiders. The new CEO will see it differently of course, otherwise why take the job but some new money from investors seems a likely outcome.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

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.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
12 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 12th June 2017

Mitie’s numbers for 2016 were released this morning and as expected they make grim reading but no grimmer than expected. The election result was the main driving force in the sector and, as we know, will remain so. For the remainder of the year the issues are clear; it depends on what you think will happen with Brexit.

Mitie’s numbers for 2016 were released this morning and as expected they make grim reading but no grimmer than expected. The company will tell us about the new “connected workplace” strategy later this morning. There are no guarantees there are no more accounting issues to come but KPMG’s Accounting Review seems to have been thorough. Revenue last year was up 0.3% to £2.1bn and adjusted operating profit was £82m. The statutory operating loss was £43m. Year-end net debt has fallen to £147 from £178m but no final dividend is to be paid; the covenants have been rearranged given the net debt/earnings ratio. The statement plays down future opportunities simply indicating that it seeks transformation and, much improved use of technology as a strategic weapon to create a higher growth/higher margin business. The ambition side of the goal is played down but the determination is there. The investment proposition is very clear; the company does FM in the UK and will improve its position through the use of technology and be much more careful about cost control, stating that a £45m programme to reduce/transform cost is underway. Understanding progress to date on cost reduction will be a key question this morning.

The cost of restructure has been high for Mitie holders but what is emerging, quite swiftly, is a well-managed operation that is presenting a sensible platform for customers and investors. We shall be interested to see this morning what the applications of technology might be but what is key is getting right (and reporting right) what exists within the business. Our contention has been that Mitie, under Ruby, was not a bad business, it was just not as good as the numbers made it appear. The data released today, showing an underlying margin of 3.8% tends to bear out what we have been saying. The fact that it has retained its revenue at a low but still positive margin indicates it is doing some sensible things for customers. Some of the work it does is relatively low value/low skill but that may alter over time.

Setting aside the detail if Mitie has £2bn revenue, 4-5% operating margins and reducing debt it should be capable of 16-20p of EPS, depending on interest costs so at 242p it may be fully valued but with some growth in revenue and margin the price does not look too out of line with peers. The company is promising some progress in earnings this year as the impact of cost reduction improves the bottom line. Mitie’s approach is good news for the FM sector as well as it will behave as a sensible competitor. There is not much in the release about contacts and customers but that can follow; the main job was to get its own house in order and show that beneath the surface a good operations exists and it seems to have done that today.

Elis and Berendsen have announced that an agreement has been reached for Elis to acquire Berendsen at 1261p (including dividend) comprising 540p in cash and 0.403 new Elis share for every Berendsen share. Looks like the show is over as a quoted entity for Berendsen.

The other notable announcement today is the intended IPO of Residential Secure Income Reit, a £300m IPO of another company offering housing as the core investment of an income stock. This adds to our observation made on Friday last about the size and scale of funds going into housing due to limited income stocks, need for housing in the UK and the reduced attractions for individuals of Buy to Let.

The election result was the main driving force in the sector and, as we know, will remain so. The leaders on Friday were Compass, up 1.0% and Rentokil up 0.7%, given the importance of overseas earnings to both companies that make sense. Only six stocks rose in our universe of 22. The losers were Travis Perkins, down 2.9%, Babcock, down 2.9% and Grafton, down 2.2%; clearly concerns about UK MoD contracts and spend on housebuilding had an adverse impact. The odd outcome, in stock market terms, is that the reaction was quite mild, so maybe some concerns are priced in already and/or the impact of the 2017 election outcome has yet to sink in. An alternative view is, of course, that the outcome might be a much softer approach to the EU exit, possibly ending with no exit at all. The weekend press was full of Mayhem’s “woulda, coulda shoulda” and its consequences and will be for some time. We can take no view on that but the prolonged uncertainty, as we all know, are unhelpful but create opportunity.

Moves last week

The sector was a slightly weaker performer than the market, which fell 0.4%, despite Friday’s rally. The sector’s performance varied, however, as previously discussed overseas earnings got a tick on the box, so G4S and Rentokil did well but UK earnings got a black mark, especially the housebuilders down 1.3%, though still 17% higher YTD.

For the remainder of the year the issues are clear; it depends on what you think will happen with Brexit. It not appropriate to discuss Brexit here but the consequences. But it is clear that London has already suffered some damage, in terms of global companies reassessing their need to be so heavily weighted in London and decisions on investment are being delayed. The leads and lags in economics are often deceptive and never regular but surveys of intentions, the UK slipping in the EU league table for Foreign Direct Investment and London house price moves are all telling us things we need to hear.

Berendsen led the table last week in terms of weekly movers, up 9.6% as Elis raised its proposed offer to 1261p (including dividend) and the BRSN board is inclined to recommend. The strong language used to reject 1180p suggested the BRSN board had much higher number in mind so accepting 1261p looks a tad tame. But no doubt soundings with shareholders allowed new information into the board discussion!

Only five stocks in our universe of 22 last week which is also a signal that the HICS shares are under pressure. The other risers were Morgan Sindall, up 3.3% after a positive CMD, Mitie up 2.2%, G4S up 2.8% and Rentokil up 3.9%. FX will also have aided some of these stocks but WOS and Compass were fallers, so it’s universal.

The largest loser was Capita, down 9.7% as hopes for more new public sector in the next six months fade a little. CPI has problems of its own of course! Babcock was down 5.8% for similar market reasons. Perhaps the market is forgetting that extensions to existing contracts can often be very lucrative and that delay in replacements on existing essential work are sometimes no bad thing at all!

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
9 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 9th June 2017

What do we make of that? There is no company news today as you may have expected. In the absence of news we mention below two fundamental changes taking place in the sector, Partnership Housing and Modern Methods of Construction on which we have done much work recently. Get in touch if you want to hear more. The recent positive news from quoted entities about prospects in Partnership Housing begs the question of who might pay to have the properties built and how. The Modular/MMC (Modern Methods of Construction) market looks right and the news that Berkeley is looking at a site for a 2,000 unit pa modular factory at Northfleet is a big move.

What do we make of that? There is no company news today as you may have expected. The election outcome will of course delay projects and raise uncertainty. Not ideal for the large scale projects and long term contracts on which sector stocks depends. In the absence of news we mention below two fundamental changes taking place in the sector, Partnership Housing and Modern Methods of Construction on which we have done much work recently. Get in touch if you want to hear more.

Before we do that thank you very much to the many readers who have given to the Royal Marsden Cancer Fund via https://www.justgiving.com/fundraising/CoombeWoodGolfCharity and I am looking forward to seeing many of you next Friday at the Golf Day at Coombe Wood. If you have not sent a few bob yet please see if you can.

The recent positive news from quoted entities about prospects in Partnership Housing begs the question of who might pay to have the properties built and how. The Housing Associations themselves can do some of that from resources and HCA grants of course but borrowing is clearly the main source of funds. There seems to be no shortage of support. Scottish Housing Association Wheatley has just done a deal to get £100m from Blackrock for new developments (adding to the £300m bond raised in late 2014)  and 13 Housing Associations are expected soon to create a £750m bond to fund expansion. Pennaf, the third largest Housing Association in Wales has just completed a £250m bond raising. PRS Reit raised £250m recently to build new stock. Civitas is buying up existing stock with its £350m of new equity but of course that is releasing cash to owners to build new stock. The claims of Kier, Morgan Sindall and others that they see a very positive picture have a strong basis.

The Modular/MMC (Modern Methods of Construction) market looks right and the news that Berkeley is looking at a site for a 2,000 unit pa modular factory at Northfleet is a big move. There are many factors aligning that say MMC is going to be different this time. The grey beards remain sceptical. Of course but government support, changing patterns of buying and renting, existing extensive use of components and sub-assemblies and skills gaps point to more MMC and modular. The UK may have capacity for 30,000 off-site dwellings a year by end 2017 with more investment in the pipeline. That has substantial implications for materials, supply chains and many other aspects of the way we build dwellings. The expansion of Partnership Housing reinforces the increased use of MMC. The topic is quite complex but the trend is very clear.

The moves yesterday were in the same narrow band as recent days. Berendsen predictably headed the risers with an 11.2% increase as the proposed offer from Elis hit 1261p. That is likely to be recommended, so farewell Berendsen and Atkins quite soon. The next highest riser was Morgan Sindall following its CMD on Tuesday; it rose 2.8% to hit 1285p with 101,278 shares traded. The message is getting through for MGNS and we expect targets to be 1800p by the year end. SIG was the largest loser, down 1.3% to 147.8p but of course it went XD yesterday with 1.8p of final dividend so a 2.6p decline has some mitigation. There is no obvious catalyst for the current “deadlock” to alter. Over the coming months it seems likely that the word “uncertainty” will feature more in company statements than it has in the last 12 months and that is unhelpful for bulls but not necessarily strong enough for bears.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
8 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 8th June 2017

The proposed offer by Elis for Berendsen has been increased to the equivalent of 1250p (plus 11p of dividend), from 1180p and at 6.35pm yesterday it was announced that it is now recommended by the acquiree’s board. Two macro pieces of news are worth considering. The Halifax Building Society yesterday indicated that house prices are growing at the slowest rate for four years at 3.3%, which is believable and consistent with other monitors of house prices. The OECD stated the UK needs to take steps to counteract the adverse impact of Brexit and slowing real growth in real household incomes; the recommended steps included more borrowing.

The proposed offer by Elis for Berendsen has been increased to the equivalent of 1250p (plus 11p of dividend), from 1180p and at 6.35pm yesterday it was announced that it is now recommended by the acquiree’s board. It’s hard to see how a new bid could emerge at that level as there are few if any other parties who can apply the same synergies as Elis to a combination with Berendsen. The proposed offer is a combination of 540p in cash and the remainder in Elis shares. There may be some frustration at Berendsen that a bid in excess of the share price peak of 1337p, reached in mid-2016, is not on the table but since that time two substantial profit warnings have exposed the company. At least the new offer is ahead of the 1200p level the price was at the day the appointment of current CEO James Drummond was announced; little things like that mean a lot! Our sense is that Berendsen holders will take a sanguine view based on the new proposal being well ahead of the undisturbed price of 864p and recycle the cash; if it is reapplied to the sector G4S, Rentokil and Compass are the natural “homes” with similar risk/reward to Berendsen. Mitie, though it has different geographic exposure to the others may also benefit from the recycling and maybe all four stocks have had a boost already.

There is little other news on Election Day 2017. Mears AGM yesterday occurred without a trading update release, just two replacement NEDs were appointed and Compass had a general meeting at which the £1bn special dividend was approved with a 99.99% vote!

Two macro pieces of news are worth considering. The Halifax Building Society yesterday indicated that house prices are growing at the slowest rate for four years at 3.3%, which is believable and consistent with other monitors of house prices. Tthe OECD stated the UK needs to take steps to counteract the adverse impact of Brexit and slowing real growth in real household incomes; the recommended steps included more borrowing. The disjoint between the macro data and the cautious optimism in company statements about market demand is becoming a tad more obvious. The only real concerns we hear about from companies those of are estate agents who have few second hand dwellings to sell and some sectors that fear a shortage of cheap low skilled labour. We are heading for a slower growth according to the macro data but it’s too early to know how deep that will go. It is also not clear yet whether it is cyclical or the early stages of a structural change triggered by the politician’s determination to exit the EU.

For several days now we have been saying that the sector is stuck in election doldrums and that remained the case yesterday. Travis Perkins was the best riser, up 1.5% to 158p and Capita was the worst performer, down 2.1% to 541p. Such moves are arguably in the ebb and flow of trading on the day. But it also has to be said that in Capita’s case the just is still out and the lack of consistent support indicates that the absence of a new CEO and concerns about an equity fund raise and, in the age of robotic automation of back offices, what Capita’s offer might be in the future. With near 60p of EPS due this year Capita looks cheap, unless the issues are much deeper than even we fear.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
7 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 7th June 2017

Galliford Try, Workspace and St Modwen have news this morning. Yesterday we attended Morgan Sindall’s Capital Markets Day. The upwards moves yesterday were unconvincing, befitting the uncertainty we know exists

Galliford Try, Workspace and St Modwen have news this morning. GFRD has replaced a NED with former Serco FD Andrew Jenner leaving and Jeremy Townsend, FD at Rentokil, taking his place from 1st September. Workspace released its final results today and St Modwen has a trading update to accompany a CMD. We have looked at the releases of both companies largely for read across. Both state similar sentiments around demand being good despite present uncertainties. St Modwen has issued new targets that include growing its commercial activities and its residential and housebuilding operations. So no evidence of any real slowdown though market comments signal caution

Yesterday we attended Morgan Sindall’s Capital Markets Day. The company has been saying for some 12 months now that things are looking up and it continued with that theme yesterday, adding that it now has real momentum. The topic yesterday was the Regeneration side of the company which comprises Partnership Housing and Urban Regeneration. We had presentations followed by a visit to Woolwich to see a live site. The core financial message is that the £190m of capital employed in the operations is targeted to expand to £400m (£250m Partnership housing/£150m Urban regeneration) and the rate of return should rise from 13-14% blended at present to 20% or more in the mid term. The precise split of capital allocation between the two will depend on the projects as they roll forward, existing and new. This will provide the main earnings growth engine for the group as in Construction and Infrastructure the objective is to raise margins and in Fit-Out the view is that both revenue and margin are good now can be sustained. The increased capital allocation and level of return will be boosted by customers and land sellers moving to staged payments profiles thereby boosting the return for MGNS

The site at Woolwich was impressive. We saw a 120 dwelling unit for private sale and examined that and observed a 120 dwelling social init that is in construction. The 1 and 2 bed units for private sale are findng no shortage of demand at 500-550 per sq ft. The location is close to Woolwich station which has good links and is on Crossrail. The site has poor lorry access but that is solved by having intermediate logistics points. From our questions there have been few issues in getting labour and at one stage there were 450 operatives on site. The key issue to date has been supply of heavy materials, bricks and blocks the UK capacity for which is near full stretch and in the case of lightweight blocks there are raw material issues. Good news for Forterra and Ibstock!

We have been banging the drum hard about the good things happening at MGNS for over a year. There will be increasing evidence of success in our view. The net cash position at present, the level of demand and the low risk approaches to contracts point to sustainability. It does build things so there will be good and bad projects but the four legacy projects that caused the warnings some five years ago are now long since settled. Risk is managed very differently today. So with earnings heading for 160p a share by 2020, in our view, MGNS is still in growth mode at 1251p. Realistically, over the next year, targets might start to hit 1800p, depending on the rate of progress.

The upwards moves yesterday were unconvincing; befitting the uncertainty we know exists. Serco and Mitie were joint leaders both rising 0.99% the former to 117.44 and the latter to 244.4p. Clearly companies providing services on long term contracts should be in greater demand in uncertain times and that is holding true. Mitie report sit 2016/17 numbers Monday next and provides a brief on the Bentley Strategy for the business. We have had some glimpses already with mentions of the “Connected Workspace” as a competitive approach but this time we expect some performance targets as well.

The downwards moves were more decisive with Capita falling 5.6% to 544p giving back recent gains and companies with a construction bias falling sharply, Carillion was down 4.5% to close below 200p at 192p, its lowest close since March 2004; Balfour Beatty was down 3.0% to 269p, Kier down 2.5% to 1183p and Galliford Try down 2.4% to 1160p. There is very limited support for these stocks at present as the promises of an infrastructure boom fade and in some cases Middle East exposure, especially Qatar, weighs on expected earnings forecasts. In the construction company examples valuations are low and seem to ignore reliable earnings streams from other activities. We suspect though that investors will wait until the election outcome is known as the risk is binary at present and there is no need to rush. Valuations are so low there will be time to get on board if the UK infrastructure boom happens.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
6 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 6th June 2017

VP plc, WYG, Countrywide and Fulcrum Utility Services grab the headlines in the HICS sector this morning. There were few upwards moves in the HICS universe yesterday. The downwards moves were more numerous but they were small indicating the ebb and flow of trading rather than big changes.

VP plc, WYG, Countrywide and Fulcrum Utility Services grab the headlines in the HICS sector this morning. VP has reported a 19% rise in revenue in the year to end March 2017 (achieving £249m of sales) and a 20% rise in EBITDA to £71.2m. The growth is based partly on acquisitions but also the company reports strong organic revenue growth, amount unspecified though we are told that fleet investment in the year was £58m versus £46m in the prior year. The other key metrics in the business are in line of better than expectations and none provide any cause for real concern. The company has continued to acquire post year end with two more deals. It reports that trading conditions last year were variable but generally favourable which has good read across to Speedy and others. VP has always had a bias towards hiring the more specialised end of equipment and the second of its acquisitions this year, Zenith Surveying Equipment shows that. The foundation of growth last year was the UK performance which showed a 14% rise in revenue to £220m and a 17% rise in underlying operating profit to £36m. Trading YTD in the current year is said to be positive which provides good read across for Ashtead’s UK operations and Speedy. HSS Hire is in a different situation at present and will be for a while until the new CEO finds his feet.

WYG reports a good performance last year and a new CEO. On the second issue Paul Hamer, who led the recovery of the operations will leave to take the role of CEO at Sir Robert McAlpine and Douglas McCormick, ex Atkins and Sweett will take over at WYG very soon. Despite the hiatus of Brexit in his last full year as CEO Paul was able to deliver a 14% rise in revenue to £152m and a 22% rise in adjusted operating profit to £8.8m. Clearly there was some help from FX but as with VP the UK performance was strong with revenue up 12% to £108m. Indeed the FX help came in the form of mitigating some of the 15% reduction in revenue from the Europe, Asia and Africa operations in which the Polish business suffered a particularly weak year, as indicated in earlier statements from the company. The year seems to have started well for WYG though it does point out that the election has delayed some project awards, which is normal but there have been a lot of elections! The share price has been hit badly by newsflow at it closed at 100p last night while adjusted EPS for last year were 11.9p. The valuation is therefore extraordinarily low especially given the promise of further growth this year. Strategically the business has focussed more on its UK revenues in the last 12 months and we suspect that process will continue under the new CEO, a veteran of UK consulting and a man with a very valuable customer network that should be very useful. Some investors may also look to his actions at Sweett and see read across at a corporate as well as operational level.

Himanshu Raja takes over the role of FD at Countrywide. He oversaw the first three years of the transformation of G4S as FD there so has a great deal to offer troubled Countrywide, at least in terms of its share price. From peak of near 700p in March 2014 the stock closed last night at 150p. Conditions in its markets have been difficult but there were some own goals along the way as well. This is a good appointment as it provides a steady and experienced FD who can support the industry experts in the business.

Finally this morning’s news includes Fulcrum which is remarkable turnaround story. There’s also a change of CEO as Martin Donnachie leaves soon to be replaced by the current FD Martin Harrison and the new FD will be Ian Foster. The numbers for last year are in line with revenue up 4.4% to £38m and underlying EBITDA up by 38% to £7.3m. The company ended the year with £12.6m in net cash. The dividend is more than doubled for the full year to 1.9p from 0.9p last year. The prospects are bright from what we can see with the order book up by 39% since March last year to £30m, the accreditation to adopt, run and maintain all classes of metering devices has been obtained and there are further operational efficiencies to be achieved. The business is a hybrid with its main operations being the installation and maintenance of utility services but it also owns and maintains gas pipelines and is now moving into the metering business. It therefore has good prospects ahead. The shares closed at 59p last night so with 4.1p of underlying EPS last year the valuation is not low but the asset ownership and the net cash position (market cap is £100m) go some way to explaining the valuation, along with strong growth prospects.

There were few upwards moves in the HICS universe yesterday. The downwards moves were more numerous but they were small indicating the ebb and flow of trading rather than big changes. Galliford Try was the largest faller, down 2.8% to 1186p as it is struggling to find solid support at present. Carillion, Kier and Balfour Beatty (all down by more than 1.5%) were the other main fallers as clearly the market is getting slightly more nervous about the prospects for construction. The infrastructure demand prospects are broadly unchanged but fears about rate rises, commercial developments in London and skills gaps post Brexit are current themes that may make life tougher and have a negative impact on future earnings. We cannot argue those issues are not real ones but we also know that mitigating actions are well underway in terms of costs, bid and project management and the use of off-site construction methods.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
5 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 5th June 2017

Telford Homes provides the news today with an announcement that it has signed a development agreement with US build to rent specialist Greystar to deliver 894 new homes on two sites at Nine Elms. There is some new news planned for this week with Fulcrum Utility Services having finals on Tuesday and Morgan Sindall has a site visit. On Wednesday Mears has its AGM and Halifax Building Society is due to release its monthly price index; St Modwen is also due to make an update on election day and on Friday there is no planned news.

Telford Homes provides the news today with an announcement that it has signed a development agreement with US build to rent specialist Greystar to deliver 894 new homes on two sites at Nine Elms. The land has been acquired from the Royal Mail by Greystar. For Telford the deal has substantial advantages not the least of which being staged payments such that its own working capital input is limited and it is taking no sales or rental risk. Our sense is that completion is a long way off as the project is still in development and there is still a great deal of unsold property in that area at present and many dwellings near completion now, which will tell us something about the likely success of the area. The other significant element is that Telford tell us that the operating margins on the project will be typical of its target for build to rent; we believe that is usually in the 5-8% range which given that it has construction risk only is relatively high. Several companies have pushed hard to get work in building homes for rent (whether for PRS, Housing Associations or Local Authorities) as the margins are currently attractive (Kier, Galliford Try, Morgan Sindall). 

There is some new news planned for this week with Fulcrum Utility Services having finals on Tuesday and Morgan Sindall has a site visit. On Wednesday Mears has its AGM and Halifax Building Society is due to release its monthly price index; St Modwen is also due to make an update on election day and on Friday there is no planned news.

On Friday last there was little movement among sector stocks. In our universe Homeserve rose 1.3% to 756p and was the best riser and the worse faller was Grafton, down just 2.1% to 778p following a good run in recent months. The winners and losers were equally balanced in our 22 stocks and the sector indices finished level. Investors are sitting on their hands it would seem despite concerns about the economic situation. The data is mixed though clearly growth is slowing and in construction skills shortages seem likely to worsen. Arguably demand remains positive and order books are full so companies remain positive and why not!

Moves last week

The FTSE100 index closed Friday last week on exactly the same number as a week earlier. In the sector there was limited movement with a slight bias to a small increase. The housebuilders fell slightly and seem resilient at present to news of monthly dips in prices and slowing annual rates of price rises. Shortage of stock on the market, save in some parts of London is sustaining optimism.

The best riser last week was Capita, up 3.9% to 591p. Optically the stock remains cheap given the market forecast of 55-60p of EPS this year and a return to growth in 2018. But as long as the CEO role remains uncertain the price will be restrained. There seems to be a growing consensus that an equity fundraising will not be needed though we should not rule out further accounting adjustments, many of which will be non-cash.

The two main losers last week were down for very different reasons. Interserve fell by 3.1% to 224p as it struggles to get any support and it has had an interim CEO for too long. In our view that situation has been an unreasonable environment in which to operate for all concerned (customers, the departing CEO and staff) and has made it even more difficult that it might have been for new CEO Debbie White, when she starts in September. MGNS fell by 3.3% and was the largest loser after its very strong run post the results; despite the dip last week it is up 64% YTD so some adjustment is to be expected. The base case is that EPS might reached the 150-160p level by 2020, possibly earlier and at 1233p at close the stock is not overly expensive. The fact that the value in the business went undetected for so long suggests the company needs to broadcast the story a bit harder as it is unchanged since the middle of last year. As with any stocks were there is limited volumes in the MiFiDII environment they will struggle to get “air time” and that seems to have happened to MGNS even prior to the forthcoming changes in the way research is paid for (or not!).

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
2 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 2nd June 2017

Half term, election next week and the sun is shining so little surprise there is limited new news. On house prices the City has gone quiet on the risks facing the sector. Regular readers will be aware that we have been a fan of SIG and this morning LXi Reit plc has announced that it has paid £9.3m to buy a 250,000 sq ft/15 acre facility near Carlisle used to cladding and components and sub-assemblies by the Distributor.

Half term, election next week and the sun is shining so little surprise there is limited new news. Today we hear that UK house prices fell 0.2% between April and May and are now up just 2.1% nationally on an annual basis, according to Nationwide. SIG has done a sale and leaseback on its cladding factory in Cumbria worth £9.3m and WYG has announced new work that the company estimates will be worth £50m over the next three years.

On house prices the City has gone quiet on the risks facing the sector. Share prices are up near 20% on average in the sector YTD. Fears of lower house price growth, perhaps even declines have been allayed by the housing shortage and the stress tests now applied to mortgage lending under MMR. The average house price in England and Wales is now 7.6x UK average earning according to the ONS, with the median price up 259% between 1997 and 2016 and average earnings up 68%. It could be that the optimists are ignoring the potential impact of lower immigration. The data on the lack of housing is real and lower prices do not necessarily translate into lower volumes. But clearly the housebuilders are faced with undeniable pressures now from slower price growth and higher labour and material costs. For some this news from Nationwide may signal the start of a dip in house values as it has a familiarity to it. As Twain said, “history may not repeat but it sure does rhyme” and we have been in a situation of political uncertainty (which the election may not cure) and high average price to income situations before. The arguments are too complex for a morning note so let’s just leave it that there are signs showing that house price growth has stalled and the issue is whether that causes buyers to hold off, because if they do in expectation prices will be lower tomorrow the prophecy might be self-fulfilling. The counter arguments around the shortage of stock and the encouragement to demand provided by government have been robust enough so far.

Regular readers will be aware that we have been a fan of SIG and this morning LXi Reit plc has announced that it has paid £9.3m to buy a 250,000 sq ft/15 acre facility near Carlisle used to cladding and components and sub-assemblies by the Distributor. The initial yield is 7% and the term of the lease is 25 years with no break clause. SIG has made no announcement today, perhaps because in the scheme of things this is not that material. We believe it is another step forward for SIG in terms of reducing its net debt, a key priority and clearing out things it does not need to do, such as own freehold property. The terms of the leaseback seem to be generous alongside other deals but that would be nit picking. We are not aware of the market conditions in Carlisle for large, single use production facilities so it’s not clear what level of competition was created for this asset. What we do know is that it is the right way forward for SIG and releases capital to reduce debt and in due course earn 15-20% ROCE for SIG shareholders and that has to be progress. We see few reasons stopping SIG moving swiftly towards 15-17p of EPS if it gets the right relationships with its suppliers and that means target prices for the shares of 200p from the larger brokers, in our view. The shares closed last night at 154p.

WYG’ s share price has had a tough time since the referendum as a meaningful part of its work arises from EU funds and from the much criticised DiFiD in the UK. The arguments that it will continue to operate its EU dependent operations from within the EU has held limited sway with investors and the price has hovered around 100p recently versus a close of 135p on 22nd June 2016. The shares climbed back from post referendum lows but the warning of project delays in late March saw the price slide back to the 100p area. The new contracts announced today from the MoD (£12m over three years), Crown Commissioning Services (£3m pa/two years) and in South Africa with the Climate Resilient Infrastructure Facility (£2.5m pa/two years) are signs that good progress is being made. So up one ladder again and hopefully for investors there is not another snake ahead! Our sense is that the company will get through the short term issues ahead. There were many ways to get around any issues it faced in winning EU funded work and in many ways it was resilient as one of the few providers of the type of work that it does in economic and social development in disadvantaged areas. With EPS of 11.5p expected in the year to March 2017 (not yet reported) and 13.5p for the current year WYG looks cheap at 101p.

Grafton was the clear leader yesterday; up 2.5% to 796p as it moves slowly back to over 800p. Good news on Euroland economic recovery will help the business and in the UK demand remains resilient so its approaches to sales and marketing should be paying off. Carillion had a positive day rising 2.4% to 208.3p; we have been patient with the stock and remain positive as we believe it can trade through its balance sheet issues. The interims are due in mid-August and while new FD Zafar Khan has had little time we may see a new approach to handling its twin problems of high net debt and a high pension deficit. The commitment to lower debt was made at the full year results announcement in March. The half year is not the best time to judge progress but no doubt indications of the 2017 year end position will be provided and we expect them to show expectations of substantially lower net debt.

Serco was the back market, down 0.8% to 117.8p. We read little into the move as it’s small and follows a period of share price strength after which a small amount of retrace is quite normal. Polypipe was the next weakest performer, down 0.8% to 414p for similar reasons. These moves have no real new information to offer about two well run businesses operating in good markets.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
1 June 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 1st June 2017

Student accommodation developer and contractor Watkin Jones (WJ) reported its first half numbers to end March 2017 this morning. Capita is creeping slowly upwards and crept faster than anyone else yesterday, 2.8% to 583p. At the other end of the table Interserve crept down a further 2% to 224p and was the largest faller.

Student accommodation developer and contractor Watkin Jones (WJ) reported its first half numbers to end March 2017 this morning. The company specialises in multi-occupancy dwellings and has a position in the build to rent segment and a small operation in residential development. It has started tentative steps into the student letting and management area, acquiring Fresh Student Living Ltd in early 2016, just before the company floated on AiM in March 2016 at a price of 100p a share and closed last night at a record level of 187p.

The 8% fall in revenue in the period in question at WJ to £134m was distorted by one-off factors in the prior year, timing of sales and £11.7m gained from inventory sales helped generate £146m in the prior year first half. The earnings picture tells a better story with adjusted EBITDA up 27% to £22m and adjusted operating profit up 14% at £19.4m. Net cash fell 24% to £12m which should not be of great concern though the explanation of the fall being due to seasonal factors bears little scrutiny as the same factors were in place last year. Importantly the future pipeline has some credibility with 31 student developments in progress of which 20 are in the next two years and 15 of those are already forward sold. In our view the build to rent expansion might be more significant in the future and six schemes are currently in progress though they are not scheduled to complete until 2019 at the earliest. The net cash position and the pipeline suggest that activity levels will be sustained.

The operating margin at Watkin Jones of 15% begs the questions of why the larger companies in development and contracting are not doing more in multi occupancy, as margins are notably lower in general contracting and, of course, whether the company now being more evident, having floated, the margins might be competed away. On the former, competitor activity, WJ is more involved in the development phases of sites and land so in that sense its margins might be better compared with a housebuilder. On the issue of the levels being more vulnerable to now the competition is more aware of WJ’s work we can only say that it is a real risk. There are barriers to entry in what WJ does that will provide some insulation and the company is expanding into managing the properties it develops. There is no real short or mid-term threat to margins from competition, from what we can tell but longer term there will be.

Capita is creeping slowly upwards and crept faster than anyone else yesterday, 2.8% to 583p. The absence of a new permanent long term CEO is not helping the story as that appointment is crucial (look at rise in SIG since Meinie Oldersma was appointed CEO and showed his face to the City). Buying Capita now in the hope the right CEO is appointed makes little sense on its own, of course. Outgoing CEO Andy Parker is selling some of his shares at present, 55,686 were sold in early May at 571p a share. Having said that there are many good contracts at Capita and the work it does is essential to the operations of many of its customers. The market is warming increasingly to the view that with 60p of EPS this year, disposals nearing completion/balance sheet issues resolved and a 5.4% yield Capita may have a lot of attractions.

At the other end of the table Interserve crept down a further 2% to 224p and was the largest faller. It looks like it is heading back to the lows of the recession in 2011 when it closed at 158p in March 2009. There are some good operations in IRV, not least the Kwikform operation which it failed to sell last year. The potential liabilities on construction contracts might be very substantial and the incoming CEO, Debbie White who joins in September from FM Company Sodexo has here work cut out finding out where the real issues exist and how to solve them. No doubt much preparatory work is being done now but action cannot yet be taken and cash will be draining away, we expect as the position was flattered at end 2016. IRV, as with other restructure/special situations may have some value but it could still be too early to take the risk.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
31 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 31st May 2017

Telford Homes and Styles and Wood, the former a London property developer and the latter a specialist contractor have provided new information this morning. Galliford Try’s analysts’ dinner last night was helpful. The moves yesterday were in a very narrow band with Compass, the leader, up 1.1% to 1661p, a new record level and the largest faller Kier down just 1.2% at 1255p on a large number of trades at 558,596 shares transacted.

Telford Homes and Styles and Wood, the former a London property developer and the latter a specialist contractor have provided new information this morning. Telford’s finals for 2016/17 show revenue up by 19% to £292m and operating profit rose by 8.1% to £37.3m. The reduced operating margin is due to an increased proportion of PRS units in the mix, which are often sold at a lower margin than individual sales to de risk projects and improve capital return. That factor also explains why margins at 12.8% are lower than the industry average. Investors also are aware that the company uses percentage of completion, taking a proportion of the expected revenue and earnings each period on large scale work that is not yet completed. Given the pre-sold nature of many of Telford’s developments that does not overly impact on revenue adjustments but could expose the company to some dangers on costs adjustment, depending on movements in cost and contract terms.

The key aspect of Telford’s news today is that the London market is, in its view, still undersupplied. That leaves scope for Telford to build in the non-prime areas of London and increasingly do so for PRS operators who last year accounted for 77% of sales compared with 24% in the prior year. The target market switched substantially last year away from individual investors to corporates. Owner-occupiers accounted for three percent of sales last year compared with seven in the prior year. The future mix of buyers is likely to alter, depending on the mix of developments. We do not cover Telford in depth so remarks are focussed on market issues. Reading between the lines the sense is that demand has weakened a little in some parts of the market but overall remains robust. The devaluation of sterling has made Telford’s products more attractive to overseas buyers offsetting the negative impact of other factors, such as stamp duty changes. The company is more forthright about the need for Brexit negotiations to provide some certainty on the rights of overseas workers in post EU Britain. In summary, Telford is seeing good market conditions in its niche in London dwelling development but the accent on de-risking by forward selling, while part of the developing model, is also driven in part by market considerations.

Styles and Wood’s AGM update tells us little other than trading is in line and that the order book is strong (up 36% on last year at £137m), reflecting what seems to be good demand in the construction sector. The read across from S&W to Morgan Sindall and others operating in similar services is positive.

Galliford Try’s analysts’ dinner last night was helpful. The share price has yet to recover after the strategy presentation on 21st February were closely followed by two unexpected events, the opportunistic proposed bid for Bovis and the £98m exceptional cost announcement on the Aberdeen ring road and Forth road bridge. The meeting was intended, we suspect, to reassure us that the strategy is still intact and despite the potential cash costs of the two troubled infrastructure projects, the 20% pa growth promised in February is not jeopardised. We never really doubted that was the case, the greater concern being whether there are any more issues to come and whether it might grow faster in some areas to fill any cash gap in the plans. On the former GFRD operates in contracting so it can never say never. But recent work has been won on terms than have a much lower levels of risk, a situation more common across the industry and examination of the other projects shows manageable risk levels, certainly assessed as manageable within current guidance. On the issue of faster growth in some areas it certainly seems possible that Partnership Homes could grow more rapidly than expected, without risk levels rising. The company share the industry view that the top five UK housebuilders are unlikely to raise output volumes substantially from current levels so growth in new build will come from Local Authorities, PRS operators and Housing Associations. Enquiries from these areas and expected future demand point to potential outperformance. Galliford Try is cheap with 163p of underlying EPS expected this year and the price at close last night at 1240p, yielding 7.6%. It will take time to restore reputation and build investor confidence, we believe but the foundation is solid. What is clearer is that the company is less wedded than it was to remaining a hybrid in construction as well as developing and building dwellings.

The moves yesterday were in a very narrow band with Compass, the leader, up 1.1% to 1661p, a new record level and the largest faller Kier down just 1.2% at 1255p on a large number of trades at 558,596 shares transacted. There was not much to read into the moves yesterday. It is half term so there seems to be limited appetite for big news and large market moves, despite the sentiment changes in Whitehall. The economic data, while it has been better, remains robust tough devaluation has not yet really had an impact on output.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
30 May 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 30th May 2017

The only formal item of news this morning is the appointment of John Tonkiss as COO at McCarthy and Stone. Moves on Friday last saw Morgan Sindall soar to greater heights rising 6.2% to 1274p on 159,908 shares traded. The sector performed broadly in line with the market’s 7% rise last week. It therefore remains up around 11% overall versus the market up by 6.5%.

The only formal item of news this morning is the appointment of John Tonkiss as COO at McCarthy and Stone. He joined the company in early 2014 and after several roles became National Operations Director in September 2016. Immediately prior to joining McStone he was CEO at Human Recognition Systems.

News later this week comes from London Metric Property and Telford Homes tomorrow with Finals. On Thursday Watkins Jones delivers its interims and on Friday Amec Foster Wheeler has its AGM and the UK Construction PMI data for May is revealed. It’s school half term, as most readers will know so it’s all gone quiet, election or no election.

Moves on Friday last saw Morgan Sindall soar to greater heights rising 6.2% to 1274p on 159,908 shares traded. The investment proposition in the last 12 months has been based on the company reaching industry average margins, which is happening. Progress has been accelerated by market conditions being better than expected in Fit-Out and by good contract wins in other areas. A Balance Sheet with net cash and no pension issues help as well! Progress towards 160p of EPS by 2020 (our thought, not the company’s) or earlier is solid so the price at close on Friday is underpinned by good prospects.

Babcock was the backmarker, falling just 0.9% to 942p. Expectations around the finals for 16/17 were high and the shares hit 1030p in intraday trading on the day of the release. But they have since retraced to the pre results level. Performance and prospects remain unconvincing and yet another restructure of the divisions always raises concerns. Optically it looks cheap with 86p of EPS expected this year though with just 30p of dividend the yield is sub market levels. Avincis was not well timed, with hindsight and has not cured the systemic issue of over dependence on UK MoD. Sentiment will turn, in our view but a better balance sheet and a few other changes might be needed to convince investors.

Moves last week.

The sector performed broadly in line with the market’s 7% rise last week. It therefore remains up around 11% overall versus the market up by 6.5%.

The best performer last week was SIG, up 10% to 154p, the highest level since October 2015. As with Morgan Sindall all SIG needs to do is get to industry average margins, easier said than done but a credible target nonetheless. If it does that a target price of 200p a share is viable based on 13-14x 15p of EPS. The fractured relationships with suppliers are being mended and that is key as the value added by SIG in its product areas can be considerable. Its position is less open to disintermediation via the internet than with other materials distributors.

Galliford Try was the weakest performer last week, down 2.5% and it remains down 3.9% YTD despite the UK housebuilders index being up near 19%. The problems in construction were unexpected in terms of their scale and too large for other areas that are performing well to balance out. The company is holding a meeting later today for analysts so we can explore what the recovery plan might be in some detail.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
26 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 26th May 2017

There is no formal RNS news this morning in the HICS sector. In the absence of news we thought it worth highlighting the recent trend to new money going into housing in new ways. The moves yesterday were in a relatively tight band with Capita falling by 31p to 546p, 5.4% but of that fall 20.6p can be ascribed to the stock going XD with its final dividend payment for 2016. Kier got some support yesterday and was our best performer rising 1.1% to 1246p having been a tad friendless in recent months.

There is no formal RNS news this morning in the HICS sector. In the absence of news we thought it worth highlighting the recent trend to new money going into housing in new ways. The newly floated company The PRS REIT plc begins trading next week having raised £250m to buy newly constructed rental properties. Its focus is on family accommodation in large urban areas outside London. The Homes and Communities Agency (HCA) which is noted more for the support it provides to Housing Associations made a direct investment of £25m into this new vehicle. Aberdeen Asset management is investing in a £100m scheme in Bath to build 244 residential units along with some office accommodation on the five acre former Bath Press site. So cash is going into housing just at the very time the incumbent government’s new manifesto states that net migration (which is falling but was still near 250,000 in 2016) will reduce to tens of thousands. There is a shortage of housing that is clear but if the promises about migration are kept population and economic growth might diminish reducing the housing shortage more swiftly that anticipated. Moreover there is a growing outcry that the skills shortages to build new properties is getting worse despite attempts to push forward with a training and apprenticeships. So some interesting issues ahead, as always nit least in housing funding and the impact the new entrants, including Civitas might have on the Housing Associations in the long term.

The moves yesterday were in a relatively tight band with Capita falling by 31p to 546p, 5.4% but of that fall 20.6p can be ascribed to the stock going XD with its final dividend payment for 2016. The debate still exists regarding whether a fundraising is needed, in the absence of a new CEO and news on disposals. There is also, in our view a question mark surrounding its ability to sustain its operating margins which having been in the low teens for many years were just 11% last year. The current planned disposals involve revenue reduction of near £450m based on recent performances and a reduction in operating profit of £70m, all other things being roughly equal. That will result in a business with annual revenue of around £4.6bn (assuming some growth in other areas) and operating profit of £470m. Taking those numbers and assuming lower interest payments and a 20% tax rate we get EPS of 54-57p which easily justifies the current price, in our view. The key judgement is therefore around the sustainability on 10-11% margins. That is a bigger issue not for a morning commentary!

Kier got some support yesterday and was our best performer rising 1.1% to 1246p having been a tad friendless in recent months. The selling has been a tad harsh but the shares now look to have found a floor and might be ready to bounce back. SIG continue its climb back with a 1.1% rise to 153p, a level not seen since October 2015. The support is justified by the potential ahead in terms of margin improvement and revenue growth; the new top team have been given the thumbs up by the city and the story they are telling about how improvements might be made are at the right level of optimism and credibility.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
25 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 25th May 2017

Updates from two small sector companies, Van Elle the piling contractor and Henry Boot the developer and contractor, point to market conditions remaining positive. Van Elle’s update is to its year end 30th April. It came out with a small warning on 22 March due to workflow timing in Network Rail but that has not changed further and the year has started well with new work arising in all division. Henry Boot has told us quite early in the year that it expects to exceed previous market expectations for the current year, especially as by its own admission it is a transactions led business and timings are not always in its control.

Updates from two small sector companies, Van Elle the piling contractor and Henry Boot the developer and contractor, point to market conditions remaining positive. Van Elle’s update is to its year end 30th April. It came out with a small warning on 22 March due to workflow timing in Network Rail but that has not changed further and the year has started well with new work arising in all divisions. Revenue last year will be around £93m according to the company and market EPS forecasts fall just short of 10p a share, so the valuation at the closing price of 98p last night does not look stretching and the net debt of £4.1m at the end of the half year is not a drag on valuation. The company floated in late October last year placing 40m shares at 100p each. The warning and some board changes have not aided sentiment but the business has restored some of its composure and its markets remain positive, albeit that given the size of the company delays in key contracts can sometimes have a meaningful impact on results. Revenue in the year just ended are likely to be at least 10% higher than the £84m obtained last year and adjusted operating margins slightly lower than the 13% obtained last year due to the delays in certain contracts.

Henry Boot has told us quite early in the year that it expects to exceed previous market expectations for the current year, especially as by its own admission it is a transactions led business and timings are not always in its control. The company reports that the uncertainty created by the election is having no impact. The business operates in three main areas, Land promotion, Property investment and development and Construction. In all three areas the companies cite several projects that are performing well. YTD the land promotion business has concluded the sale of 900 units on seven sites and permission has been obtained on a further 1,965 sites giving a total of 17,600 sites currently available. In Property and Housebuilding the developments at Markham Vale, Manchester City Centre and Terry’s Chocolate factory are said to be progress well. In construction there is no evidence of as shortage of sensible projects and the order book for 2018 is being increased. Henry Boot operates outside the South East so it may be enjoying better market conditions than other parts of the country that are more dependent on activities in financial services. EPS of 23p was the expected level for this year before the update and the shares closed last night at 280p.

Yesterday we saw SIG have another strong performance, up 50% YTD and 4.4% during the session, to close at 151.4p. There is no new news so the rise is a mystery to some but we suspect that the market is waking up to the potential that exists to improve and crystallise shareholder value. The news from Polypipe that it is trading well in Euroland helped, we suspect. The rise has been solid since new CEO Meinie Oldersma started to get involved with investors, supported by FD Nick Maddock. There is sometimes retracement when strong buying drives a price so swiftly on no real new data. The stock goes XD on 8th June. But the longer term prospects remain positive so do not be deceived by short term profit taking and the dividend impact. Polypipe saw a positive reaction to the update and the changes on the board to close up 2.5% at 437p and was the second best performer.

Homeserve’s charge upwards on Tuesday saw some 40% of the gain reversed yesterday as it was the largest faller, down 4.4% to 743p. The valuation is stretched, in our view. 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
24 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 24th May 2017

There is a substantial amount of news today from Babcock with its finals, Ibstock and Polypipe with AGM updates, HSS has issued a Q1 trading update and Berendsen has issued a punchy rejection of the approach from Elis that includes forecasts for operating profit for this year and next.

There is a substantial amount of news today from Babcock with its finals, Ibstock and Polypipe with AGM updates, HSS has issued a Q1 trading update and Berendsen has issued a punchy rejection of the approach from Elis that includes forecasts for operating profit for this year and next.

Brickmaker Ibstock has made its AGM statement today and Forterra made its statement yesterday. All appears to be very well in UK brick markets as deliveries are higher than last year, though comparators are weak and prices have been achieved that will cover cost rises. As expected the projects that were outlined in the flotation prospectus by Forterra are going ahead; Claughton brickworks will reopen in the summer after a major capital project and Desford will get new gas supply and kiln burners later this year. Forterra promise progress this year and forecasts have been edging up having started the year showing limited progress. Ibstock describes progress YTD as encouraging. It also promises progress this year in terms of earnings and it may get some help from the new 100m brick pa new factory to be opened in Q4 this year. UK brick capacity is rising to meet the increase in new build that is occurring and replace imports, which at one stage in recent years reached 15% of sales. Forterra is expected to produce 23p of EPS this year and could get to 25p next year, the share closed last night at 262p. Ibstock will deliver EPS of 19p this year and 20.5p next year, all according to market consensus and closed last night at 242p.

Babcock’s underlying/adjusted numbers issued today show revenue 7.7% higher in the year to end March 2017 at £5.2bn and operating profit up by 6.5% to £575m. Net debt has fallen by 5% to £1.17bn, 1.8x EBITDA versus 2.0x last year. The only key number that is down is the order book, at £19bn versus £20bn last year. EPS rose to 80.1p from 74.2p last year. The dividend is raised 9% at the full year. The company outlines a number of contract wins in its statement and the emphasis in on their long term nature and the degree on integration its activities have with those of the customers. Relatively new CEO has “re-aligned” the operations into four sectors Marine, land, Aviation and Nuclear; the constant reshuffling of activities around the divisions is not a good sign so let’s hope it’s the last such change for a while. There is enough in the statement to reassure investors but not enough, in our view to alter the views of those concerned about levels of debt and the ability of the business to grow in international and civilian markets.

Polypipe’s trading in the first four months of 2017 was positive with revenue up by 4.6% L4L and by 6.0% at the headline level. UK margins are slightly lower than last year as cost increases are being recovered gradually. The 4.2% L4L rise in sales in mainland Europe (14% in headline terms) is worthy of note as this is based partly on company efforts but also on economic recovery in its territories. That has important read across as well as a benefit for Polypipe shareholders. The most substantial news however is that CEO David Hall will retire in early October this year and will be replaced by Martin Payne who joined late last year at FD. Martin has substantial sector experience having most recently been FD at Norcros and having had management roles at JCB and IMI. The search for a new FD has started and a COO has been appointed, an internal promotion for Glen Sabin.  These moves will be positive for the business as they combine a relative newcomer with substantial experience alongside continuity in the operations with the COO role. The shares closed at the record level of 427p last night.

The size of the task at HSS for new CEO Steve Ashmore is shown today in the trading update for Q1, the 13 weeks to 1st April. In revenue terms the Q1’17 numbers are broadly level with last year given the number of trading days but adjusted EBITA at a loss of £4.5m compares with a profit last year of £4.9m. The number are said to be in line with expectations and reflect parallel running costs as branches are closed and new operating format is adopted. Net debt fell to £226m from £234m which is welcome and dent headroom was £30m at the end of Q1. The company outlines measures taken to raise revenue and reduce costs in the release but the prospect of the need for a further fundraising is not eliminated. The new CEO will take a view after a few months of what else needs to be done. As we stated yesterday some of the problems are systemic and will take a long time to work through. Clearly HSS had a flawed and outdated strategy on coming to market and the wrong financial structure. The balance between trading through the issues and having a one-off adjustment is very fine.

Berendsen’s rejection of the Elis proposed offer is based on its view about the bid undervaluing Berendsen, it being opportunistic, on the combined entity being highly leveraged (i.e. financial risk) and the combined entity having substantial commercial and operational risk due to, among other things, Elis having limited experience of large scale deals. Investors will look at the adjusted operating profit forecasts of £150m this year and £170m for next as the main guide as the other factors are views rather than facts. The forecast are for levels of operating profit that are slightly higher than existing forecasts for 2017 and much higher in 2018 and better than achieved in 2016 (£141m), though they are dependent on FX which boosted the outturn last year. Operating Profit of £170m should produce EPS of around 75-80p next year so at 1173p the implied p/e is around 15x; the stock was trading on c 20x prospective p/e before its two profit warnings. The arguments Berendsen uses are what we might expect and the profit forecast are bold.

The main moves yesterday saw Homeserve get a very positive response to it numbers for 2016/17; the shares rose 12.5% to 790p. Several other stocks rose as well to reach highs, at Rentokil its 1.8% increase saw it breach 260p at close and Polypipe rose 1.5% to reach a record high of 427p. Berendsen was the main faller, down 1.6% to 1080p as the marker was perhaps anticipating that the company will continue to reject the 1173p offer and the price could fall to a level that reflects more accurately current trading.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
23 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 23rd may 2017

Renew Holdings has delivered its interims to end March today and Homeserve has told us its finals. In both cases the results are good. Morgan Sindall scorched ahead again today with a 5.7% increase to 1257p.

Renew Holdings has delivered its interims to end March today and Homeserve has told us its finals. In both cases the results are good. Homeserve’s adjusted PBT and EPS are possibly a tad ahead of expectations but that may be due to the difficulty for some outsiders to factor in FX tailwinds. Revenue rose 24% at AER to £785m and adjusted operating profit was up by 22% to £119m. The 11% rise in group customer numbers to 7.8m points to more revenue customer (up 2% in the UK and by 7% in the USA, though in the US the figure is flattered by excluding recently acquired USP). Retention rates in the two main territories are stuck at around 80%, with the UK seeing a fall from 82% to 80% and the US level at 82%. The 54% rise in net debt to £261m (1.7x EBITDA) is probably not a concern as £99m of the £90m increase is due to acquisition spend that has yet to make a full contribution to earnings. The company devotes some attention to technology changes in its markets and how it is at least keeping pace with innovations. The company has done enough to show that the strategy is delivering the expected growth and that potential for further advances exists in the USA (e.g. penetration of the addressable market is 6% in the US versus 10% in the UK) but we retain our concerns about the model. More below.

Renew Holdings has continued its surefooted progress with a 9% rise in revenue to £290m at the halfway stage of 2016/17 and a 15% rise in adjusted operating profit to £12.1m, a margin of 4.2% so it is on track for 4.5% for the year, as promised. The strategy of focussing almost entirely on engineering services in regulated sectors in the UK has developed over several years and has been executed well. The only recent blot on the copybook is that it has taken a £5.8m non-cash charge to close the low pressure gas operations that were acquired as part of Forefront as they are loss making; there will be a cash cost of £0.5m from redundancies in addition to this goodwill impairment.  Other than that issue progress in the six months to end March 2017 seems to be positive with the order book level at £517m and all revenue for 2H fully secured. Net debt has fallen to £3.5m and by the year end the business should be cash positive, we are told today. Adjusted EPS rose 56% to 15.5p and the dividend was increased by 13% at the interim stage. The shares closed at 456p last night at have made limited progress in recent months as management changes are absorbed. The typically cautious but solid performance in 1H 16/17 should reassure investors that after Brian May’s departure the Renew remains in good hands. The market expects EPS of 32p for the full year and given performance to date and better margins in 2H the earnings risks seem to be on the upside.

It was announced yesterday that Steve Ashmore will take up the CEO role at HSS. He will need all the experience he has learned at Wolseley and Brammer in particular to create the turnaround needed at HSS. The issue is whether investors will have the patience as many of the issues are systemic relating to redundant and old stock, onerous long term leases and long term contracts with some customers that are at the wrong rates. It will not be a swift or easy job as it seems to us as outsiders that the market and customer proposition needs to be altered quite significantly. That will take time and may cost cash which the company does not currently have in abundance. No surprise therefore that despite what seems to be a very good recruitment the share price did not react.

Morgan Sindall scorched ahead again today with a 5.7% increase to 1257p. There were just 32,928 shares traded but clearly demand is high and perhaps only a few investors were willing to “pay up”. Indeed it was a day for construction stocks as recent woes about warnings were on the back burner and Carillion, Kier and Balfour Beatty all rose by over 1.5%. SIG also rose and was the second best increase at 3.3%, closing at 144p. We mentioned the stock yesterday and nothing in our view has altered; a target price this year of 200p is realistic. Our thesis about construction stocks holds up well save that Galliford Try suffered another weak day, the largest faller, down 1.3% to 1255p, the lowest level since mid-December last year. Clearly the unexpected warning about Scottish infrastructure has made new CEO Peter Truscott’s firs year tougher than expected. But with 85% of earnings arising from housebuilding its underlying position should be positive and we suspect it is. The selling is overly harsh, in our view; at this level GFRD looks cheap.

Back to Homeserve as we hold a cautious view on the stock and have seen its share price rise and it became one of the highest valued stocks in the sector; the historic p/e last night was 26x. Our principle concerns are that the company needs growth to succeed, that there is limited transparency between revenue and operating profit, it loses 20% of its customers each year in its main territories (obverse of 80% retention) and that it has continually found difficulties operating outside its core operations. The latter is now increasingly relevant as the business needs to adapt to new technology in the core and new ways of working, hence the acquisition of Checkatrade in the UK. The growth it has achieved is undeniable and we recognise the potential ahead in the US. But we suspect it could unravel at some point.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
22 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 22nd May 2017

There is little new news this morning. Civitas, the social housing REIT, has spent another £6m of its £350m equity fundraising. Mortice, a small quoted FM company has won two new contracts worth £2.3m pa in revenue. There is no further news on the proposed acquisition of Berendsen. News flow from AGM updates and March and September year ends flows strongly during the remainder of this week.

There is little new news this morning. Civitas, the social housing REIT, has spent another £6m of its £350m equity fundraising on buying the freeholds of supported living properties and leased them back; the yield is in line with expectations but the company is only inching along with getting stock. Mortice, a small quoted FM company has won two new contracts worth £2.3m pa in revenue with BMW and Surrey and Sussex Police; there is a number of small FM companies (some quoted, most are private) that are winning such contracts that the larger companies ignore as being too small, especially when their overheads are applied. It is allowing the small guys to grow and perhaps at some point compete at a serious level.

There is no further news on the proposed acquisition of Berendsen. The shares closed at 1091p on Friday last despite the intended cash plus shares offer being at 1173p and having improved slightly with the Elis share price rising 2.9% on Friday to €20.06 (the proposed offer is based on €19.90) after initially falling to €18.57 in the hours immediately after the announcement. Berendsen stated on Friday that there is no further basis for discussion as the bid significantly undervalues the company. We suspect that sounding with shareholders may have taken place.

News flow from AGM updates and March and September year ends flows strongly during the remainder of this week. On Tuesday we have interims from Renew Holdings, finals from Homeserve and Epwin has its AGM. On Wednesday Babcock announces its finals for 16/17, Ibstock and Travis Perkins hold AGMs and Kingfisher is due to make a trading statement. On Thursday G4S has its AGM and on Friday the pace slackens as there are no relevant scheduled announcements.

On Friday last SIG topped the leader board with a 5.0% increase to 139.3p; the shares are now up 35% YTD. Mainstream brokers have consistently under estimated the potential for SIG to strike betters accommodations with manufacturers and improve the value added it creates in the distribution process, which in its case can include a high level of technical; content and therefore value. At the turn of this year we indicated the potential for SIG to possible double this year with the right management appointments and a favourable trading background; that potential still exists.

The backmarkers on Friday were Serco, down 1.3% to 118.7p and Morgan Sindall down 0.6% to 1195.5. The moves were simply adjustments after strong recent runs in both situations. The faller to note was Balfour Beatty which dipped by 0.3% to 278.5p. Its AGM statement failed to get much interest, which is consistent with the company taking a cautious approach to recording its progress.

Moves last week

The sector on average outperformed the market’s 0.4% rise last week but that was due largely to the house builders rising by 2.5%; Services stock were level and Building and Construction fell a tad, affected by fears of a slowing of activity and profit warning concerns.

Berendsen’s 28% rise in the week was for the obvious reason of the proposed offer which has been discussed earlier. The other major riser last week was SIG which may be rising due to fundamentals but the PE background and deal record of the new CEO might be creating some thoughts about how shareholder’s value might be created at SIG, sooner rather than later. Note also that Capita rose by 5.3% last week to 581p; if it really does not need to raise new equity and the new CEO is credible the shares have substantial recovery potential, in our view.

The largest loser last week was Interserve, down 6.6% to 230p. The management really is in a very difficult spot at present with some substantial issues in the operations and the departing CEO in post for another three months waiting for his successor to arrive officially. The business has some substantial problems that cannot be handled until the CEO is in place. In the meantime the uncertainty is affecting the company. It may look very cheap at 230p but there is no strong reason to own it and plenty of time to buy into the recovery, if it is to happen, when more facts are available. In the short term the risks are pretty high.

The situation with Interserve is different from that of Capita as the former does not have contract longevity and strong market positions in the manner of Capita, across a large proportion of revenue or a disposal opportunity that can be used to get the balance sheet in order. The contract situation allows a bit more time to adjust and a smaller requirement to win new work in the short term.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
18 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 18th May 2017

Balfour Beatty has its AGM today and the update wins the prize for the shortest statement so far this year. The surprise news today is that Elis SA has made a proposed offer to buy Berendsen comprising 440p in cash and 0.426 new shares in Elis SA for every Berendsen share.

Balfour Beatty has its AGM today and the update wins the prize for the shortest statement so far this year. We are told that progress is being on the second phase of Build to last and that trading is in line. The company is pencilled in for 13.1p of EPS this year and near 20p next year but they are not the reasons to buy the shares. It’s the long term value that can be unlocked from the PPP/PFI portfolio, that is worth around £1.2bn that drives the market capitalisation of near £2bn and at 281p at close last night the shares remain good value, in our view. The construction and services operations are in recovery mode and, we believe are worth more than the £0.8m or less implied in the current valuation.

The surprise news today is that Elis SA has made a proposed offer to buy Berendsen comprising 440p in cash and 0.426 new shares in Elis SA for every Berendsen share. That will provide each holder with 1173p a share, a 51% premium on close last night. So far the Berendsen board has resisted attempts from Elis to engage so Elis has gone public with its proposal which stated at 1100p a share on 28th April. Clearly the value of the offer is some way short of the 1355p the shares reached in July last year before two profit warnings. That was a long time ago. The real issue is whether the price will get back over 1173p under the leadership of the current top team in the, next two years. That is open to some doubt, moreover the combination of Elis and Berendsen creates a very strong global operation, exposed to among other things recovery in Euroland that may be attractive to some Berendsen holders. 

It is still early days in the “Battle for Berendsen”. Management will no doubt resist strongly as the bid has come at a low point in the development of the company, though it must be said it was a low that was quite unexpected and the share price reaction has been stronger than the news would suggest is justified. Our sense is that shareholders will hang on for more money but will be inclined to listen to an offer at this level. It may be that other parties now take a view and one or more may emerge with a viable alternative proposal. So there is much to play for, in our view and the Elis proposal leaves room for private equity, again, in our view.

Tiddler North Midland Construction has its AGM today and reports a strong improvement in performance in the first quarter with revenue up by 5% to £62m and operating profit more than doubled to £0.6m; the margin at below 1% is not satisfactory, according to us and management but the direction is right. Two factors of interest, firstly North Midland, with around £250m of annual revenue provides us with a 22 paragraph AGM update while BBY with £8bn annual revenue provides just two short ones! Maybe the company takes the view that it must use the opportunity to have its say when it has one. Secondly North Midland is very positive about its markets and progress, due to its order book but so concerned about skills and labour shortages that it is being cautious about growth.

The wobbles on Wall Street (down 1.8% yesterday) might be a macro factor that triggers a similar issue in UK markets, though for different reasons. Uncertainty in one place, albeit the cause is not transferable, can trigger uncertainty elsewhere.

SIG was the pick of the bunch yesterday, rising 3.9% to 131.9p, 28% up YTD. When the new CEO is a veteran of a number of turnaround and sell situations the shares will attract attention for reasons other than just trading fundamentals. Sticking with just the fundamentals SIG has bags of scope to improve margins just on existing business by working in harmony with the materials manufacturers; the previous regimes lack of attention to detail throughout the supply chain has changed already. In our way of thinking about SIG there are few reasons why 5% margins on the current £2.8bn revenue are not achievable which equates to operating profit of £140m, double last year’s adjusted level, and points to EPS of around 15p, given certain assumptions around interest and tax. At 132p SIG remains cheap. Attitudes at present are focussed on the frequency of false dawns at SIG; having met the management there is no reason to look backwards.

The losers yesterday were stocks that have had good recent runs and we are now seeing some profit taking/retracement. Interserve was down the most at 232p, a 2.2% fall and Grafton also dropped 2.2% to 741p. Kier was also among the losers and is the exception as the trend has been one way in recent weeks; it fell 1.9% to 1238p and now yields 5.3%. There is no compelling reason yet to buy the stock even at this level but on a 2/3 year view it is good value, given the unchanged commitment to 10% pa CAGR in earnings to 2020 and market conditions.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
17 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 17th May 2017

Countryside’s half year numbers are all that attracts attention this morning in the HICS area as they provide a steer on the housing market, following Crest’s update yesterday. One company that should attract attention is having a Capital Markets Day later, Blue Prism. Its software and products are termed Robotic Process Automation (RPA); essentially the company’s products tackle the routine rules based administration work that abounds in FM and many other areas of HICS sector companies everyday workload.

Countryside’s half year numbers are all that attracts attention this morning in the HICS area as they provide a steer on the housing market, following Crest’s update yesterday. The numbers are a tad ahead of expectations and the company has flagged it expects to beat previous estimates for this year’s out-turn. The company is also raising mid-term guidance Completions rose 31% in the period to 1,437, revenue and operating profit were up by 39% and the ROCE was 26%. There are many statistics that show Countryside to be doing well now and having the potential to continue the trend. The order book in private sakes is up 69% the landbank in Partnership Homes is up 18% to 17,528 plots and in Private housebuilding the landbank is at 20,472 units, 12% higher than last year and 85% are converted from the strategic landbank. We do not cover the stock so will not go into further detail; for us the issue is that there seems to be no shortage of demand. The company has deliberately aimed at a lower price point to adjust to the current market; its ASP fell 13% to £441,000 in private sales, despite underlying inflation of 6% in 1H’17 so it is having to adjust a little but having said that it has seen no issues with demand and mortgage availability.

One company that should attract attention is having a Capital Markets Day later, Blue Prism. Its software and products are termed Robotic Process Automation (RPA); essentially the company’s products tackle the routine rules based administration work that abounds in FM and many other areas of HICS sector companies everyday workload. Such work is the bread and butter of what Capita does and we expect it is advanced with its preparations for use of new technology but RPA also has applications in the 1,000s of routine jobs and transactions carried out by the FM and other services companies, including the distributors. The creation of the Digital Back Office is happening, most companies are aware of it and making plans. It should start to become an important element in the way HICS stocks operate and has serious implications for the value added by BPO companies. If you do not know about this already then take a look. It is an area analysts should be asking about as it would be easy for a company to get left behind in the use of technology such as RPA which will affect its competitiveness.

The moves yesterday were mainly positive in a strong market. Polypipe closed at a record level of 420p having increased 2.4% yesterday and there are many reasons to expect it to sustain its current strength, given the news from the housebuilders and its own efforts. Kier was the weakest performer, down 1.0% to 1262p as it struggles to get traction at the moment. The stock has fallen steadily since it topped the 12 month high of 1500p in late March and it went XD at the end of that month. The news from the company has been positive so far with few concerns though forecasts have been stable in recent months with little encouragement to upgrade. We expect that it’s simply a valuation issue as EPS of 107p this year and a 1262p share price are not out of line with rivals. The Galliford Try warning a few weeks ago has created nervousness about all companies involved in Construction.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
16 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 16th May 2017

Speedy Hire has reported its full year numbers for the period to March 2017 this morning. Crest Nicholson has updated the market and Civitas Social Housing has made another small acquisition. Speedy’s numbers show why its statements are now quite upbeat; it is signalling that the turnaround is down and it is now ready for sustainable growth. Morgan Sindall broke through 1200p rising 2.6% to 1232p. The last time the shares were at this level was November 2007 when the recession forced them downwards. The shares are up 66% YTD and yes it was one of our five picks for this year, the others were SIG up 23%, Costain up 34%, Forterra up 44% and MJ Gleeson up 15%. The FTSE All Share is up 5.3%.

Speedy Hire has reported its full year numbers for the period to March 2017 this morning. Crest Nicholson has updated the market and Civitas Social Housing has made another small acquisition.

Speedy’s numbers show why its statements are now quite upbeat; it is signalling that the turnaround is down and it is now ready for sustainable growth. It took a step back two years ago to get the basics right and having done what was needed is now well positioned, in our view. The statement contains some pretty punchy stuff! Revenue rose 12% last year to £369m, most of which was organic growth and EBITDA was up 19% to £63m. EPS rose 209% to 2.2p and the company has raised the dividend by 40% to 1.0p. Arguably net debt at £71m and gearing of just 1.1x is low for a hire company but that may just be a step along the way; ROCE is rising but at 8.4% has some way to go and leverage will help. Utilisation has risen and the hire fleet adjusted to hold products that are in high demand the business can start to reinvest in new products and acquire a little faster, at the right prices, as it did with Lloyds British just before the year end. What is clear is that the company is broadly content with its infrastructure right now, including the vastly improved IT systems and therefore the issues are around customer service and long term relationships. That is important not just for progress in the operations but also financially and in terms of management focus.

We shall attend the analysts’ meeting at 9.30 to get more background. With EBITDA at £63m and rising and with debt at £71m, Speedy looks to be cheap at 55p at close last night. Long term the hirers trade at 5-6x forward EV/EBITDA so with £71m of debt and market cap of £281m Speedy is bang in the middle of that range on an historic basis. We suggest however that the valuation is probably too low (given the superior quality of the earnings)  and that the EBITDA might reach £70m+ this year so there is plenty of scope for the share price to rise, even if net debt increases to say £100m. Target prices of 65p are likely based on the numbers today and the prospects.

Crest is probably more vulnerable than most to a slowing of the market around the M25 but that does not seem to have affected performance to end April, the first six months of its year. The business is said to be on track for 10% growth in revenue for the full year with the ASP 12% higher YTD though completions are down by 142 units to 1,604 for to the timing of the sale of PRS units last year. Forward sales are 5% up on last year in unit terms. We are told by the company that the market remains robust in its regions of operation and that it is able to get modest price rises which are covering build cost rises; the company mentions skilled labour shortages as an issue. The land market remains benign. The election does not get a mention. Our conclusion is that conditions have got a bit tougher for Crest but are manageable. The progress towards £1.4bn revenue and over 4,000 units a year is on track, we are told and land is being bought, in a benign market to secure that growth. In line with its house building sector peers, Crest seems to be confident it can make progress in the current market.

Civitas has acquired more properties, this time it has spent £6.1m on five properties with 51 tenancies in supported living. This is progress but the company is struggling to find stock as we have said before. The initial net yield on the latest acquisition is said to be in line with expectations, which we believe are around 6%. The operations are still some way short of spending the £350m raised and while its right that its sticking by its targeted returns it is still some way short of leveraging quality portfolio. As we have stated previously Institutions can disintermediate Civitas by investing directly in social housing and get 4-5% returns overall on leveraged capital, and therefore a much higher return on equity.

Moves yesterday were in a tight range and continued the trend of last week with the sector underperforming the market a little. Morgan Sindall broke through 1200p rising 2.6% to 1232p. The last time the shares were at this level was November 2007 when the recession forced them downwards. The shares are up 66% YTD and yes it was one of our five picks for this year, the others were SIG up 23%, Costain up 34%, Forterra up 44% and MJ Gleeson up 15%. The FTSE All Share is up 5.3%. While some investors might be tempted to take profits at this stage we believe there is still some way to go with all five stocks, depending on the macro picture.

The main loser yesterday was Interserve, down 3.4% by close of play to 237p. On trading grounds we could argue the stock is cheap but the uncertainty at the top level and the net debt picture make us wary. Even at this level, with near 60p of adjusted earnings likely this year it’s still one to avoid as the new CEO has yet to understand the numbers fully and take a view. Carillion was the back marker for much of the day and closed down 1.7% at 200.3p.

We attended a Serco Analysts’ dinner last night where no new data was provided. We will get an update with everyone else at end June. What is clear is that progress is on track, the pace being dependent on contract wins and for the next say 12 months, the outcome of Obamacare reform which accounts for around £200m revenue each year at present. The company seems to want us to be content with progress to date but far from complacent. There is still some sorting of historic projects to complete but the business is back on the list of favoured companies with all customers, including HM Government and bidding hard, especially into the UK MoD. The 120p share price is justified by the mid-term prospects, in our view.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
15 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 15th May 2017

It’s a day for updates from sector tiddlers with Bilby and Mortice updating us on progress. We attended the SIG meet the top team event Friday last. We got a very positive impression from the new CEO. The sector performed weakly last week against a positive performance in the overall market.

It’s a day for updates from sector tiddlers with Bilby and Mortice updating us on progress. Both have said that trading is pretty good, Bilby seems to be getting back on track after a distinct wobble and Mortice has said it is trading ahead of expectations. Bilby, a provider of maintenance services to Social Housing operators, came to the market just over two years ago with a buy and build strategy and as often happens it rose swiftly and then dipped severely. In even capitalised business development costs at one stage but soon restated as the treatments were potentially misleading. The company states today that it will make EBITDA of £3.6m for the year ended 31st March 2017, compared with the restated £2.5m last year. While EBITDA may have risen we expect, given the performance at the half year revenue in 2017 was in excess of £60m compared with £31.4m in 2016 so the margins are more in line with sector averages than the much higher levels it had when coming to the market. With a market capitalisation of just £24m it is too small for many investors. But in terms of read across to Mitie and Mears the news from Bilby is that demand in social housing for external providers of maintenance services remains positive.

Mortice provides security and FM services in the UK, India and some countries in the Far East. Like Bilby it has a buy and build strategy. It boast today that in the year to end March 2017 it will be materially ahead of current expectations but the data provided, in US$, does not break out FX impacts from underlying. But with EBITDA margins of 3.7% on revenue up 35% to $180m the performance is not stellar, in terms of profitability. We have met the company and the management is highly ambitious , evidenced in part by the acquisition of Elite cleaning services recently in the UK. It is one to note for the future, in our view and is seems to see no issues in creating demand for its services


There is also news from SNC-Lavalin which informs the market that Its bid for Atkins will not be increased from 2080p unless another party proposes or makes an offer, in which case it reserves its right to reconsider and, that the company has received the necessary clearances in the US for the deal to proceed.

We attended the SIG meet the top team event Friday last. We got a very positive impression from the new CEO. With 12 turnarounds already to his credit Meine Oldersma would seem to have the experience, and from the meeting, the credibility to turn around SIG. We see not market reasons why that will not happen. OK there have been false dawns before so why is this time different. Our conversation suggests that the new top team has grasped swiftly the key issues and taken actions where it can (eg closure of sub scale operations), understood where margins can be improved and recognised many of the flaws the previous team had with the materials manufacturers, which in many cases had become quite adversarial, which is not the best way forward in this sector but mat work in retailing. We are more positive now than before teh meeting in our view on SIG

News this week is expected tomorrow from Speedy Hire with its finals for 16/17 and Crest Nicholson is likely to update us; on Wednesday Countryside has its interims; on Thursday Balfour Beatty’s AGM should result in the company telling us a bit about recent trading and on Friday it’s the turn of PRS operator Grainger to provide its interims. If there are to be any surprises this week they could potentially arise from Crest, who may be seeing tougher trading in its South East markets and Balfour Beatty , who we suspect will be trading well. The stock suffered post Galliford’s recent recognition of issues on the Aberdeen by-pass, a JV with BBY and CLLN. BBY will have taken its view of this project, which is far from being completed and factored it into guidance this year to date s we are not expecting news on that.

On Friday last Morgan Sindall’s progress towards a 1200p share price continued with a sector leading 2.4% rise to 1188p. As we have stated earlier, the possibility of the company reaching a EPS of 160p in 2020 or earlier remains very real so there is some way to go yet in the valuation. Interserve was also a notable riser, up 1.9% to 246p as some investors se that the worst may now be in the past and that, despite substantial levels of debt, and equity fund raising is not absolutely necessary and that some issues can be traded for some time as the cash position recovers.  Capita was the most notable faller on Friday, down 1.4% to 552p as views sway on its need to raise new equity and speculation on the identity of the new CEO increases. We expect it will not need new funds but that does not make the buy argument at this stage strong, merely emphasising that owning the share s carries above average risk/reward.

Moves last week

The sector performed weakly last week against a positive performance in the overall market. HICS stocks were broadly unchanged at the end of the five trading sessions last week whereas the market was up over 1.6%. So while the HICs sector is up around 10% YTD versus the market up 5%, the gap is closing.

Morgan Sindall was the best performer, up 7.7% in the period. We have mentioned the company earlier. Its rise is based on the company’s strong balance sheet and trading performance across all divisions being good and in some areas just getting nearer to industry average margins over the next few years.

Carillion was the largest faller over the period, down 5.3% or 11p, which matches roughly the 12.65p final dividend as the company went XD last week. The stock has a marmite element to it as some take a view it will trade through its balance sheet woes and others do not. The shorting of the stock remains at 21.3% in Castellaine Capital’s data, better than few weeks ago but still high. We are optimistic that the company will find a way through which will satisfy all stakeholders

Incidentally, Mitie (up 1.2% last week to 225p) remains highly shorted as well with 12.4% of its stock loaned to short funds. Given recent newsflow shirting at this stage seems to have limited justification. The company has made remarks about future margins , which will be around 4-5% which seem reasonable to us and is realistic about balance sheet recovery. The new top team has had plenty of time to read the situation and ‘fess up to past regime’s “failings” so we have to expect that the shorts are just ignoring recent statements and believe there are more skeletons, which we doubt.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
12 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 12th May 2017

Interserve and Tyman both have an AGM later today and have issued update this morning covering the year to date. Interserve’s news is very much a holding statement as the new CEO is not due to arrive from Sodexo until September. Tyman’s news is that all is as expected in the mainstream with some ups and a few downs balancing each other.

Interserve and Tyman both have an AGM later today and have issued update this morning covering the year to date. In both cases trading is in line with expectations however both point out that trading is 2H weighted, more so than in previous year at Interserve. The political uncertainties have not slowed government work for IRV, we are told but, we and they, suspect the election purdah might have an effect in the coming weeks.

Interserve’s news is very much a holding statement as the new CEO is not due to arrive from Sodexo until September. It’s a tough task for the current top team. Remarks about the UK services and construction segments being robust and mixed respectively are designed to just hold what exists, playing for a 0-0 draw which, realistically, is all the current team can achieve at present. The most positive remarks about trading are in the Equipment services area, for which an acceptable offer was not obtained last year; the business is said to have good momentum in demand and to be benefitting from management actions. The company mentions some selected contract wins in each division of the business in the release. Importantly also the £170m exceptional charge for the waste to energy operation seems to date to be big enough, which will be seen as positive by investors. Adjusted EPS of 58p is still the expectation for this year’s out-turn but the net debt position is uncomfortable and the company passed on the full year dividend (having paid 8.1 at the interim stage) reducing the attraction of holding the stock. Interserve has some good contracts but at present is clearly in an unsettled position and will remain so until later this year. It’s hard therefore to determine value and the risk/reward.

Tyman’s news is that all is as expected in the mainstream with some ups and a few downs balancing each other. Revenue is 31% higher than last year in reported terms, the rise being due to FX and acquisitions as revenue overall is level with last year at CER and like for like. The text however suggests that trading might be a bit better than level as Amesbury Truth, the North American operation, is said to have had an encouraging start to the year, ERA, the UK business is said to have revenue ahead of last year and Schlegel has had an encouraging performance. There are few areas on sluggish sales performance (Latin America and Middle East) but in the main areas of operation the words used are upbeat. The UK operations are of course adjusting to higher input costs due to FX and that remark is extended to all operations; these are being managed though cast reduction programmes and efficient procurement. The market is expecting 28p of EPS this year so with the price at 348p last night the valuation is not stretching alongside its peers, in our view.

The HICs sector continues to be in the doldrums as the main news flow that affects it is broadly positive but investors and companies are cautious about what lies ahead. Carillion, as might be expected was the worst performer yesterday falling 6.8% to 207p as it went XD with a 12.65p final dividend payment. The 14.4p fall in the price was a tad greater than the dividend payment of course but not by so much that it changes views on the stock. For investors who believe it can trade through its balance sheet issues the price is very cheap. Polypipe was the best performer as it rose 1.1% to close at 406p. It has performed very well since the results announcement. On fundamentals it should be able to sustain its price at around 400p in the current trading climate. SIG also rose well yesterday (1% to close at 125.2p) after the AGM update and today it is holding a lunch time “meet the top team” session.

 

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
11 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 11th May 2017

SIG and Keller have issued trading updates today and Fulcrum Utility Services has announced that CEO Martin Donnachie is leaving after four years in the job to be replaced by current FD Martin Harrison. The moves yesterday were in a narrow range. We spent an interesting morning yesterday at the launch of ilke Homes, a joint venture between Algeco Scotsman’s UK subsidiary Elliot and Keepmoat. The company intends to expand its production of offsite volumetric 2/3 bedroom homes over the next few years through building a number of factories each capable of 500+ homes a year on a one shift/5 day working cycle.

SIG and Keller have issued trading updates today and Fulcrum Utility Services has announced that CEO Martin Donnachie is leaving after four years in the job to be replaced by current FD Martin Harrison.

SIG has told us that L4L revenues increased 1.4% in the first four months of the year with a 0.5% rise in the UK and Ireland and a 2.4% rise in the Euroland operations, all at CER. Including FX impact revenue rose by 6.5%. The company points to fast growth in the air handling operations which delivered a 16.3% improvement in the period. The new top team, which is holding an “Hello and Welcome” meeting tomorrow lunchtime has moved swiftly to close down the offsite manufacture of bathroom pods (Metechno) and taken the decision to shut the Austrian operations; no one-off costs in relation to these actions are mentioned. We shall be interested to know of the plans for the other offsite construction operations as substantial investment is taking place in that segment at present and SIG runs the risks of being subscale and in some cases competing with customers. We believe that investment in offsite is a very sensible idea at present but Distributors may face commercial conflicts. The company has reiterated its commitment to debt reduction as it steps back from past expansion strategies in the short term in order to make a stronger leap forward sometime in the future. We expect the market will greet the update today positively as trading is in line though the first half out-turn will be lower than last year due, in part, to tough comparators there will be growth in 2H, present political uncertainties permitting. The company is expected to deliver 10p of EPS this year and 11p next year which justifies the current price at 124p, up 20% YTD.

Keller is a bit of a mystery company to many as it has no direct UK comparators and it has had a few random warnings that have made brokers nervous about committing on the stock. We like to look at it because, as a piling company (Geotechnical contractors to be formal), it provides an early lead indicator on future activity in construction. The news today is that the company is trading in line with expectations. The geographic mix of performance shows activity in the US to be slid but a tad behind a string 1H last year, EMEA has continued its growth trend and Asia Pacific showed good revenue growth. The read across therefore remains quite positive albeit that progress is steady rather than spectacular. The company tells us that tendering and contract awards remain generally healthy which to us translates into “good but could do better”. The company has also made a separate announcement about the sale of a property for £62m; the tale is complex but essentially the property was acquired in 2016 to settle a long running trade dispute and has been sold at profit of £8m and £4m of rental income has been received, all of which will be treated as exceptional. The impact is to reduce net debt/EBITDA by 0.3x; the ratio was 1.9x at end 2016.

We spent an interesting morning yesterday at the launch of ilke Homes, a joint venture between Algeco Scotsman’s UK subsidiary Elliot and Keepmoat. The company intends to expand its production of offsite volumetric 2/3 bedroom homes over the next few years through building a number of factories each capable of 500+ homes a year on a one shift/5 day working cycle. We saw a pair of semi-detached homes at Gallions Reach yesterday and were given an insight into the strategy. The long running debate about the acceptability, competitive build costs and other advantages of offsite residential construction are starting to be settled after a number of false starts. As more investment is made in production facilities and as the skill shortages in conventional construction become more parent off-site provides many of the required answers. By the end of this year the UK will have enough capacity to provide the core elements of over 30,000 dwellings via offsite methods.

The product we saw yesterday was highly acceptable as a home which can be mortgaged and has longevity and customer appeal. Volumetric production, building the whole dwelling offsite, will require a long timescale to become significant in volume terms but the arrangement between Elliot and Keepmoat provides advantages for both parties that reduce risk and allow “incubation” of the fledgling operations, factors that has been missing to date. Industry operators who dismiss off-site are possibly ignoring the substantial numbers of components and sub-assemblies that are used today in residential as well as other construction. SIG’s withdrawal from making pods in indicative of the scale that is now present in this market and its operation was just too small to compete. Increased use of offsite has implications not just for building but also for the whole supply chain, especially the Merchants.

The moves yesterday were in a narrow range. Mears was the biggest gainer with a 3.5% rise to 517p as 291,162 shares were traded, a high number for the company. Its long term sustainable contracts in Social Housing provide a very stable position and the Care operations which have been restructured may also benefit from recent changes of views about the funding of Care in the UK. Mears is well placed to benefit from the outcome of the election, based on noises about future policies currently being made. Note also that Grafton rose 2.5% to 792p and is getting ever closer to the 800p level. Serco, down 2.3% to 117p, was the backmarker as it retraced recent gains. The move was not significant, in our view and the shares will trade in an 112p-120p band, we suspect, until there is news about new contracts or the dividend.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
10 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 10th May 2017

The interim numbers from Compass and trading updates from Michelmersh Brick, Barratt Developments and Marshalls are the attention grabbers today in the HICS sector. Shareholders in Compass will be pleased to see the company performing well in the first six months with organic revenue growth at CER of 3.6% and margins up by 20bps but the main eye-catcher will be the proposed 61p a share special dividend expected to be paid in July along with the 11.2p of interim payment.  Carillion was the leader of the pack yesterday as it rose 5% to 226.5p. The stock goes XD tomorrow with a dividend payment of 12.7p so the rise yesterday on 10.5p was proportionate.

The interim numbers from Compass and trading updates from Michelmersh Brick, Barratt Developments and Marshalls are the attention grabbers today in the HICS sector though the warning from John Wood will cause some distractions for read across, especially as it is mid negotiations to acquire Amec Foster Wheeler.

Shareholders in Compass will be pleased to see the company performing well in the first six months with organic revenue growth at CER of 3.6% and margins up by 20bps but the main eye-catcher will be the proposed 61p a share special dividend expected to be paid in July along with the 11.2p of interim payment. We are pleased to see the return of cash, in this case £1bn, being made via a dividend rather than a share buy-back which has been the main method used to date. The geographic split of performance is familiar with the US performing very well with 7.1% organic growth in revenue at CER, Europe with 2.3% organic revenue growth and the Rest of the World (RoW) slowing with 6.6% reduction in revenue as Brazil and Offshore & Remote had continued weakness. The issues in the areas of decline are being addressed and adjustment being made to the cost base and methods of operation. FX has affected the reported results considerably with revenue 20.3% higher in the statutory accounts at £11.5bn and operating profit up by 24.6% at £877m, operating margin 7.6%. Net debt at the period end was down a fraction to £2.87bn, an £8m fall; free cash flow was £502m after £325m of capex and £46m of net acquisition/disposal spend. The special dividend looks affordable with only a small rise in net debt likely, after reinvestment in growth and it will remain below 2x EBITDA. The shares closed at 1593p last night and 73p of EPS is expected this year; forecast may rise a little this morning after a confident first half performance.

Michelmersh has made a short statement to coincide with its AGM. It confirms that trading is in line with expectations, based on the first four months of trading though no numbers are provided. The update suggests that all is well in the brick industry at present in terms of demand and pricing, confirming other indicators so it good read across for Forterra and Ibstock.

Barratt Developments has told us that trading YTD, 1st January to 7th May, points to the out-turn for the full year being at the top end of the existing range of expectations; that range was £675-£733m of PBT for FY 2017. The confidence arises from strong demand with total forward sales at 7th May up 12.7% on last year at £3.2bn equal to 12,822 plots and private sales up 21.7%. The company continues to buy land that meets the minimum hurdle rates of 25% ROCE and 20% net margin. Net cash of £600m is expected at end June 2017 so the cash return policy seems to be fully intact. Given the current political circumstances and the shortage of housing stock and the increasing consensus that UK interest rates are unlikely to rise during Brexit discussions the housebuilders look set for some very good trading results. The ending of HTB in 2021 on current plans is some way off.

Marshalls update gives a positive picture of trading YTD and the company hints at a forecast upgrade with references to increasing confidence about the full year out-turn. Revenue rose by 6% in the first four months of the year to £135m with a particularly strong showing in the Domestic market with sales up 13% and order books at 12.7 weeks compared with 10.9 weeks at end February and 12.4 weeks this time last year. With EPS expected for this year at 20p before the announcement today and the shares closing last night at 393p the stock would seem to be up with events, in our view. The valuation has positive read across for the main UK Brickmakers (Forterra and Ibstock) and Polypipe which have lower valuations despite having similar risk/reward profiles.

Carillion was the leader of the pack yesterday as it rose 5% to 226.5p. The stock goes XD tomorrow with a dividend payment of 12.7p so the rise yesterday on 10.5p was proportionate. Our longer tem view is that Carillion will resolve its balance sheet issues but it’s not a quick fix. Mitie was the next largest riser up just 1.1% to 240p on news of the new Chairman and a stronger emphasis than we have seen previously on the Connected Workspace idea. The company has mentioned the idea previously in city releases and it has some insights on its website regarding how it operates but the financial implications have not yet been indicated. We expect that on June 12th we will get the update on operational performance and penetration for the Connected Workspace and some idea of he expected financial implications.

The largest faller yesterday was Travis Perkins, down 4.0% to 1628p, perhaps due to Grafton’s update creating concerns about Plumbing and Heating markets in the UK Merchanting sector. The Merchants have seen strong support in recent weeks but TPK has been left behind a little as its updates have reflected there is still much to do in re-structure of the operations and the markets. Kingfisher’s (B&Q) statements about UK performance and the rise of competition from Bunnings (Homebase) are also concerns. The company does not have meaningful overseas revenues to offset some UK market concerns in the way that SIG and Grafton enjoy. With 112p of EPS expected this year the share price at close last night might is not out of line with the competition and does not suggest a valuation gap investors can exploit at present.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
9 May 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 9th May 2017

It’s all going to plan at Grafton, if we have understood correctly the update released this morning to coincide with the AGM later today. Mitie has announced a new non exec Chairman today, Derek Mapp, who joins the company after having similar roles elsewhere. The sector moves yesterday, as in the market as a whole, provided limited sense of direction.

It’s all going to plan at Grafton, if we have understood correctly the update released this morning to coincide with the AGM later today. Trading in the first four months of the year was positive with revenue up 6.1% L4L and at CER; actual revenue was up 7.7% to £851m. Such levels of improvement are likely to have had a favourable impact on margins and the company states it benefitted from profitability improvement measures made in 2H ’16. The geographic split of revenue growth was predictable with the UK increasing sales 4.8% L4L, Ireland Merchanting showed 13.6% growth, Netherlands 4.3% and Belgian sales fell 3.4%. The Belgian out-turn was impacted by a switch in the business model. No specific comment is made on progress in UK plumbing and heating but the combination of remarks about the success of Selco and actual revenue in the UK rising just 2.5% (versus 4.8% L4L) suggests adjustments are still being made in that area. So it would seem that Grafton is on track though the company itself acknowledges “political uncertainty” that may alter the market environment. The market forecasts of around 49p of EPS this year and 53p are intact on the progress so far and the risks are on the upside, in our view.

Mitie has announced a new non exec Chairman today, Derek Mapp, who joins the company after having similar roles elsewhere. The clean sweep of the top roles is what happens in Mitie’s situation so this is no surprise. The most interesting element is in the quote from Phil Bentley, the CEO, in which he refers to Mitie’s journey of transformation “Beyond FM….to the Connected Workspace”. This is new stuff from the company as it starts to reveal its new strategy, due to be presented to the City in early June with the results. The strapline sounds as though Mitie might have some new angles on FM so we look forward to hearing about them.

The sector moves yesterday, as in the market as a whole, provided limited sense of direction. Investors appear to be assuming that the authorities and policy makers will take actions needed to sustain economic growth. But within the generally benign picture some companies continue to make headway. Morgan Sindall was the best riser yesterday, up 1.6% to 1123p and it is up 47% YTD but with just 36,767 the move is based on few shares traded. If we are right and 150p+ of EPS is possible in 2020 or earlier the price is cheap. Mears was the largest faller, down 2.4% to 502p but with just 20,377 shares traded the move was just ebb and flow of trading. The recent trading updates have been generally positive and while the election and Brexit slow decision making, on investment in particular, companies appear to be faced with positive trading situations in the UK.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
8 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 8th May 2017

Costain has issued a very short statement today to coincide with its AGM. Centrica’s update today is interesting for its comments on energy price caps. Friday last was a good day for stocks that have been out of favour in the last few months. The sector did a little better than the market last week with a 2.0% increase versus the market up by 1.1%. YTD the HICS stocks are up 10% with the housebuilders leading the way, up 12%, versus the 3.3% rise in the All Share.

Monday, 08 May 2017
Costain has issued a very short statement today to coincide with its AGM. The company has said it is trading in line with expectations and that is very much it. The company’s focus on substantial projects for larger UK customers in energy, water and infrastructure is well known and is yielding good results. The termination of the Manchester Energy from Waste deal was announced last week and the resolution of that project is nearer to a conclusion; it has been a drag on the financial numbers for some time but the share price has started to indicate investors can see an end to the losses on that work. The stock closed at 475p on Friday last, still some way short of the peak of 567p in 2006 but well ahead of late 2007 levels of 171p. Market expectations of 33p of EPS this year and 36p next year should be fulfilled and may be higher depending heavily on the Manchester waste outcome.

Centrica’s update today is interesting for its comments on energy price caps. The company makes a bold counter argument to the notion that price caps on energy bills to consumers are a good thing. Direct state interference in the manner described is likely to reduce the attractions of investment, which clearly has read across to the stocks covered here. Its early days in that battle but Centrica states that it has proposed alternatives to price regulation to the Government and there is an ongoing dialogue. If the UK is to return to more manufacturing and be a sovereign nation then domestically produced energy is essential and right now that means much more investment, a positive for Balfour Beatty, Costain, Carillion and others.

News this week is expected from Grafton tomorrow with its AGM. On Wednesday Compass reports its interims and on the same day Marshalls, Barratt Developments, Galliford Try and Rentokil have AGMs though only the former two might update, the latter two having done so recently. Thursday will bring AGM updates from Keller, Serco and SIG. And on Friday Interserve and Tyman will no doubt update with their respective AGMs.

Friday last was a good day for stocks that have been out of favour in the last few months. Interserve was the best performer up just 2.1% to 241p, Carillion up 2.0% to 215p and Serco up 1.9% to 119p. Arguably the rises are small and were just ebb and flow of trading on the day. At present we see limited logic for a positive move in Interserve as its new CEO is not scheduled to take up the role until September and there has been little new news; Debbie White joins in the top job from services company Sodexo and starts with substantial issues in the Construction segment at IRV. Carillion’s operations are thought to be trading well in most regions (notwithstanding any relevant read across from the Aberdeen road) and assuming the dividend is maintained at current levels a buyer will get over 14% return from that over the next 12 months (two finals and an interim)  as the stock goes XD on Thursday. Serco is regaining ground lost when the most recent guidance pushed the recovery in earnings slightly to the right. Recent contract wins point to a positive trading update more than balancing other current threats.

G4S slipped in trading but the 2.1% fall to 318p was just retracing earlier gains after the trading update and just a bit of short term profit taking, in our view. Balfour Beatty also slipped a tad, down 1.8% as with Carillion it is highly concerned about the outcome on the Aberdeen ring road but experienced enough to know that with around a year to completion there is a lot to resolve and agree.

Moves last week

The sector did a little better than the market last week with a 2.0% increase versus the market up by 1.1%. YTD the HICS stocks are up 10% with the housebuilders leading the way, up 12%, versus the 3.3% rise in the All Share.

Mitie was the best performer as the update last week was the new FD’s chance to draw a line under the history of the previous management’s approach to financial reporting. The outcome was not as damaging as the worst case the market could think of so there was a sense of relief. We have said for some time that in the core FM operations Mitie was and remains a good business, just not as good as the numbers suggested and outside FM the top team always struggled to buy properly. At 236p at close on Friday the shares might just be ahead of events but not by much. Also note last week’s rise in SIG’s price of 5.5% such that it is now up 22% YTD; we expect good news at the AGM this week and with Euroland recovery it is well positioned, alongside others such as Grafton which also has € exposure.

No surprise that Galliford Try was the largest faller, down 10% last week after its unscheduled update informing us of a £98m hit to operating profit. The provision for potential losses on the Forth Bridge and Aberdeen ring road projects (with a suggested 20%/80% split) was unexpected at this stage, at least on the latter. Balfour Beatty and Carillion are also involved in the Aberdeen project and remain highly concerned about progress but are trading the situation at present as it is some way from completion (over a year) and there are claims and counter claims as always with such work. The EV of GFRD fell by around £100m last week which stacks up against the potential loss in one area but good performances elsewhere.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
5 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 5th May 2017

T Clarke, the small building services operation, has its AGM today and has issued a short update. The good news from Morgan Sindall and G4S in trading updates yesterday brought instant improvement in the share prices. Carillion fell again yesterday, by 2.6% to 211p. It has suffered from read across following Galliford’s views on the out-turn on the Aberdeen roads project (Galliford Try/Carillion/Balfour Beatty JV.

T Clarke, the small building services operation, has its AGM today and has issued a short update. The company is confident and, due to the order book rising to over £400m (£402m at end April, up 22% from the start of the year), management now believes that it will beat current market expectations for 2017 of £300m revenue, £6.1m PBT and 11.3p of EPS (adjusted PBT last year was reported at £6.2m and adjusted EPS was 11.6p). So it may be that the adjusted earnings out-turn this year could match the achievement of last year on revenue indicated to be around 10% higher than last year’s £278m. The company mentions a number of construction projects and long term maintenance programmes on which it has been successful in securing contracts in recent months.

So it’s all looking better at CTO we are told but there is no mention of the cash flow, the recent fraud or the £20.6m pension shortfall on just £32.7m of assets. The company signs off with a commitment to target opportunities that further improve margins but given relatively stable PBT this year versus last and much higher revenue, it’s not clear how margin improvement is coming through. The read across in terms of market demand is very positive but the company’s approach to presenting its position fairly and reasonably is unique.

The good news from Morgan Sindall and G4S in trading updates yesterday brought instant improvement in the share prices with the former up 4.1% to 1089p and the latter up 3.5% to 325p. Regular readers will know that we see many good signs of progress in both companies and there is no reason to change view, even at current valuations. In both cases increased revenue and improved margins are likely and clearly net debt is improving. There is no talk at either company about acquisitions, though we suspect G4S may make some bolt-ons, leaving cash for organic development and the shareholders.

Carillion fell again yesterday, by 2.6% to 211p. It has suffered from read across following Galliford’s views on the out-turn on the Aberdeen roads project (Galliford Try/Carillion/Balfour Beatty JV). We have talked to all three companies in recent days. While Galliford has taken its view the others are less concerned. The project mobilisation was not smooth and there have been periods of bad weather that have hindered progress. But the project is far from completed and there is still much to discuss with the customer and the usual counter claims with the customer will exist. There is not enough data in the public domain for outsiders to take a view. What we do know is that all three companies are aware of the rules of engagement in the quoted arena and have different areas of expertise and other commercial considerations to look at when forming a view of the likely out-turn. At 211p and with a 10% + yield over the next 12 months (the shares go XD next week) there is some protection with CLLN and we expect to see the balance sheet improve significantly over the next 2/3 years which will reduce the pessimism around the share price.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
4 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 4th May 2017

Morgan Sindall and G4S have updated this morning and made very positives starts to 2017; the former indicating that its earnings out-turn this year will be slightly ahead of previous expectations. Morgan Sindall is going through its best period of trading for several years. G4S has issued a short statement but when revenue is up 8.9% in Q1 on the same period in the prior year the numbers are doing the talking!

Morgan Sindall and G4S have updated this morning and made very positives starts to 2017; the former indicating that its earnings out-turn this year will be slightly ahead of previous expectations. So how come there is such a contrast with the news yesterday? The answer really lies in today’s releases coming from companies that have been through their bad patches and are now trading with clean accounts and conservative assessments of revenues and costs on work that straddles more than a few years. The issues that arise in the sector are nearly always down to management assessment of revenue and cost, as accounting rules allow such leeway and companies are not as transparent as they might be over their assessments. Some of the caution may arise from commercial confidentiality but clearly a lot is due to management incentives being geared to financial numbers that are based on management judgement. It begs question in many areas, including audit committees and external research. 

The emerging situation in third party, independent analysis of companies arising from MiFiD II will not improve either the amount or quality of research. What is also clear from recent updates is that it is possible to create sustainable and profitable operations in Construction, Infrastructure and Services if risk is managed well and accounting treatments are cautious. Investors require a bit more exposure to management and a range of views on the numbers to get an understanding of those issues.

Morgan Sindall is going through its best period of trading for several years. The company tell us today that in all areas of the it is trading well, including Fit Out which has had a very good 12 months in 2016 that continued into the first four months of this year. The prospect of doubling earnings over the next few years from the 80p achieved in 2016 is very real. The signal this morning is that EPS this year might be near to the 100p level, based on PBT of £52-54m versus £44m last year. The company points to its net cash of £115m at end March 0217 and the average daily cash in the first three months of £154m; it starts to beg the question of what it might do with the money as clearly the balance sheet might be “more efficient”. Our sense is that having been through a bad period in 2012-2014 the management will want to pause for a while longer on making commitments. Thereafter we suspect its will see opportunities in regeneration and partnership housing as well as perhaps returning any surplus cash to investors. That is probably an issue to be resolved later in the year/early 2018 and it’s a very high quality one. The company has been strong in its commitment that it will avoid acquisitions. So expect to see MGNS shares perform well today and in the mid-term as 160p of EPS is possible and if it gets near that level the price at 1043p at close last night looks wrong.

G4S has issued a short statement but when revenue is up 8.9% in Q1 on the same period in the prior year the numbers are doing the talking! A few more numbers on comparisons on a L4L basis and at constant FX rates would help. But the indication that organic revenue growth was in excess of 10% in developed markets and stable in the emerging ones tells us much of what which is reasonable in the UK context, less so for US investors. The other important way of looking at the statement is that the company has not highlighted any issues to worry investors and is now moving forward solidly and sustainably. The increased revenue should allow margins to improve, as promised previously as overhead absorption increases. We are also told today that the disposal programme has led to the sale of Youth Services in the US realising $57m of cash so the trend to having net debt/EBITDA below 2.5x by the end of the year continues. The market expectation for EPS this year is 18.5p and taht will rise in 2018 to just over 20p. At 314p at close last night G4S looks cheap, based on progress YTD.

No prizes for guessing that Mitie topped the table in our universe and Galliford Try was the largest loser. There is much chatter in the press on these two today so further comment on the obvious is avoided here.  Mitie’s 9.3% rise to 231.1p came after it cleared out all of the history and can now show a clean set of numbers; the issue for investors is whether at this level much of the upside is already in the price. That may be the case for now as proof that the changes made to the operations and management is delivering results is needed. Butte long term nature of its contracts and the essential nature of its work suggests that in the mid-term the rating will improve.

Galliford Try’s unscheduled update did not help the price, it fell 10.5% to 1308p, and almost exactly £100m was wiped off the market capitalisation which matches the c £100m of reduced Enterprise Value from the cost of the write-offs on the Forth Bridge and the Aberdeen roads. Clearly the recovery in Construction margins in 2018 and beyond will now be more certain but the performance in recent years begs the question of why continue in this space. Part of the answer is that pulling out is very difficult and the part ids that ROCE can be very good when things go well. The company assured us that it is trading well apart from on these two large projects so we can expect the share price to pick up a little from the close past night but it will take time and some ”selling” to get back to previous peaks.

The other comment that is not covered in the press relates to the collateral damage suffered yesterday by GFRD’s partners on Aberdeen, Balfour Beatty and Carillion, both of which fell, 5.1% and 2.1% respectively. It is possible that both could be trading through the known issues on that project and the absence of specific comment from them suggests that they are. But the market will remain cautious as it may take a view that GFRD is being more reasonable than the others. It depends on the work packages in which each is involved, of course. The answer may lie in GFRD having taken a very cautious view on contract out-turns and the others being more optimistic. Both BBY and CLLN know the rules of engagement in the quoted space so if they have known problems of a substantial nature they would have told us by now. The issue therefore is about accounting and contract assessment which is where we started!

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
3 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 3rd May 2017

Whoops, we missed Mitie’s announcement as we were a bit distracted by Galliford and Costain Galliford Try has provided a bit of shock this morning with a £98m write-off on two infrastructure JVs in a trading update that indicates almost all other activity is going as planned or better. We shall do a bit more work on GFRD and the company may call us back before the 10am conference call. There was some relevant news yesterday after close of play. Costain, John Laing Group (JLG) and Pennon all announced that Manchester waste project has moved to the next stage.

Whoops, we missed Mitie’s announcement as we were a bit distracted by Galliford and Costain. The news today has several parts but seem to draw a line under the previous regime’s worst habits and while trading is said to be challenging that is not new and is no worse for Mitie than others, in our view. The key thing is that the company can now look forward with a clean set of numbers albeit that here are some cash costs which will cause debt to rise and creates the need for an EGM to alter articles relating to debt limits. The write-downs announced today reduce reserves such that the company may technically breach net debt to reserves ratios. The company is also seeking to alter its banking covenants to remove the risk of a breach if cash costs of restructure and lower earnings in the restructure phase.

The key number today is that a further write-off of up to £50m is expected as the company now believes its treatment of percentage of completion on contracts and allocation of mobilisation costs is more aggressive than most rivals and needs to be adjusted. Of that amount only £6m is expected to be a cash item, payable this year. Also, somewhat curiously the company has identified “material errors” in the 15/16 accounts which mean the 16/17 accounts will show results up by between £10 and £20m; the phrasing is a bit vague but suspect it refers to operating profit. Finally the costs of change have risen to £15m from £10m as more redundancies than originally planned have been processed; this may be positive for earnings but we will need to wait for the results to find out, now planned for the later date of 12th June as a bit more work is needed.

This is probably the end of most of the storms the new team will face with just one more that is likely. When the Annual Report is published the departure terms for Ruby and Suzanne will be released. Given that the historic accounts contained not only substantial differences of approach to the timing of declaring revenue and cost, compared with sector peers but also material errors shareholders might be disappointed when they see the leaving packages. After that the new top team should be able to proceed with creating a £2bn annual revenue company with 4-5% operating margins and 4-5% annual revenue growth by 2019; that should deliver EPS of 18-21p depending on interest costs and tax rates. That prospect justifies the 200p++ share price.

Galliford Try has provided a bit of shock this morning with a £98m write-off on two infrastructure JVs in a trading update that indicates almost all other activity is going as planned or better. The group is anxious to point out that these were contracted in 2014 or earlier and are now “legacy” contracts, a term used more frequently in the sector these day to mean an expensive set of mistakes, usually which can be blamed on somebody else! We have yet to speak with the company to identify exactly which projects are being referred to and who the partners might be. The issues in the Scottish schools with collapsing walls are well known and came mainly as part of acquisitions. The problem for GFRD right now is of course that its risk management on recently contracted work is now in question. The costs are mainly cash it would seem and are due to be completed this summer and the larger proportion will be completed this time next year. It would seem to an outsider that the company expected to contain the costs within guidance but they are just too large. There will no doubt be some legal battles over liability and we suspect £98m is worst case but we have yet to confirm. There might also be questions around the timing as these issues must have been known on 21st February, if not quantified, when the half year results were announced and the new targets were outlined.

Of course this comes at a time when the new CEO is settling and in general the operations are performing well. In house building GFRD confirms the evidence of others that trading conditions are good and forward order books are strong and margins are higher than last year. The landbank has been shortened slightly to improve ROCE. It has secured planning on 97% of plots for 2017/18 and 76% for the following year so the changed approach to land should not affect production rates. In partnership homes the order book is up 6% compared with end December and margins have improved, as expected.

We shall do a bit more work on GFRD and the company may call us back before the 10am conference call. It looks to us as though this will not impact greatly on the achievement of the targets set out in late February other than in terms of the net debt. These contracts in question were large ones and were on a fixed price basis, a type of arrangement the company no longer uses so there is an expectation they are one-offs. The company has stated it intends to pay its dividends as outlined in recent updates. The share price has been winking at investors for some weeks and refused to budge while other sector stocks were rising a little. Our view is that this is a one-off but the company needs to have 6-12 months of solid performance, with no diversions into intended acquisitions, before trust will return. Damage may be limited today as this is really only about some historic projects but it may hit 1300p in the next few weeks before seeing 1800p again. It closed last night at 1461p.

There was some relevant news yesterday after close of play. Costain, John Laing Group (JLG) and Pennon all announced that Manchester waste project has moved to the next stage. The Greater Manchester Waste Authority (GMWDA) has agreed to serve notice to terminate the contract in which JLG and Pennon have a JV to supply waste treatment plants to GMWDA, the main subcontractor being Costain. The work started in 2009 and is said to be a £630m project. In JLG’s announcement the plants are said to be operational and landfill conversion is ahead of contractual requirements. JLG refers to a decision that appeared in the minutes of the GMWDA at its meeting on 28th April and not any formal direct notification to them; we suspect that the informal discussions started some time ago so the situation is not wholly fraught with tension. Whatever the communication process the toothpaste is out of the tube now and it’s not going back in, contract termination means contract termination. A joint transitional plan is due to be presented at the AGM of GMWDA on 12th June 2017 and a limited liability company is to be established to manage the facilities in the future.

For all parties this changes the dynamic and, in the JVs case the long term delivery contract it’s not clear. Costain is our main focus and its task was to complete all 43 facilities. That is nearly done to contract terms and is taking a bit longer than expected as the sites access is restricted because they are operational. We suspect the change makes little difference for Costain. No doubt discussions have been ongoing about the transitional deal as that is the way these things work but until the detail is known it’s difficult to assess the outcome on earnings. We expect Costain will see none and it may be good news as it will close the chapter on these events.

The winner yesterday was G4S which rose 2.9% to 314p; we have been saying for some time that the market had been missing the point on this stock. The update later this week is likely to be positive though the share price is getting nearer to being up with events. Catalysts for further improvement will arise from completion of the disposal programme, lower net debt and new work contracts. All three things are going to happen and there is still time to get on board on a 2/3 year view as revenue and margins are both set to grow faster than the sector average. Atkins was the back marker as it fell 1.8% to 2108p; the price has recently been pointing to expectations of another party entering the bidding but the move yesterday suggests that the sentiment has altered. The sector performed well yesterday with few losers.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
2 May 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 2nd May 2017

News this morning comes from Bovis with a trading update related to its AGM, Breedon has made a small bolt-on acquisition and Civitas Social Housing has spent a bit more of the £350m of equity raised. Bovis has made the expected affirmation that the start point is getting the build process to where it should be. Breedon has bought a small “mini mix” concrete operator based in Oldbury. News this week is expected from Carillion on Wednesday at its AGM, at which it usually provides an update. On Thursday from Morgan Sindall, has its AGM and G4S provides an update and on Friday T Clarke has its AGM and will most likely tell us about trading YTD.

News this morning comes from Bovis with a trading update related to its AGM, Breedon has made a small bolt-on acquisition and Civitas Social Housing has spent a bit more of the £350m of equity raised.

Bovis has made the expected affirmation that the start point is getting the build process to where it should be. New CEO Greg Fitzgerald is wasting no time by visiting all sites and getting right what exists before resuming growth. The read across on market demand is positive; the company states that interest is high, evidenced by prospects per site being higher than last year, though no data is provided. The high level of visitors may also be evidence that the brand, while possibly tainted by recent experience, is recoverable saved in partly by location trumping brand in housing in the UK. The issue therefore is whether Greg will make the difference. It’s too early for clear signs but the focus on getting the basics right is encouraging. With the sales rate at just 0.48, well below the industry average, there is scope for much productivity improvement in that key measure and other factors such a good landbank, which means most of 2018 production already has the required consents, point to a high probability of success.

At 921p making the case for Bovis being a recovery play within the sector is not difficult but it will be 2019 before it shows fully in the business and in the meantime there is a lot that might happen in the housing market. The risk level on Greg getting the best from Bovis is low in our view, the likelihood is that he will succeed swiftly so any risk is more market that Bovis specific in our view. The company has confirmed the dividend increase at 30p for last year’s final (up from 26.3p); it also stated that the dividend for 2017 will be at least the same as in 2016 at 45p for the year.

Breedon has bought a small “mini mix” concrete operator based in Oldbury. No data is provided on the business which seems to have little more than eight mixer trucks and a customer base in the West Midlands for its four tonne loads of concrete and screeds. Operating downstream from its quarries is good business for Breedon as it allows them to sell lower grade quarry product that has limited use other than in ready mix at a good price. There is no trading news reported but we suspect that the positive first quarter continued into April, given what the housebuilders are saying and the favourable weather conditions.

Civitas has struggled to find housing stock and the news today shows it not really getting any easier. The company has paid £11m for 10 properties in three different regions with 55 tenancies, all of which appear to be special needs ones. The yield is not stated but said to be in line with expectations and will be enhanced when leverage is applied. At present the company has spent a small part of the £350m equity raised, we estimate around £50m, so seeking debt funding might be premature. But such leverage is needed for the company to get the returns promised in the float. We expect Civitas will continue to struggle to get scale as most Institutions can invest in the sector with requiring a quoted vehicle, with its associated costs, to mediate in the process. Most Housing Associations do not need to sell their stock.

News this week is expected from Carillion on Wednesday at its AGM, at which it usually provides an update. On Thursday from Morgan Sindall, has its AGM and G4S provides an update and on Friday T Clarke has its AGM and will most likely tell us about trading YTD..

In the last trading session on Friday Balfour Beatty was the best performer, up 2.7% to 291.8p. The market capitalisation is now £2bn. Assuming that the PPP/PFU portfolio is worth £1.2bn the £0.8bn implied price tag on the rest of the business remains very low. OK on a p/e basis on current earnings expectations is look expensive but value it as a long term assets (PPP/PFI) and an operating company and a value of 350p+ a share is not out of court.

Berendsen was the biggest loser in the last session, down 3.0% to 842p but it was not a big issue as it was just some retracement on earlier gains. The valuation at just under 14x will look quite cheap if the management gets the full benefit of its many initiatives into its earnings.

Last weeks moves

The market rose 1.3% last week but the sector’s progress was quite mixed with the housebuilders faltering, down 0.4% (though still up 11.4% YTD) and the Services stocks rising 1.9% and the Construction and Materials index up 3.6%. The HICS segment is still well ahead of the market YTD. On fundamentals we expect it to shed some of the relative gain but recent M&A talk (Bovis & Redrow or Galliford Try) and action (e.g. SNC-Lavalin & Atkins) point to such speculation being a support for sector share prices.

Berendsen was the best riser over the week as a whole, up 7.8% despite the dip on Friday. We have commented earlier on the substantial number of management initiatives that we suspect might be hard for the business to digest. But certainly there seems to be no external reason for the company not to succeed.

The largest faller, down just 2.4%, was Galliford Try as it is having to work hard to get a following at present. The management changes that are not yet proven and difficulties in Construction, allied with market nerves about housing, are combining to create a bit more uncertainty than normal. The approach for Bovis also related some nerves about strategy implementation coming so soon after a good declaration of the new CEO’s goals and ideas. With 150p of EPS expected this year and a yield of 6.5% Galliford Try looks cheap on that measure and on many others.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
28 April 2017

Market Commentary - Housing, Infrastructure, Construction and Services 28th April 2017

Following a plethora of news yesterday, today is relatively quiet with just SNC-Lavalin’s announcement that it has raised C$1.3bn of the required C$3.6bn needed to buy Atkins, slightly more (C$80m) that was expected from the public subscription and CDPQ placing. Berendsen’s update was popular with investors and the stock rose 5.8% to 869p, its highest level since early March this year when the second warning triggered a sell off.

Following a plethora of news yesterday, today is relatively quiet with just SNC-Lavalin’s announcement that it has raised C$1.3bn of the required C$3.6bn needed to buy Atkins, slightly more (C$80m) that was expected from the public subscription and CDPQ placing. Including the pension deficit the deal is worth C$4.2bn but the cash needed is lower. So with funding in place it seems that the only potential glitches might be from regulatory sources and from contracts that need to be novated. We expect that neither will be an issue but time will be needed to reassure some of the major customers. Useful therefore to have Heath Drewett remain as the new CEO.  So all the milestones for the deal to complete in the Autumn are being passed and Atkins will soon be part of a larger entity.

Berendsen’s update was popular with investors and the stock rose 5.8% to 869p, its highest level since early March this year when the second warning triggered a sell off. The release yesterday was short and played down the extensive measures being taken to improve performance and focused on the intended outcome, better margins. So even though sales are down in the UK, as expected, investors gained more confidence from hearing less! Or perhaps it was just that the update was reassuring and showed that there is no systemic issue at the company, either internally or with its markets. EPS of 58p this year and a share price at 869p is a prospective p/e of 15x which is still below the valuation of several peers but may be up with events until the half year numbers are released. There were few other upward moves yesterday and all were by less than 1% as sentiment turned a little negative on the HICS sector.

The backmarker yesterday was Morgan Sindall which fell 3.9%, 34p, to 1060p. There were only 20,530 shares traded and the stock went XD with the 22p final dividend from last year so it was really a 0-0 draw with the market. Other stocks that went XD yesterday were Polypipe, 7p final and G4S 538p final, both of which fell a little, just over 1p, so not as much as the dividend which is a result on a dull day.

We spent quite a bit of time yesterday with organisations discussing the effects on equity research arising from the implementation of MiFiD and, with a different group, ways of corporates handling pension deficits without handing over large chunks of cash the shareholders will never see again.

MiFiD II is happening, starting later this year and the preparations at many financial sector organisations are well in hand, including the main information providers. But our sense is that many corporate have yet to work out how they will handle the inevitable substantial loss of research capacity as broker lists are halved and funds allocation to research much reduced. The impact might be very substantial. Get in touch if this is of interest and we can provide more background.

Companies that have a large pension deficit and are paying big amounts of cash each year into a pension fund seeking 3% pa returns which might remain in the company and earn 15-20% pa now have a viable alternative that will mitigate some of the cash allocation burden. Get in touch if this is of interest and we can talk you through it.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
27 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 27th April 2017

It’s a big day for news with AGM related trading updates across the patch including Berendsen, Taylor Wimpey and Persimmon. Q1 trading updates from Howden Joinery, Countrywide and Travis Perkins have added to a busy morning. The trend in the last week has been for there to be far more risers than fallers in the HICS sector and stock prices are creeping upwards. That trend is not wholly consistent with the increased level of uncertainty now faced by UK companies in terms of the home market.

It’s a big day for news with AGM related trading updates across the patch including Berendsen, Taylor Wimpey and Persimmon. Q1 trading updates from Howden Joinery, Countrywide and Travis Perkins have added to a busy morning. The theme in all of the statements is similar in that trading is tough but improving despite, in some cases, high comparators. Only Countrywide bucks the trend as it is faced with a 13% decline in revenue versus last year due to stamp duty changes boosting Q1 last year and a reduction in transactions that is happening, due to current conditions. With most major banks starting to take staff and activities to Euroland cities at present London activity was bound to be lower. Countrywide tell us that the General Election should not alter expected activity in 2017 as whole and transactions will be around 5% lower than last year. The company is upgrading its digital marketing and has a cost transformation programme in place which will aid performance. But it is clear the market for buying and selling hand houses is suffering from a lack of available stock; there is not obvious evidence of a lack of demand at present.

Berendsen’s update tells us that trading in Q1 to end March in line with expectations with underlying revenue at CER up by 3%, reported revenue up by over 10%. The company continues to implement substantial change programmes which it expects will improve margins. CFO Kevin Quinn has indicated he will “retire from the company” in April next year; new CEO’s tend to have their own ideas about who they want as FD so 21 months on from the change at the top this is no shock. The market is expecting EPS of around 58p for the current year and 59p next year; the risk on next year must be upwards as the impact of operational changes begin to take effect. At 824p at close last night a 14x prospective p/e is on the low side compared with past valuations and below peers such as Rentokil and Compass so there should be support today.
Taylor Wimpey gets the General Election impact into its statement quite early, which is realistic as elections tend to slow activity and given we are into the spring selling season the housebuilders did not need the third big poll in three years in England and Wales to disrupt the market, but they have. The good news is that the market in the first four months of the year has been positive and TW tell that they have done very well. The sales rate was 0.93 sales per site per week and reservations are 16% higher than last year and the cancellation rate has dropped to 10% from 11% (below 20% is good). The order book has 9,210 dwellings in it now compared with 8,811 this time last year. The only blot on the landscape is the £130m provision the company is making for selling houses with a leasehold entitlement with onerous increases in rents. The cash impact will be spread over a number of years. The company is seeking to alter terms on the leases it has sold as well as those it retains. This type of lease contract, used from 2007 to 2011 must have seemed like a good idea at the time but not now. The £130m is not onerous in the context of TW and therefore the company statements about trading and the mid and long term prospects and the dividend programme will find support, in our view. It will, however be a long six weeks between now and 8th June.

Persimmon’s update tells us the company has had an excellent performance (does that beat TW’s “very well”!). Forward sales revenue is up 11% at £2.6bn, compared with £1.9bn at end 2016 and visitor levels are up 6% against last year. We are told the sales rate is 12% higher in Q1 than at this time last year but not the actual rate. We expect that it is around 0.8 which is clearly a tad lower than TW’s but it is an improvement and is strong compared with many peers. The capital return plan is intact we are told at the new higher level. The company does not mention the Election as a factor in its thinking though we are sure it will be there, especially in relation to continuing support for the housing sector from government. The company is more exercised over the issue of getting detailed planning permissions which is needs to open 90 new sites this year of which it has opened 67 to date.

Both TW and Persimmon have provided positive updates. It has yet to be seen whether the Election will have an impact on Spring selling activity, the number so far suggests not but no doubt there will be questions on conference calls about any changes in the last week. With new build being the main source of supply of dwellings at present and mortgage rates remaining low the outlook described by the pair seems to pass all tests of reasonableness.
Travis Perkins indicates that it has achieved solid L4L sales growth in Q1 with a 2.7% increase, 4.9% overall. The increase has come from pricing to recover inflation costs rather than volumes. The problems in plumbing and heating are not yet resolved, it will take time and sales in that segment are down 1.1% L4L in the period versus last year. The more significant issue is that sales in general merchanting are down 0.3% L4L (up 3.1% overall) which the company indicates is in line with expectations and it seems more concerned about price inflation recovery than volumes. The highlight was a 12% L4L rise in sales in the contracts division, against a weak comparator in 2016 but as the company points out on a two year view sales are 14.5% up L4L. Travis Perkins states that it will meet expectations for the full year which are for EPS of 113p so the share price at 1607p last night might be seen to be up with events by many people.

We visited the Stewart Milne timber frame factory in Witney yesterday. There are a number of findings that are important but the impact on Merchanting is relevant today, given TP’s news. The impact of more factory production of sub-assemblies and component in new house building going to site via the factory, made with materials bought not through a merchant but direct from the manufacturer, is only starting to play out. There is a strong case to say we are at an inflection point in this regard with substantial investment currently being made in offsite production, especially of wall, floor and roof assemblies.
Howdens tell us the company is performing in line with expectations with revenue up by 3.9% overall and 2.4% on L4L depot basis. The expansion programme continues with 30 new depots expected this year making it 650 in all at present. The company tell us that the market is stable and that it has mitigated some of the impact of FX inspired cost inflation with sales initiatives. But, as might be expected, there is a hint in the release that the company is hoping for the best and preparing for life to get a bit tougher and more uncertain as the Election (not mentioned by the company) approaches.

The trend in the last week has been for there to be far more risers than fallers in the HICS sector and stock prices are creeping upwards. Yesterday Berendsen led the way with a 3.4% rise to 824p as it gradually restores its credibility in the eyes of shareholders. Rentokil fell back after its trading update last week to the 240p level but another 1.7% rise yesterday saw it back at 2499p. That trend is not wholly consistent with the increased level of uncertainty now faced by UK companies in terms of the home market. The main losers yesterday were down just 1.2% (Polypipe) and 0.9% (Grafton) which we expect to be no more than trading flow rather than anything else and a bit of profit taking. We also note that the level of shorts on Carillion has fallen to 21% from 24% based on Castellain Capital data; perhaps the market is starting to believe, as we do, that the Balance Sheet cure process has started.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
26 April 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 26th April 2017

Forterra announced that the Lonestar shares had been placed a few days ago and today Ibstock has announced that the remaining private equity holdings in its shares have been placed. CRH has updated the market ahead of its AGM today. We are visiting the Stewart Milne modular housing factory this morning.

Forterra announced that the Lonestar shares had been placed a few days ago and today Ibstock has announced that the remaining private equity holdings in its shares have been placed. So both companies now have 100% free float which will make price moves a little more representative of the underlying performances. Forterra closed last night at 219p, its highest level since flotation now that the “overhang” is gone and the Ibstock shares were placed at 215p. The initial indication for Ibstock was that only 50m shares might be placed but this morning it was announced that all 101.6m shares held by Diamond SARL have been placed, such was the level of demand.

CRH has updated the market ahead of its AGM today. L4L sales rose 3% in the first quarter to end March and EBITDA is said to be ahead of last year. The company starts by telling us that the weather has been favourable generally, an important factor to bear in mind in this sector, especially so in some of CRH’s product areas. Sales in the US were in line with last year in L4L terms, against tough comparators but 6% growth in Europe provided a boost. The main point we note in the CRH update is the positive remarks about trading in Europe which is picking up quite strongly, an important read across to other stocks. The only black spot for CRH appears to be the Philippines were sales fell 12% L4L, due it is said to unfavourable weather and highly competitive market conditions. We look at CRH only for read across.

We are visiting the Stewart Milne modular housing factory this morning and will report any relevant news on that tomorrow. Some significant investment is taking place in modular housing at present which will have an impact in several different ways, not just in terms of build processes but also for supply chains and routes to market for materials.

Morgan Sindell rose 3.6% yesterday to 1117p, its highest level since late 2007, on 341,311 shares traded, a large volume in this stock. It has more to gain than many rivals from getting margins back to industry norm levels, a journey it has started and will continue. The route to EPS well above 100p in 2018 is clear from what we can see given progress to date and the markets in which it operates. It successfully exited its troubled projects some time ago and the level of risk management now applied is high. Carillion received favourable broker comment and rose 2.8% to 222.4p. The level of shorting of the stock has fallen in recent weeks and now stands at near 21% versus 24%, according to Castellain Capital’s data. That is still a high level but the direction is much improved. There is no silver bullet that will improve the balance sheet but we suspect the new FD is looking at options, other than raising new equity. The EPS level has been static at around 35p for a few years; forecast indicate that some growth is possible in the next 2/3 years but the real boost to the price will come from balance sheet improvements.

Grafton was the back marker yesterday but we suspect that was just a bit of profit taking after the recent good performance, it fell 1.2% to 755p. The same can be said for other fallers such as Serco, down 0.9% and G4S down 0.8%.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
25 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 25th April 2017

News from three companies provides interesting read across, Havelock Europa (fit out specialist), Carpetright and Vp, the hire company. Serco was the class act yesterday, up 3.8% to 117.9p. Our view has been consistent; inside the operations there is a great company emerging with the right values and systems in place.

News from three companies provides interesting read across, Havelock Europa, Carpetright and Vp, the hire company. Haveloock’s finals for the year to end December were good with revenue up 21% to £59m, despite the loss of a major customer at end 2015 and operating profit was £0.5m, following a loss of £0.6m in the prior year. So Havelock has improved and been able to make a profit; Havelock is not a great story at present but the read across to the fit out operations of Morgan Sindall and Interserve is positive in terms of demand.

Carpetright is a good indicator for housing market conditions as changing the carpet and house moves generally correlate closely. UK trading in the 12 weeks to 22nd April saw L4L sales up by 1.4% despite tougher market conditions; according to Carpet right competitors also found trading tougher. It’s not clear what the comparison point is but that may be being a little petty. Interestingly, for read across to Grafton and SIG, sales in Europe (which is Belgium, Holland and Ireland in Carpetright’s case) also rose 1.4% in local currency which is regarded as part of a continuing recovery in consumer confidence. The read across in the UK, where RMI has struggled since 2008 is OK, but not overly positive, which is consistent with the message so far from the Merchants.

Vp has announced its second acquisition in recent weeks. On 7th April it announced it had paid £3.6m for parts of Jackson Mechnical Services and today it has released a statement telling us it has bought Zenith Surveying Equipment for £3.9m, plus assumption of £2.3m of net debt. Vp has avoided the hire of generalist low end kit (picks, shovels, hedge trimmers, concrete mixers, arrows, drills etc) that can now be bought as easily and cheaply as it can be hired. This extends its operations in specialist kit that needs to be in 100% condition to be accurate and is not used every day on most projects, hence hiring is better than owning for an operator. In the mainstream hirers this is also the direction of travel in terms of equipment but HSS has been left behind in this area, hence its difficulties. It is still piling low end stuff high and trying to rent it cheap; compare the websites for yourself. Vp’s recent trading update (7th April) was positive and indicated it had traded in line with expectations for the year ended 31st March and its results will be released on 6th June 2017.

Serco was the class act yesterday, up 3.8% to 117.9p. Our view has been consistent; inside the operations there is a great company emerging with the right values and systems in place. But from the outside there are concerns about the dividend restarting (it will happen), contracts being retained and new ones won (they are happening) and the old bad stuff being sorted (happening, albeit slowly). The prospect that the business might be renewed swiftly was always remote but when looking back in 2019 it may seem to have been very rapid, such is the degree of change. Some big contracts are still in the mix, Compass and Obamacare the most notable but the big picture is the best place to look. Many will say it’s cheap on a 2/3 year view.

Interserve also had a positive day, up 2.8% to 229.7p. While we believe it has many good contracts the new top team has yet to appreciate the size of the tasks ahead and the £170m provision for waste to energy was a best guess, not worst case. Debbie White, the new CEO does not join officially from Sodexo until September. Investors still need to take care, even at the current level.

Only three stocks fell yesterday Capita, Galliford Try and Mitie, all companies about which there are some concerns, different in each case. Capita may still need an equity raise, Galliford has some issues in contracting and Mitie has still to have its full and final kitchen sinking. The declines of between 0.1% and 0.5% would normally be inconsequential save that on a day when the market rose UK market rose by over 2% a dip is not ideal. But it really was about flow yesterday rather than a fundamental message.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
24 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 24th April 2017

Bovis, Interserve, Civitas and Mortice have all released small items of news today that are relevant to them and have read across. The sector performed relatively well last week, down just 1.0% against the market down by 2.6%. The strength of Sterling versus the US $ caused some changes in views on earning which were purely technical, FX related, rather than a comment on business performance.

Bovis, Interserve, Civitas and Mortice have all released small items of news today that are relevant to them and have read across. At Bovis Greg Fitzgerald has spent £1.2m on second hand Bovis shares at 925p each as he starts his new role as CEO. Not quite the amounts spent by Phil Bentley and John Morgan in recent months (>£3m in their cases) but it is a strong statement of intent that will be heeded. It’s not a massive amount of cash but it is meaningful enough to make the statement Greg should wish to do at this stage. Interserve has announced a small contract worth £36.5m to design and build a new school in South Wales. Civitas floated six months ago raising £350m of equity to buy social housing assets and has really struggled to find stock on acceptable terms. Today’s announcement that it has spent £3.5m on the three properties with 13 tenancies with a net yield of 6% is typical of what it has been able to achieve so far. Institutions can invest directly in property and in social housing projects so the role played by Civitas in the process, which is purely about tfhe property and not the services, is debatable. Civitas remains unleveraged so the returns to date at around 6% on purchases are likely to be some way short of the cost of capital. Whether Civitas will eventually find stock remains to be seen but at present it is sitting on at least £300m of the funds raised and earning sub-optimal returns on investments. Investors might have expected a more mature investment execution plan on coming to market. Mortice, a small FM and security operation, is quietly implementing its plans and has paid up to £4.5m to buy Elite Cleaning and Environmental Services with a mix of £1.8m net cash, £1.5m new Mortice shares and a £1.0m earnout.

The week ahead is relatively quiet as we enter the AGM trading update season and the reporting of the March and September year ends. It all happens on Thursday when Countrywide, LSL Property Services, Berendsen, Persimmon and Taylor Wimpey have their AGMs and we suspect that they will say something about trading YTD. Travis Perkins has a trading update scheduled, its AGM is not until 24th May and Howdens Joinery will also update on trading ahead of its AGM on 2nd May. We are expecting some positive statement from the housebuilders, merchants and materials producers regarding trading YTD all slightly tempered by a comment of caution regarding Brexit and the Election. Rightmove indicate today that asking prices for houses are still rising, up 1.1% in April; albeit slowly but that buyer affordability is stretched.

Atkins was the best performer on Friday last with a 5.4% rise to 2101p as the price responded to the recommendation of the Atkins board to the 2080p bid for the business. The bid is recommended and is unlikely to be topped by a rival bidder, in our view. At £2.1bn the consideration for £174m of EBITDA in 15/16 (as reported) and around £190m for this year (11x propective), is a full price in our view, especially when buyers must take into account the recent deal with pension trustees to pay c £35m a year to help to clear the pension deficit through to 2025. Nothing can be ruled out of course especially if another party believes it can create greater synergies than SNC-Lavalin believes it can deliver. Atkins is a unique asset, in our view so there may be a new bidder especially if they can unlock the issue of the pension deficit contribution, which we believe should be possible.

Mitie was the back marker, down 1.5% to 210p. We do not read much into that move in itself, but remember it has it results soon, end May and they will include whatever is needed to kitchen sink the financial reporting history and make a fresh start. We expect that most adjustments will be non-cash and the rebasing will do a bit more than the indications to-date. As we have said all along, it’s not a bad business just not as good as the numbers were showing in the reported headlines; the accounts showed enough to make investors wary but the way in which some accounting rules were interpreted were well outside the norm.

Moves last week

The sector performed relatively well last week, down just 1.0% against the market down by 2.6%. The strength of Sterling versus the US $ caused some changes in views on earning which were purely technical, FX related, rather than a comment on business performance. YTD the sector is up versus the market with the housebuilders near 12% higher and services 7% up, while the market is down (FTSE100) 2.9% and 2.6% (FTSE350). The relatively benign conditions for company earnings and in the markets are unusual and with ratings where they are the risks are down not up it might be thought. But there is a momentum at present that has few obvious catalysts for change. 

The moves last week were small and not really indicative of any change of view. The stocks took the election announcement in their stride really and seem impervious at present as earnings forecast are not undermined at present that seems logical enough. A bit of M&A chatter helps of course and with some real approaches being made it is not idle!

Atkins was the best riser last week, up 5.4% to 2101p for reasons already discussed. We note also the rises in Berendsen, where reputation is slowly being regained, up 2.7% to 781p and at Polypipe, which rose 3.5% to 406p. In the case of PLP the rise follows a positive report on 2016 and the recognition of good prospects for 2017 and beyond; FX moves have also been helpful. The back marker was Rentokil which had a positive Q1 trading update last week but FX moves probably reduced some of the impact of that. Other stocks with meaningful US earnings also took a small hit (e.g. Balfours, Serco, Compass) but there was nothing substantial enough to alter views on underlying trading.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
21 April 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 21st April 2017

The main (and only substantial) item this morning is that the Atkins board has agreed to accept 2080p a share and is recommending it to shareholders, the T&Cs having been settled. The week has been quiet for most companies and sector observers and there are few planned announcement for next week. Rentokil did announce today that it has won the Queen’s Award for Enterprise for International Trade in its Pest Control division but we figured that would not move the dial much on the share price; there is much other good stuff in the company that will, as we have stated.

The main (and only substantial) item this morning is that the Atkins board has agreed to accept 2080p a share and is recommending it to shareholders, the T&Cs having been settled. Montreal based SNC-Lavalin are likely to be the new owners and the process will conclude in Autumn of this year. The total consideration is £2.1bn plus the pension deficit/net post-employment liability of £424m. There is no doubt that SNC-Lavalin are buying a good business in which most of the heavy lifting to get to 8% margins has been done and which is operating in favourable markets. Equally there is no doubt that the consideration is ahead of where the Atkins share price might get to on 2/3 year view and the pension deficit is rising, creating a buying deterrent for some UK Institutions. SNC-Lavalin has recognised over £100m of cost synergies to be achieved in the first full year by combining the entities which help to justify the deal. Heath Drewett will remain with the combined entity and be promoted to “lead Atkins” and Uwe Kreuger will depart on completion.

Clearly the deal is subject to regulatory consents but aside from that our quick read of the documents suggests no reason for it not to go ahead and the price, we believe is full, taking into account the prospects, the pension deficit cash of £35m a year, payable until 2025 and £174m of EBITDA last year. The pension trustees might want greater assurances than shareholders and could still have their say and that may unfold; arguably the combined entity provides them with a better covenant and SNC-Lavalin appear to have recognised the potential issues. The Directors have given their irrevocable comprising 0.14% of the total shares so there is some way to go to get to the required 75% but few barriers. It will be interesting to see how the £2.1bn of SNC-Lavalin’s cash is re-cycled, which will be mainly into the UK market. There is no real quoted equivalent to Atkins and in terms of sector and geographic exposure Balfour Beatty is probably the closest.

Polypipe was the leader yesterday, up 1.7% to 402.7p, the first time it has closed at over 400p. 27p of EPS this year and 29p next are the current forecasts and a few bits of new data are helping the risks towards being up not down. There was not much movement at all yesterday, as we saw for much of the week. PLP was one of only two stocks that rose by more than 1%, the other being Homeserve which closed at 658p. Few stocks fell, with only five dropping by more than 1%, in a range from 1.0% (Travis Perkins) to 1.3% (Interserve). So nothing much at all to indicate future moves but the solid support for SIG (up 0.6% to 117.6p) is interesting and the graph on G4S, up 0.5% to 307p suggests that it has found a range of 290-310p at the moment.

The week has been quiet for most companies and sector observers and there are few planned announcement for next week. Rentokil did announce today that it has won the Queen’s Award for Enterprise for International Trade in its Pest Control division but we figured that would not move the dial much on the share price; there is much other good stuff in the company that will, as we have stated.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
20 April 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 20th April 2017

It’s all pretty quiet this morning with no company news to report. Balfour Beatty, Tyman and Barratt Developments trade XD today with the first two having final dividends at 1.8p and 7.5p respectively and the interim pay out from BDEV at 7.5p. SIG was the best performer yesterday rising 3.0% to 116.9p, its highest close since October last year.

It’s all pretty quiet this morning with no company news to report. Balfour Beatty, Tyman and Barratt Developments trade XD today with the first two having final dividends at 1.8p and 7.5p respectively and the interim pay out from BDEV at 7.5p.

SIG was the best performer yesterday rising 3.0% to 116.9p, its highest close since October last year. It is now up 15% YTD and the new CEO has not even started yet! The share price improvement reflects the latent/intrinsic value in the operations, we believe which the previous top team was not able to realise. Taking the current revenue of around £2.8bn, with 5% margins, £15m of interest payments and a 25% blended tax rate EPS of 15p+ is likely. Foremost among a number of recent issues was the failure to get the core operations in the best possible shape and get the margin for the value added it provided in distribution. Distribution is not simply another form of retailing and in SIG’s case it is quite different. If our quick maths is correct 116.9p is still the wrong price at p/e of at least 10x is justified. We expect that an equity issue is not needed and there have been several write-offs of past errors, which we believe contain the worst of the “bad stuff”. It’s not all plain sailing from here but there is enough to indicate that getting the core in better shape, which has started and by exploiting new areas, such as Insulshell/components for modular construction and air handling equipment, SIG’s pace of improvement could be quite rapid.

Grafton up 2.8% and Travis Perkins, up 2.7% were the other main risers yesterday. There may be a drift away from Wolseley, which is at its lowest level, 4781p, since early December last year as it drifts towards becoming a US domiciled entity. It may also be that the market has realised that the subsector with large UK exposure was a tad oversold. In the case of WOS its seems to have difficulties in all territories at present, apart from the US.

The back markers at close of play in yesterday’s session were Rentokil, down 1.4% to 244p and Compass down 1.7% at 1494p. FX changes, specifically £ strength versus the US$ will take some of the gloss from earnings improvements at both companies so a bit of selling pressure should be expected. The markets for both companies are unchanged but adjustment to FX was and remains inevitable.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
19 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 19th April 2017

Rentokil’s update this morning shows a positive picture for trading in the first quarter to end March 2017 with organic revenue growth of 3.1% and growth from acquisitions at 6.9%, all at CER. RTO is busy trading out of dull old Europe and into thriving emerging markets and the US, the prototype/poster child for post Brexit Britain?

Rentokil’s update this morning shows a positive picture for trading in the first quarter to end March 2017 with organic revenue growth of 3.1% and growth from acquisitions at 6.9%, all at CER. Growth in revenue at AER was 24% to £579m. The mid December announcement of the transfer of parts of the workwear and hygiene operations (Germany and Benelux) into a JV with Haniel is on track; excluding those operations boosts the organic growth rate to 3.5%. The geographic pattern of progress was similar to that we have seen in many UK operations, US and Emerging pretty good, UK alright but not great and Europe still struggling a bit though in RTO’s case revenue grew in the period. The overall picture is that Rentokil is performing in line with expectations. More below

Fourth big vote in four years will be enough to confuse the data and create a few fudge factors. In 2014 when the Scottish vote was in all seemed to be going fine, lots of positives ahead. There still are but there are greater uncertainties.  It’s not our job to comment on the Big Picture. But it’s enough to say that the uncertainty provides plenty of valid reasons for consumers and the public sector to avoid decisions and for companies to hold back on investment plans. The outcome of June 8th is uncertain as we all know. So expect the updates for UK biased companies in the next few weeks to be ridded ifs, buts and maybes about trading performance, driven by political events. No prizes for spotting the first UK General Election profit scare!

The stocks that will thrive will be those providing essential services in the UK, which means Mears, which topped the table yesterday with a 0.7% increase and services companies though many have construction arms which confuses the picture. When Mitie has its results out of the way, which is before 8th June we may have more visibility on its potential and it should trade well in the current uncertainty given contract durations. Serco and G4S should see good UK performance but struggled yesterday due to US FX exposure. The contractors performed weakly yesterday, no doubt election inspired projects delays were in investors’ minds. Infrastructure spending promises will be a key feature of the election debate we suspect and that will affect sentiment on the builders.

The main fallers yesterday had US$ exposure so that meant that Wolseley fell 3.2%, Balfours dipped 2.5%, Serco dropped by 2.4% and Rentokil tumbled a little, down 2.2%. In terms of trading prospects nothing altered but sterling’s rise affected expectations about headline earnings. Whether Sterling’s strength was just short covering as uncertainty increased or genuine reappraisal has yet to be seen.

The rise and rise of Rentokil continues. We are told today that the company has bought 12 businesses YTD of which 10 are in pest control and one each in hygiene and property care and that most of the buys are in emerging markets. RTO is busy trading out of dull old Europe and into thriving emerging markets and the US, the prototype for post Brexit Britain? The JV with India’s largest pest control company, announced in March is further evidence of its intentions in terms of geography and markets. The JV is managed by RTO and currently operates nationwide and has revenue of £50m and employs 6,900 people. Rentokil also expanded in Saudi as its JV there acquired the market leader in commercial pest control, Sames.  The market expectation is that the company will achieve 12p of EPS this year and 13.5p next. But those numbers are, of course, subject to FX, which has clearly boosted headline performance in Q1 and will provide a varying effect as the year progresses. The shares closed last night at 248p, down 5p on the day. The rating at 21x 2017 earnings remains high by UK standards but not by that of its main US rival and the emphasis on rapid growth in pest control and emerging markets should aid sentiment today.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

18 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 18th April 2017

Bank Holiday over and the US market seemed to take Fake Armageddon in its stride. There is no new news today in the sector. Timely therefore for Balfour Beatty to issue another of its short thought pieces on UK infrastructure, the latest out this morning is on UK aviation facilities. The moves on Thursday last, the most recent trading session, had no real pattern.

Bank Holiday over and the US market seemed to take Fake Armageddon in its stride. There is no new news today in the sector. There is the usual speculation about housing and house prices which allied to news from recruiters (such as Hays Group which showed UK revenue down 10% in 1H’17) that job creation is slowing tells us that we are in a period of much slower growth but not recession. Most sector stocks have issued guidance that is cautious for this year and next so the slowing is well heralded. The point is that more dials are pointing in the “Slower” direction.

Timely therefore for Balfour Beatty to issue another of its short thought pieces on UK infrastructure, the latest out this morning is on UK aviation facilities. The main gist of what is being said is that the government needs rapidly to join a few dots on aviation infrastructure spending. If Post Brexit Britain is to be a success and “open to trade” then we need urgently to build new aviation capacity and not just a new runway at Heathrow but also new capacity at other UK hubs, such as Manchester in a holistic approach. We have long held a view that it’s not Gatwick or Heathrow for a new runway, it should be both and if Manchester does not get a new runway than the M6 will need ten lanes each way. Brexit in two years and a new runway at Heathrow in 15 just does not cut it, is the thought.

News later this week comes from Rentokil tomorrow with a trading update tomorrow and that’s it in terms of timetabled releases. 

The moves on Thursday last, the most recent trading session, had no real pattern. Grafton was the best performer, up 2.8% as confidence returns and Euroland recovery is aiding stocks with EU exposure. We cannot say it was the merchants in general that got support as Travis Perkins, down 0.5% and SIG, down 0.4% were the back markers! Our sense is that the sector has gone a bit drifty lately in the absence of much news in the last 2-3 weeks which is to be expected post results and with a lot of noise over Brexit but not much action. The rise in sterling in the last week may take the shine from some FX exposed stocks this morning (Compass, Rentokil) but there is no strong shift in sterling just a drift to strengthening.

Moves last week

The sector was broadly flat at the end of the four trading sessions last week as was the market. For choice the housebuilders improved slightly, just over 1% but it was not substantial. The HICS sector remains well ahead of the market YTD. The main UK related market indices are up 3.5% YTD and the sector is up by 7% with the housebuilders leading the way, up by 13%.

High flying Balfour Beatty was the best riser last week, up by 7.5% to 290p, following favourable broker comment. We believe it will not be very long before the company is able to be much more confident about its outlook in normal trading. The PPP/PFI portfolio is also now more valuable than it was six months ago, in market terms, as the share price of InfraCo rivals have strengthened. We regarded 300p as the level were targets might be pitched at the turn of the year when it was 270p; the absence of adverse news and the progress shown at the results suggests that 350p might be a realistic target as long as earnings continue to trend to 30p a share by 2019. Given the timing of the rewards packages and that we are now over two years in to the renewal project we expect to see some substantial developments next year.

Mears was the largest faller down just 2.5% to 503p. Given the low volume of trade in the shares it is always wise to look sceptically at short term moves as indications of longer term trends in this stock. It has been trading in a higher range since mid-January 2017, 500p to 540p and there are few reasons in terms of the underlying operations why that should change in the coming months. It is a well-run company doing fine in good markets having resolved some structural issues during 2016; strategically it has been well ahead of rivals at spotting the trends in its market and acting accordingly and proportionately.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
13 April 2017 · 2 min read

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

HSS Hire has announced that CEO John Gill is to step down and the company is now seeking its third CEO since floating two year ago. Sodexo has released its first half numbers and they are not the best improvement on last year that we have seen.

HSS Hire has announced that CEO John Gill is to step down and the company is now seeking its third CEO since floating two years ago. The new man will lead the next phase of the recovery we are told as the heavy work load in reshaping the business is done and sales growth is now needed. John will remain in post until a successor is found which is usually not a good idea, in our view. It’s most likely that this will trigger a bit more upheaval in the business as any new CEO will want to do more than implement the other guy’s strategy. The evasive answers to some key questions at the results meeting (5th April) gave evidence of some lack of conviction about what the group might look like in 12 months’ time. The decision to have a change at the top is clearly quite sudden and unfortunate for all concerned. The shares closed at 64p last night and if we are right that there is likely to be more change ahead and uncertainty in the short term the price looks to be vulnerable. 

Sodexo has released its first half numbers and they are not the best improvement on last year that we have seen. Revenue was €10.6bn in six month period to end February, a 0.3% increase on last year at CER and no change at AER. Adjusted operating profit rose to €723m, up 7.7% at CER and 9.7% at AER; there was a €137m exceptional charge to profit in the period for the Adaptation and Simplification project which has accounted for €245m of spend and is now completed. The company still expects to grow revenue by 2.5% this year and operating profit by 8-9% and points to contract wins and easier comparatives as the main reasons for optimism. The company indicates that the performance was in line with expectations and of course the operating margin to 6.8% will be welcomed. The read across to Compass is clear. The message in terms of regional performances shows reasonable revenue growth in N America and good growth in the Rest of the World and weak performance in Europe; performance in Euroland was adversely affected by the Rugby World cup having been in the prior year numbers but even so revenue was still down. More below

SIG was the best performer yesterday, it rose 2.1% to 116.2p, its highest level this year and 13% up YTD. We picked out SIG as a stock that might potentially double on a 12-18 month timescale if the right appointments were made and we stick by that view. The tightening of insulation regulations in several countries, some recovery in Euroland build rates and a better accommodation between SIG and its suppliers are needed and seem to be happening. Germany continues to have a housebuilding shortfall and production is scheduled to rise this year, as it is in the UK. Our sense is that SIG’s new top team has a tough task ahead but it’s far from being “Mission Impossible” indeed its quite likely in our view. The key is working better with its main suppliers, from what we can see to ensure it is getting a fair return on the value it adds in distribution.

Homeserve was the back marker giving back some of its post trading update gain, it fell 2% to 633p. The decline was just the ebb and flow of trading based on a bit of short term profit taking, from what we can see.

The main message from Sodexo is quite positive despite the weak Euroland performance. Sales remain affected by weak conditions in the Energy sector and that aspect features in all three geographic regions. In all five operating divisions France is picked out as a weak performer dragging down the group out-turn; Compass has limited exposure in France. The company spent €165m on small acquisitions in the period as it continues to see growth opportunities so we should expect improved performance coming through in 17/18. The improvement programme is said to have delivered €60m of savings in the first half. The company points to a number of significant contract wins during the period which should have a positive impact in 2H so the notions that it will get 2.5% growth in revenue this year and 8-9% operating profit growth seem quite realistic.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
12 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 12th April 2017

Carillion has announced yet another contract success today, Countryside has made a trading statement for the first six months of its financial year to end March and Atkins, as expected, has issued a trading statement for its full year end on 31st March. Bilby has also provided us with an update for the year to end March 2017. Carillion’s good news is success at being appointed preferred bidder on a £75m project to build student accommodation in Manchester, for the University of Manchester, which is unusual as such facilities are often provided by third parties today. Countryside’s release indicates that it is trading well, as expected. Bilby has had a troubled couple of years since floating with its buy and build strategy in social housing maintenance and gas services. Atkins has added little to what the market knew already, which is right given the attention it has received recently.

Carillion has announced yet another contract success today, Countryside has made a trading statement for the first six months of its financial year to end March and Atkins, as expected, has issued a trading statement for its full year end on 31st March. Bilby has also provided us with an update for the year to end March 2017.

Carillion’s good news is success at being appointed preferred bidder on a £75m project to build student accommodation in Manchester, for the University of Manchester, which is unusual as such facilities are often provided by third parties today. The other unusual element is that Carillion will be doing some of the design work, or at least be responsible for it which is not always the case and provides evidence that there is probably increased demand for the contractors to provide more integration. This project is not large and Carillion usually announces work worth over £100m but the share price needs some good news and this project has some interesting aspects. It may not move the share price today but this is a good win for the company, in our view.

Countryside’s release indicates that it is trading well, as expected. It is doing what it said it would do in the IPO just over a year ago. It calls itself a home builder and urban regeneration partner and the latter is a much larger feature of its work than with housebuilding rivals, that should be positive for the valuation as the risk characteristics are very much lower in that area than they are in speculative building. Completions in the first six months of 16/17 rose by 31% to 1,437 homes and the sales rate was a high one in the sector at 0.89 (dwellings per site per week). Partnership completions were up 23% to 987 dwellings (69% of group total) of which 36% were private completions, 33% PRS and 30% affordable. This mixed tenure approach to such schemes will persist and not just at Countryside. The housebuilding segment showed sales up 54% at 450 units; ASP fell 31% to £540,000 reflecting the plan to reduce exposure at high price levels in its South East base. The company has added to its considerable landbank and now has 16,124 plots in the partnership division and 20,472 in the housebuilding area representing nine and twenty years respectively of current levels of output! The company does not say it but it looks to be on track for 25p of EPS which is the consensus for this year and if current market conditions prevail the risk is on the upside. At 261p at close last night the rating is in line with its peers.

Bilby has had a troubled couple of years since floating with its buy and build strategy in social housing maintenance and gas services. In addition to the trading update it has announced yet another change in broker and adviser, its fourth broker since coming to market. The company highlights recent contract wins and that it believes it is making progress but excludes references to key issues such as net debt, performance against expectations, revenue growth and margins. The focus is on gas servicing work in London and the South east for Housing Associations, which was the mainstream business before the float which caused it to think that it could grow in building maintenance as well as gas. Some of the acquisitions, such as Purdy were good business that have been hawked around for a decade other were not quite first class. We have looked closely at Bilby in the past and it seemed to be a good business when it came to market but margins at 13% were always going to be unsustainable. Some accounting treatments (now corrected) were questionable. At 39p, compared with a float price of 58p the shares may be ready for a revival as the company gets back to basics but it needs to get through a full year of trading to show it can deliver. It’s not an issue with its markets it’s about the company growing far too fast and being naive.

Atkins has added little to what the market knew already, which is right given the attention it has received recently. Expectations remain unchanged and the group traded well in Q4. The geographic pattern of strong US and UK and mixed conditions in other geographies is unchanged. The Energy segment reference is a tad more positive than usual indicating stabilisation in oil and gas markets. The company points to the beneficial impact of currency several times more in a cautionary way than anything else as it knows that FX can swing around. The company also highlights the recent settlement with the pension trustees in which it reconfirmed the existing plan, established in 2013, to pay around £34m cash this year into the scheme rising at 2.5% a year to 2025. This sum equates to near 20% of 2015/16 EBITDA. New instruments are fast emerging that will allow companies to use bonds rather cash to satisfy the Trustees legitimate requirement to have some cover in place for long term potential underfunding; it looks as though Atkins has continued with the existing method of lobbing in cash for now. The market now expects 120p of EPS this year but at 1978p the shares are boosted by the 2080p potential bid.

Balfour Beatty broke with the trend yesterday and rose 6% to 286.7p following favourable broker comment. The pack is starting to realise that BBY is past the worst of its problems, is probably “cured” but it’s still a bit early to put the full picture in the shop window. We are talking construction so stuff can bite long after the threat seems to have gone. Mostly it’s little stuff of no consequence but sometimes it’s not. So caution is the watchword and BBY is ensuring there is more than enough good stuff in the mix to be able to handle a problem on a few jobs. But with a PPP/PFI portfolio worth £1.2bn and a market capitalisation of £2.0bn the valuation is still way too low, in our view.

As for other stocks the outcome was very bland. Capita rose 2% to 554p and was the second best riser while Grafton fell 1.3% to 712p, the largest faller. Capita is starting to get some stickiness at around 550p despite much further change to come. We suspect Capita can work its way through its issues but the identity of the new leadership team is needed before investors can take a reasoned view.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
11 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 11th April 2017

There is limited new news this week and only Victoria plc, the carpet maker and distributor, adds to our knowledge this morning with a positive trading update. The topics raised most frequently with us are around the UK central government being so tied up with Brexit it is tempted to extend existing outsourcing services contracts and whether Greg Fitzgerald can turn around Bovis.

There is limited new news this week and only Victoria plc, the carpet maker and distributor, adds to our knowledge this morning with a positive trading update. It says it will deliver results “comfortably” ahead of current expectations for the year ended 1st April. The company makes no comment on market conditions in the UK; we have assumed they remain helpful to the company given its usual very bullish statements about the past and the future. The statement points mainly to the management’s own efforts to implement its buy and build strategy in the UK, Australia and more recently in Europe rather than market factors.

There were just a few risers in the sector yesterday despite the FTSE 250 rising 0.2%. Homeserve had the best showing, rising 1.5% to 652p. With market forecasts of 25p of EPS in the year just ended and 29.5p for this year the stock is trading on 22x propective p/e which is high for the sector. The largest loser was SIG, down 1.9% to 113.7p, up 10% YTD so the move yesterday we regard as a blip. These moves were in a narrow range which is quite typical of a pre-holiday period with low volumes and no clear sense of direction in the macro environment.

The topics raised most frequently with us are around the UK central government being so tied up with Brexit it is tempted to extend existing outsourcing services contracts and whether Greg Fitzgerald can turn around Bovis. On the first issue our sense is that contracts will be extended which is usually good for services company margins as by the later periods of contracts the working processes are well understood and clearly there are no associated bid costs. This could be good news for Capita despite some clouds over recent contracts such as the DIO management project; clearly the roll-over of the Compass contracts in which G4S and Serco are involved was not ideal but the terms were improved in the two year extension. The further issue is whether Brexit preoccupation will divert away from major Infrastructure decisions and we fear it might. The notion that Infrastructure investment will be made to counter any Brexit inspired dip in activity is commendable but, as always in this area, it takes time to turn political rhetoric into actions. There are few signs of change in that regard, as yet.

On the latter issue, Bovis, it’s probably fair to say that if Greg cannot do it then nobody can! Indeed Bovis might be a less complicated project for him than Galliford Try as there is no Construction arm to distract attention from the main tasks of rebuilding confidence and improving operational performance. The Gross Development Value (GDV) of the landbank at end 2016 was around £5.1bn and the invested value is £1bn; that 20% land cost to ASP is higher than some rivals where 15-17% is the norm so there is an effort needed to get back to industry norm margins not just through better build quality but also through re-planning sites. The business tripped over itself by trying to grow too fast and we suspect that it will take a step back and may need to eliminate some overhead so that operating margins can get back to over 20% by 2018 at the latest, 16% in 2016 and kick on from there. The task for Greg is large because morale will be low but the process includes nothing he has not seen before and the base business is sound and the balance sheet is strong with net cash of £39m at the year end. The brand might be damaged a little but location trumps brand in housing, every time. Closing at 887p last night and with EPS last year of 90p the stock is not cheap but getting industry average margins of 21-23% gets EPS to nearer 120p and that makes the current price look cheap.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
10 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 10th April 2017

Carillion has announced that it’s JV with, we believe, Aramark, has won one of the seven Hestia contracts to be awarded. Hestia is the MoD’s name for its softer services FM work (including managing retail units) that is currently being tendered. We are heading for a couple of “News-Lite” weeks over the Easter break. There was no trend to the moves on Friday last that we can see. Travis Perkins was the leader up 2.2% to 1538p on 922,116 shares traded. The main loser was Galliford Try, down 1.1% to 1467p as the shares adjust to the ending of Bovis discussions and going XD with the 32p interim payment on 23rd March.

Carillion has announced that it’s JV with, we believe, Aramark, has won one of the seven Hestia contracts to be awarded. Hestia is the MoD’s name for its softer services FM work (including managing retail units) that is currently being tendered. Our understanding is that two have been awarded so far with Sodexo having won the other. Carillion hinted that it had been successful in a number of contracts at its recent results and this £200m/five year project may have been among them. Flash to bang sometimes takes a while with public sector win announcements. The Carillion JV has won the South East/London area which covers 87 MoD sites. It is likely that the same partners have bid for other UK regions but the bidding timetable has different end points for each region, so we shall need to wait for the others.

This is a very important contract win for Carillion. In the statement the company highlights its work with the MoD on hard FM with its NGEC work, currently done in JV with Amey. The MoD has been suggesting for some time that it may shift towards combining hard and soft FM in the same contracts at the next big round. The Hestia contracts currently being let are therefore important for Carillion as it is in a much stronger position if it has both hard and soft FM capabilities to demonstrate to the MoD. Of course the next bidding round is some way off, given that the Hestia contracts are only being let now and the NGEC work started only two years ago. By getting ahead of its rivals with this win Carillion is not only strengthening its revenue and earnings it is also making a very important strategic step. It may seem that the company is setting down markers on a long term basis but in terms of the MoD that is a very good thing. Carillion has also won other with MoD recently including the Aspire work announced in November last year. 

Being good at winning work in quite competitive conditions from the UK MoD does not make Carillion a buy at 219p, at which it closed on Friday. But it does tell us that there is substantial value in the business. We expect that the balance sheet issues will be resolved over the next 3-5 years, which is a long timescale but more contract wins and tight control of risk combined with good market condition may surprise some of the shorts.

We are heading for a couple of “News-Lite” weeks over the Easter break. Atkins is alone in having a scheduled statement this week. It is due to release its pre-close update on Wednesday 12th. Whether that will happen with the indicative offer from SNC-Lavalin in progress (it must put up or shut up by 1st May) it remains to be seen. Atkins has already covered some elements of the main issues affecting its price in recent weeks. Firstly, through conformation that the c £35m pa pension deficit recovery plan is to continue (statement made on 5th April). Secondly, Uwe Kreuger said at a recent City meeting that for the first time since he became CEO it was firing on all cylinders and, thirdly, the potential bid at 2080p (shares were 1981p on Friday at close). The pension deficit recovery plan makes a big hole in cash available for expansion or distribution to shareholders and means SNC-Lavalin’s proposed bid is at an historic 15.1x EBITDA. Whatever the outcome of the Canadian’s approach Atkins is clearly in good shape and that will get better in the current market climate due to management actions in recent years.

There was no trend to the moves on Friday last that we can see. Travis Perkins was the leader up 2.2% to 1538p on 922,116 shares traded. The general view should be that UK Merchants are a tad oversold if construction output reaches expected levels this year; the latest CPA forecast is for a 0.8% increase, driven by Infrastructure and housebuilding. A real kicker could come from RMI spending growth but it remains stubbornly sluggish. The structural issue for the Merchants of further disintermediation, as has happened in plumbing and heating, remains a problem. Other risers were Interserve up 2.1%, Homeserve up 1.6% and Berendsen up 1.5%; see what we mean, no real pattern.

The main loser was Galliford Try, down 1.1% to 1467p as the shares adjust to the ending of Bovis discussions and going XD with the 32p interim payment on 23rd March. It is trading on 8.6x next year’s earnings (June y/e) which is somewhat harsh. The risk to forecasts remains though as the private housing segment, which drives earnings, has its well-rehearsed “issues” at present. That has not stopped the sector or Galliford Try rising over 10% YTD. The Housing White Paper has so far been a Damp Squib, no fireworks yet and it has not really altered the scene for the housebuilders. 

Moves last week

The sector moved in line with the market last week, both were up around 1%. The sector remains up around 7% with the housebuilders up around 12%, the services stocks up 7% and the contractors and materials stocks up 2%.

Atkins was the clear leader up 29% as the potential bid from SNC-Lavalin was revealed at 2080p a share. The closing price reflects some execution risk inherent in the fundraising and the due diligence/terms and conditions of any offer. One thing was also settled last week, the level of the pension deficit plan funding. On Wednesday it was announced that the terms of the current Atkins funding plan were broadly reconfirmed, after the latest triennial review. That means the company will pay £34.5m in 17/18 rising at 2.5% a year to 24/25, based on a deficit of £318m. There is an emerging suite of products that means that companies might not need to pay very large chunks of cash each year to fund a deficit that actuaries think may exist at some point well into the future. In the case of Atkins the sum is near 20% of 16/17 EBITDA. Any deal to buy Atkins will need thumbs up from the pension fund and the basic terms are set.

The other notable riser was Homeserve, up 14% after a positive trading update and closed at an all-time high of 643p. Our view on Homeserve has been consistent and some would say consistently wrong. We retain our view that the business model needs growth and when that stops the balances sheet will unwind. That was masked in the UK by the mis-selling issues and fines. In the USA the websites show a wide range of views about Homeserve’s performance; from the comments the wide gap seems to be due to the performance of the operative sent to do the job, usually a local tradesman, who are often of variable quality. Homeserve’s customer quality delivery depends on having a sufficient network of third party tradesmen to carry out tasks usually in emergency circumstances. Customer retention is 80% in the US and the UK. It is addressing the issue in the UK with the acquisition of Checkatrade and other technology work but it still needs fingers and thumbs to do the jobs provided by people, often one man outfits, with limited day-to-day input from Homeserve.

Kier was the largest loser last week, down 8% to 1347p. The stock went XD on the 22p interim payment on 30th March but that accounts for only a small part of the 112p decline. There was some broker comment last week pointing to 1600p target share price. Our sense is that the move last week was ebb and flow rather than serious concerns. The net debt at £179m at the half way stage is of some concern to investors who are not keen on housebuilders with net debt. In Kier’s case valuation is complicated by it having both operating and property earnings. The deal to allocate land into a JV with Cross Keys Homes makes good sense from what we can see; given the cash profile it accelerates returns for Kier.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
7 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 7th April 2017

Vp, formerly called and still better known on some places as Vibroplant, has announced a trading update and an acquisition. Homeserve was the best riser, up 1.8% at close at 633p, gaining even stronger support in the afternoon after a good morning’s work, suggesting positive US investor interest. Berendsen and Mitie were the joint backmarkers, down 2.9% and 2.5% respectively.

Vp, formerly called and still better known on some places as Vibroplant, has announced a trading update and an acquisition. In terms of trading the year to end March was positive and in line. Trading conditions in the last four months were said to be positive, which is consistent with other data sources. The read across to Speedy, A Plant, and HSS is therefore positive and it tells us that construction activity was also good. The weather was quite mild in Q1’17 so there is no reason to expect that to have been a negative factor. The Vp acquisition of Jackson Mechanical Services for £3.6m cash appears to be a small bolt on. Companies House data provides us with limited help as the business has small company’s exemption and Vp provide no trading data. The latest Jackson balance sheet showed £10m of tangible assets at end 2015 and shareholders’ funds rising by near £0.5m to £1.5m at the period end from end 2015. The company added £6.5m of tangible assets in 2015 to the existing depreciated amount of £7.8m which looks like a large expansion to outsiders, like us with little detail. Drawing any conclusions would be guesswork but the data available suggests the business was profitable in 2015 but the massive capital addition might have been a problem in 2016. It also indicates that Vp might be more helpful regarding what it has actually bought as the available data is inconclusive. Of course, a lot may have changed in 2016.

Homeserve was the best riser, up 1.8% at close at 633p, gaining even stronger support in the afternoon after a good morning’s work, suggesting positive US investor interest. The customer reviews on web are real marmite with customers at one end on the spectrum or the other and naturally those most agitated to write a review are the complainers. The point is that it’s easy to see that a company such as Homeserve, with considerable dependence on third party suppliers, mostly tradesmen, is going to find variable performance. But the mix of such dependence, allegations that it is marketing insurance for stuff that does not need insuring and retains only 80% of its customers each year just tells us that it will unwind at some point. The move to buy Chackatrade and adopt digital technology we understand though such technology progress is still in the early days. Homeserve’s track record of managing businesses outside its mainstream is poor.

Berendsen and Mitie were the joint backmarkers, down 2.9% and 2.5% respectively. The recent issues at both companies are bound to cause some share price volatility. So views should not alter. Berendsen seems to have initiative overload and needs to show some results from its festival of improvements. Mitie just needs to clear up any remaining accounting issues, show greater accounting transparency and the costs of rebasing the business. It can then move on; it seems to have retained its main customers and contracts and, though wins have been scarce they were not the priority in the last six months. Our view is that it will need a large write-off, most of which will be non-cash as we have been told that it does not have excessive commitments to customers within contracts (which was an issue at Serco). Where the price will end on the day of the results in part depends on the severity and nature of the write-offs (which will indicate whether an equity fund raise is needed and we suspect it will not need one). The opportunity to create is £2bn a year revenue business with 4-5% operating margins and around 5% pa growth is clear and is worth investors’ attention, given the existing contracts and operational structure which was far from being all bad!

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
5 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 5th April 2017

HSS Hire has reported its full year numbers for the year to end December 2016 and as expected they do not make great reading but might have been worse. HSS is rebooting itself to stand a better chance of success.

HSS Hire has reported its full year numbers for the year to end December 2016 and as expected they do not make great reading but might have been worse. The original plan at float has been abandoned in favour of a modest expansion but the legacy costs of the depots leased to create the fast growth will remain a burden for some time. Revenue grew last year by 9.6% to £342m but it’s not clear to us whether that is L4L structure or not and adjusted EBITA was up just 1% at £20.5m. 2016 was a 53 week year compared with 52 in 2015. Mainstream rental revenue was flat at £263m and its contribution (revenue less COGS) fell to £179m from £182m in the prior year. Logically therefore all of the growth arose from services activity, the only other segment, services were revenue rose 61% and the contribution increased by 69%. The company provides lots of statement about how it will improve in the future and the business buzzword generator is in overdrive with references to right-sizing, industrialised engineering function alongside retail like logistics, paradigm shifts, superior fleet availability and delivering operational innovation to hire. If all that means is that it expects to improve its financial performance then investors should be relieved. They should certainly be pleased to see that investment is now in better control and that net debt was up by only £1m to £219m after the late 2016 equity fundraise of £13m; average net debt must be pushing the company near its limit of £250m. But not paying a final dividend this year is unhelpful for sentiment and preclude some investors from holding the stock. More below on HSS.

The important industry thought about the release today from HSS is that the market for hire and in construction remain robust, as far as they can experience. The company states that the advisory Referendum created little or no impact though revenue from customers serving RMI markets was below initial expectations. The read across so far remains positive.

Investors reading reports of a fall in the PMI for construction and about delays on big infrastructure, such as nuclear, might be thinking that it’s time to become cautious about the sector. Among the larger companies that we cover our sense is that there is plenty of work but delays are rising. The investment expected to counter any Brexit inspired falls in activity has not started and the housing shortage has not gone away, though financial services jobs are leaving London which will ease some pressure. So there remain plenty of reasons to be cheerful.

Berendsen regained some strength yesterday with a 3.8% rise to 769p; as we have said before the selling was rather harsh but there are limited arguments, as yet, for it to get back to former high valuations of near 20x p/e. But the current 13x p/e is low. Interestingly Rentokil closed up 1.7% at 250.6p, the first time it has been at that level since August 2002. Regular readers will know we have been positive for many reasons mainly due to strategy and its clean and efficient implementation but also the valuation gap with its main US peer Rollins, which trades on a prospective p/e of 38x. RTO has a consensus for 11.8p of EPS this year and 10% earnings growth in 2018, so it’s easy to see how it is getting support on that basis.

Carillion was the main loser yesterday, down 2.3% at 219.5p after unfavourable broker comments and a lowering of target prices. What is there to say that can add to what has been said? Operationally the business appears to be in better shape than most rivals but the Eaga acquisition (£400m wasted) and the subsequent financial strategy have left it with a weak balance sheet. It will take some time to unravel and we suspect it will do so successfully but it’s a hard grind for the management. Addressing the pension deficit payment and finding a solution to the convertible due in 2019 will not be easy; there are cures for the former that have not been tried yet and a longevity swap is not one of them.

HSS is rebooting itself to stand a better chance of success. The operational improvements it is seeking and the cost reduction programme should help to improve the situation. It talks of increased revenue from key accounts as well as in services, though the key ones include Amey which is as troubled as HSS at present. All of the right intentions exist but the hub and spoke model with large distribution centres creating more efficient utilisation, in theory, has yet to be proven. So far all we can see is the 8% rise in Administration costs to £156m, which while lower than the sales value increase does not suggest that there are meaningful cost savings dropping through and distribution costs rose 9% as a result of increased use of the transport fleet. HSS remains therefore in transition, a far cry from the float prospectus. With EBITDA last year of £58m and an EV of £333m at last night’s closing price HSS looks fully valued on historic earnings.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
4 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 4th April 2017

There is no direct relevant news this morning. The other rises were small with Berendsen’s 1% increase to 740p indicating some support that may be starting to return. The proposed bid for Atkins from SNC- Lavalin has received considerable press coverage so there is limited information we can add at present. Wolseley’s share price has dipped following the recent half year results and was the largest faller yesterday, down a further 1.5% to 4944p.

There is no direct relevant news this morning. The proposed bid for Atkins from SNC- Lavalin has received considerable press coverage so there is limited information we can add at present. The two key issues right now are of course what might go wrong and will another party join the race to buy.

SNC-Lavalin has confirmed the proposed bid in an announcement this morning and importantly outlined how it might fund the deal. It has confirmed it has lined up C$1.9bn of the C$3.5bn (£2.1bn)  needed in a mixture of 21% equity and the rest in loans and that the further funding will include no more than 33% equity. The bid is a multiple of 12x historic EBITDA.

The proposed cash bid works out at 2080p a share, well ahead of the closing price last night of 1953p so the market is fully aware of execution risk. Both parties have indicated the bid is subject to terms and conditions. Foremost among the issues will be the pension deficit. The triennial valuation is taking place at present and the actuary’s view at end September was the deficit was £335m, based on a discount rate of 2.4%. The discount rate is lower than many we have seen used recently which is unhelpful; the 2.8% used by many others would reduce the deficit considerably. But the current commitment to pay around £33m and year rising at 2.5% a year until March 2025 makes a substantial hole in the free cash yield for any buyer; the deficit funding was equal to 19% of EBITDA last year so it’s not a small portion of the earnings. Of course an accommodation with the pension trustees will be one of the thornier issues in the discussions and satisfying them will be essential. The other main problem is of course the novation of contracts from independent UK based Atkins to a new entity and there will be many of those to explore very quickly before a bid is confirmed. Atkins has a lot of small contracts so the task of taking soundings on novation is not small.

Another party could join the race for Atkins of course. CH2M has already been mentioned in the press as having made an approach and that is a reasonable start point. The valuation is not overly stretching from what we can see, excluding the pension deficit funding. SNC-Lavalin has been touted as having geography that is compatible with that of Atkins but there is also great appeal but that applies to a number, especially those who might covet the UK position of Atkins such as AECOM and WSP. Some Euroland entities might emerge as suitors but they are somewhat smaller and not helped by recent weak conditions in existing main markets. The search for global scale in engineering consulting has not. We are not speculating on who might take an active interest but there are others around.

The 27% rise in Atkins was the main rise yesterday and enough has been said about that! The moves in the sector were in a narrow range yesterday. The other rises were small with Berendsen’s 1% increase to 740p indicating some support that may be starting to return. Our sense is that the share price has been hit rather harshly and the business has better underlying prospects than the current valuation of 12.7x prospective p/e suggests. Signs of success from the substantial number of initiatives underway will create a large difference to perceptions but at present, to some outsiders, there seems to be an overload in intended improvements.

Wolseley’s share price has dipped following the recent half year results and was the largest faller yesterday, down a further 1.5% to 4944p. The range of target prices is wide as we have seen one as low as 4960p and one as high as 5900p; the trend post results was for targets to rise so the 4% fall since the announcement is the opposite of what might be expected. We take the view that Wolseley has clear up the issue of where it is domiciled as soon as possible. The Charlie Bank’s model has been so successful at Ferguson it has allowed it to more than double market share in the US while elsewhere it is has struggled. Some 85% of earnings are in the US. The logic of the full year results presentation was that it would transfer to US domicile but it could not quite say it. UK based funds with a mandate to invest just in UK stocks will be wary of WOS at present even though the historic rating and earnings prospects might point to a higher price.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
3 April 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 3rd April 2017

Renew Holdings has issued one of its usual short trading updates this morning up to the end of its half year to March 2017. G4S has made another disposal.

Babcock has announced a new contract which may silence some of its critics. This week is slow in terms of expected announcements. HSS Hire reports its finals for 2016 on Wednesday and Homeserve will update on Thursday with news of trading up to its year end of March 2017.

Renew Holdings has issued one of its usual short trading updates this morning up to the end of its half year to March 2017. No numbers are provided and we are just told that trading is in line and that while there will be some debt at the half year the expectation is that the company will have net cash by the year end. Renew does not need to say that much as it has delivered to shareholders in the last ten years. The share price was 107p in early April 2017, 29p in July 2009 and closed at 435p on Friday last having seen a bit of selling ahead of the announcement today. The company has succeeded in a difficult fields (Energy, Environmental and Infrastructure engineering services) by managing risk well, developing through organic means and acquisition and keeping very close and relevant to its customers. It is involved in Magnox but it’s too early to tell whether change on that project will impact on Renew, we doubt it. EPS of 32p is expected for the current year and 34p for 2017/18.

G4S has made another disposal. It is minor in the scheme of things. The Youth Services operation in the USA has been sold for £57m cash. Last year it posted PBT of $5.1m so the consideration, based on the data provided, looks sensible for the parties and not worthy of much attention. The key issue is that it is further evidence of the company implementing its strategy which is good news, in our view.

Babcock has announced a new contract which may silence some of its critics. The project is to be the Marine Systems Support Partner for the Royal Navy’s new aircraft carriers and type 45 destroyers. It is named preferred bidder for all four elements of this MoD programme worth some £360m over seven years. It’s not a big contract but it’s a win and much needed in terms of the share price as the 20% decline since the middle of last year to 882.5p on Friday is quite steep and consistent. This may help to reduce the selling pressure and the length of the statement (seven long paragraphs) perhaps bears testimony to the management’s concerns.

This week is slow in terms of expected announcements. HSS Hire reports its finals for 2016 on Wednesday and Homeserve will update on Thursday with news of trading up to its year end of March 2017.

Moves on Friday last included Serco rising 4.8% to 115.8p following favourable broker comment. We have not seen the note but we can say that on a “normal” valuation 150p looks at the top end for a stock that will deliver EPS of around 10p in 2019, on current estimates and has yet to declare exactly when it will resume dividends, though we know it will at some point. We are supportive of Serco and have been for several years. The strategy, the transparency of reporting and the focus on performance are all very impressive and the recent big contract wins (Barts and Grafton prison) show the customers are impressed as well. A good company at an expensive price is always better than a bad one at a cheap price so 115.8p will look cheap long term, we believe, but there may be better entry points as the company has been very clear about guidance for this year and next.

Berendsen was the backmarker, down 1.6% at 733p. As we have said recently management has not yet “found its feet” in terms of taking the company to the next stage of its development. With around 58p of EPS forecast for 2017 optically the shares look cheap compared with past valuations but after two profit warnings credibility in forecast is low, despite the reasons for the warnings being trading disjoints of a relatively minor nature. 

Moves last week

The sector moved roughly in line with the market last week as both dropped a tad, less than 0.2%. At the end of each quarter we often see unusual moves but not so on this occasion.

The best riser last week was Polypipe which was up 8.5% at 382p, 18.2% YTD. We indicated Friday last that we got the move wrong on Thursday after the results. The meeting was positive and the prospects very good so lack of engaging our brains early in the morning on Friday on observing the rogue number on which we commented was unhelpful; we have apologised. Moving on, the company has tackled the uncertainties that are present in future UK construction demand by building capacity in the Middle East, broadening the product range in the UK and strengthening its relationships with the supply chain. The news that Capex this year will be up 30% on 2016 levels is positive for growth. So the company is well set and expects to get the selling price rises through in Q2 that will enable it. Along with other actions, to maintain margins for the full year on higher revenue. The forecast of earnings per share of around 28p for 2017 have the risks weighted to the upside in our view.

Berendsen was the largest loser last week, down 7.5% to 733p. As indicated above and in earlier notes the mauling of the price seems harsh but with EPS at 58p this year and 59p next year, according to consensus, and as the trend in forecasts is downwards, the share valuation is not a surprise. But a prospective p/e of 12.6x is well below earlier valuations and the market has not changed substantially enough for that to be a large factor in any lowering of the valuation. So it has to be about the businesses capacity to manage its situation and it will take time to repair credibility.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
31 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 31st March 2017

Speedy has issued a short trading update to mark the end of its trading this year. It told us in early February that earnings for the current year will be above the existing expectations and since then there have been a few Director share purchases. Atkins rose by 1.6% yesterday to close at 1512p. The market may have woken up to the comments that imply it had a very good year in 2016/17, which ends today.

Speedy has issued a short trading update to mark the end of its trading this year. It told us in early February that earnings for the current year will be above the existing expectations and since then there have been a few Director share purchases. The indication this morning is that revenue for the full year (ex disposals) will be 7% ahead of last year; the indication of the 3Q revenue rise of 10.6% is consistent as the year started slowly and the Xmas period was very strong. The other bit of data released this morning is that net debt will be below £80m at the year end, in part due to a reduction in the hire fleet. That means net debt will be not much more than 1x EBITDA which is low for a hire company; our understanding from earlier conversations with the company is that it is not missing opportunities by taking an overly cautious approach to borrowing. It is looking at a range of expansion prospects and 1.5x net debt/EBITDA is a comfortable level, but will only spend if it is justified. The plans to reduce costs and raise efficiencies is continuing and utilisation for 2016 was substantially higher than in the prior year. The efforts of the last two years have been focussed on building a stable platform not on maximising short term earnings. That platform, in terms of IT, depot structure, management culture and asset base now exists, from what we see.

The business operations at Speedy have been improved substantially and the company now has a very strong base on which to build and compete with Ashtead’s A Plant, the other well-run company in the sector. Our sense is these two are in a much different place than HSS which reports next week; that company is overburdened with expensive property lease commitments and a deteriorating asset base that is causing loss of market share, from what we hear from its customers and our observations of the data. The market for hire remains positive and market growth is likely to be higher than CPA construction forecasts of c 1% for 2016. At 52p a share Speedy has an Enterprise Value of around £350m, comprising £273m market capitalisation plus let’s say £80m of net debt. With EBITDA of around £75m the valuation EV/EBITDA of 4.7x historic is low for a UK hire operation.  We suspect the share price will get some support today.

Atkins rose by 1.6% yesterday to close at 1512p. The market may have woken up to the comments that imply it had a very good year in 2016/17, which ends today. The trading update is due on 12th April and we are expecting a positive update. Atkins is traditionally quite cautious in its approach to update briefings; the company will say realistic! We appreciate its candour and it has helped it to retain its great credibility. So it will be interesting to see if the tone on 12th April is a positive as the one we heard on Tuesday this week. Note also that Mitie has been a consistent riser in recent days and closed yesterday up 1.4% at 217.6p. It is hard to believe that there will not be some further accounting adjustments when it releases it 16/17 results in May as the new top team will only get one more shot at that. Our reading of the numbers is that given its current size, scale and shareholding 20p of EPS is the stable level, probably to be reached in 2018/19. So the price could be a little ahead of itself. Pre close briefings have been positive and the longer term picture we suspect is good but there may be a better entry point in the coming months than the current level. 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
30 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 30th March 2017

Polypipe has had a strong start to the year, the shares are up 9.2% YTD at 353p and the 2016 numbers announced this morning indicate a large part of the reason for that support. Balfour Beatty was the best mover yesterday rising 1.7% to 269.3p.  Berendsen, who loves ya? Nobody at present, it would seem, as the price has drifted downwards to 740p at close yesterday, the lowest level since March 2013.

Polypipe has had a strong start to the year, the shares are up 9.2% YTD at 353p and the 2016 numbers announced this morning indicate a large part of the reason for that support. The share price is up 60% on the July 2016 low point. The numbers today show revenue up 24% to £437m (9% on an L4L basis) and the underlying operating profit is up 28% at £69m. Underlying EPS rose last year by 29% to 25.0p which is a little ahead of expectations and the dividend was also raised by the same percentage to 10.1p for the year. Net debt was down £30m at £164m which is the only element of concern that outsiders might have as it remains high at 1.9x trailing EBITDA. But with cash conversion from operating profit at 97% last year, a positive outlook and the borrowings are at a low coupon this aspect is not a constraint. The company expects to increase capital expenditure in 2017 by 30%, some of which is catch up on projects delayed last year in the post Referendum hiatus. More below

Balfour Beatty was the best mover yesterday rising 1.7% to 269.3p. (Question to Editor, when did we last write that?) The post results dip was not justified on fundamentals; in our view so the floor at 263p is well supported, we believe and 300p is probably the most “sensible” mid-term target price at present. Carillion also regained most of the dip in the price that followed negative broker comment made two days ago; it rose 0.9% to 217p. Atkins saw some support rising 0.9% to 1488p, which is roughly the level it was at prior to the news that it might be a bid target. It is slowly creeping upwards but the share price, unlike the company, is not firing on all cylinders at the moment and that is the opportunity.

Berendsen, who loves ya? Nobody at present, it would seem, as the price has drifted downwards to 740p at close yesterday, the lowest level since March 2013. It’s not going to plan for new CEO James Drummond and it’s pretty clear why, at least to us. All the management effort is on a massive number of operational developments that are too confusing for Joe Average and, at the same time, the strategic picture in main its markets is changing. Limited attention seems to be paid to that in public statements. Mmmm. 2.7m Berendsen shares were traded yesterday, which is not a lot but still quite representative of present sentiment. Optically the stock looks very cheap as consensus forecast are at 63p of EPS this year and there are no balance sheet and pension issues to be concerned about. It looks primed for share price recovery but credibility is currently in short supply.

Polypipe has had a very successful return to the quoted arena. Some of the recent focus has been on the problems but Polypipe, Forterra and Ibstock have all matched or done better than expectations since returning to the market. The attractions of PLP when it came back were its well invested plant, strong market positions and growth prospects. Since its return it has consolidated its UK position, expanded the product range and thereby become slightly less dependent on residential and RMI spend and is now investing in the UK and the Middle East for growth. The deal to buy Nuaire, a specialist in Heating and Ventilation mechanisms has proven to be very sound. The deal was done with all debt, hence the high net debt position but in effect the transactions will more than pay for itself and in the meantime investors are getting a positive return. The short term issue is making sure that cost increases incurred principally as a result of FX changes are passed on to customers. So far the experience has been positive and trading 2017 YTD is said to have started well. Some of the recovery will not take place until Q2 and the company indicate that the earnings profile this year may be slightly different than in prior years as a consequence. More data will be available at the meeting at 8.30, we suspect. The main competitor are also affected by cost increases so there is good reason to believe that it’s a market issue and not specific to PLP and the cost of PLP’s products within the projects on which it operates is small. We suspect forecasts will rise a little today but not much given the level of uncertainty ahead on a number of fronts; EPS in 2017 of 27-28p is the likely level.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
29 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 29th March 2017

Just a few items of note today including more changes at the top at SIG, results for 2016 from Entu and Telford has announced its fourth completed PRS scheme in a deal worth £54m for 112 new homes that will be finished later next year. Ferguson/Wolseley’s numbers were greeted positively yesterday and the stock rose by 5.1% to 5130p. The uplift may in part be in anticipation of the likely change of domicile to the US which should trigger a higher rating.

Wednesday, 29 March 2017
Just a few items of note today including more changes at the top at SIG, results for 2016 from Entu and Telford has announced its fourth completed PRS scheme in a deal worth £54m for 112 new homes that will be finished later next year.

The news from SIG is that the new CEO Meinie Oldersma starts on Monday next and Mel Ewell reverts to being a NED a month later. Also the current Chair Leslie Van de Walle steps down in that role and as a Director when a successor is found and the new CEO is established. So it’s still a bit uncertain at the top of SIG but with both the CEO and FD just appointed the role of new Chairman can wait a while. The stock has had good support YTD as market conditions remain positive and there have been no new shocks so our optimism is well justified and the shares remain cheap, in our view at 113.3p at close. The sequencing of the appointments at the top is unfortunate and there is perhaps regret that the outgoing CEO was able to continue for so long when he was so obviously in the wrong job. The fact that the company continued as it did it, with high resilience, with that leadership is part of what makes us positive; alone that is a thin argument but there are many others that point to good earnings growth and a likelihood of no new surprises.

Entu has faced a very difficult period since coming to the market, much of which might be regarded as self-inflicted. The numbers today show revenue down 2% at £88m and underlying EBITDA in the continuing operations down at £2.7m versus £7.6m last year. The dividend is suspended with an intention of being restored asap. The story of short term bad, good term should be OK is familiar in the sector and that is Entu’s mantra today. We look for read across and the market narrative remains quite positive in the core Home Improvements operations which is what we were looking for. Actions have been taken to reduce overheads, close the Solar panel and kitchen operations and clean up the accounting. We do not know the company well enough to comment on whether enough has been done but the intention is clear and the market remains positive.

The increase in activity in PRS is the main reason to highlight Telford’s news today. The payments schedule from the customer, a subsidiary of Notting Hill Housing, is helpful to Telford and should ease any balance sheet strain caused by its rapid expansion. Telford is now building 483 PRS homes at present. For us that is just the tip of a large iceberg that is creating a whole new market for maintenance activity as well as the new build sector.

Ferguson/Wolseley’s numbers were greeted positively yesterday and the stock rose by 5.1% to 5130p. The uplift may in part be in anticipation of the likely change of domicile to the US which should trigger a higher rating. The company denies that it has plans to alter domicile but the signs have been there for some time that it is the next logical step; the slides from the results presentation six months ago pointed straight at that outcome. Forecasts for the 2017 out turn should not have changed much save to accommodate FX and the structural changes affecting Switzerland and at some point the Nordics. So the consensus 300p of EPS for this year is a reasonable forecast in our view and 17x p/e is not stretching given US growth prospects.

Carillion was the back marker for much of the day falling 2% to 214.7p as there was unfavourable broker comment. As with SIG, and possibly more so, CLLN has shown a high level of resilience and it has delivered two good projects since the results, as promised and there are more on the way. But towards the end of yesterday’s session Capita saw a weakening in support and fell 3% to 553p. Unfavourable comments about its performance on the DIO contract made at Atkins breakfast meeting may not have helped. The DIO management contract has not been a highlight for Capita and its partners as expressed in an NAO report some six months so Atkins was saying nothing new, well not to some observers. The DIO contract is small in the scale of Capita so alone that may not have been the issue as there is more to be concerned about in the short term. The market concern about the need for an equity fundraising can be observed from available data and a view taken. What is much harder to gauge right now for outsiders is customers being more vociferous about the company’s failure to deliver as promised on many contracts, the loss of current and potential employees who go elsewhere and the live contract bids that are now in jeopardy due to the uncertainty. The next two years are going to be very difficult for the company but should the potential for change be credibly expressed by new leadership the share price might lift before the trading performance does, as has been shown at Mitie, G4S and Serco.

We attended the Atkin’s breakfast yesterday and were treated to a good presentation on how the company might increase its sales in the UK. It currently has sales of around £430m a year in the UK Water, Nuclear, Rail and Defence sectors (out of a total UK revenue of £933m) and with addressable markets worth £2.4bn in these areas the company believes it can grow with the market and take share and improve on the 8.7% margin achieved in 1H 2016/17. You know what, we think it’s probably true that it can achieve all three targets as the company has made substantial developments in its capabilities and still has a reputation second to none. The competition has not stood idle of course but its story on innovation, technology and customer relations is not as strong as that of Atkins, from what we hear.

Atkins shares dipped a little yesterday after the presentation which was odd. Perhaps the audience was not quite tuned in to the opening remarks about it firing on “All Cylinders” for the first time since Uwe Krueger became CEO some five year ago. The trading update due 12th April should perhaps be more convincing but investors should not wait until then as today’s price, all things being equal, will be a tad low given the news we expect. The only real downside on 12th April could be the news on the pension deficit which may be quite ugly; perhaps that should wait until the final results!

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
28 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 28th March 2017

Wolseley has produced a solid set of numbers at the half year with organic growth in revenue of 3.2%, which translates to 6.7% at CER and 24.5% at AER. G4S was the most popular stock in our universe rising 1.5% yesterday to 302p. Predictably Babcock was the back marker after its news yesterday on the Magnox nuclear decommissioning contract. It fell 4.3% to 877p.

Wolseley has produced a solid set of numbers at the half year with organic growth in revenue of 3.2%, which translates to 6.7% at CER and 24.5% at AER. The gross margin at group level is up 0.3% to 28.6% but trading profit margin at AER is level at 6.1%. We shall need to get accustomed to a new name at Wolseley, it will in future be called Fergsuon as the US accounts for 84% of operating profit and that is the brand name used across the Atlantic. At the last set of results the logical conclusion from the presentation was that domiciling the business in the US was the best course of action and the change of name is possibly another step in that direction. Certainly the struggles with its operations outside the US must also be of concern. The pattern of trading across the geographies reported today is familiar with the US showing revenue growth of 9% in the period but the Nordics and Canada and Central Europe declining and the UK with just 0.3% revenue increase. The company has announced today that it has started a process to exit the Nordic area. The business appears to be on track for the year as a whole and there is no hint here today that forecasts need to drop. Sales since the end of the half year are up by 4.5% at group level and 5.5% in the USA.

Redrow has announced that it does not intend to make an offer for Bovis above the level which has already been rejected and will therefore focus on growing its existing operations. There may be further twists and turns but this leaves the field free for Galliford to buy the business should Bovis shareholders be willing to accept its offer. There will be little bit of surprise today that Redrow has withdrawn as it has stalked Bovis for many years but equally Steve Morgan was never going to get near to potentially overpaying for the company, that is he would not pay a “strategic” price in his view. Galliford Try will have its own view on value and equally is not likely to pay a premium for Bovis so the decision is now a bit clearer.

Severfield’s trading update indicates that the 2016/17 will be ahead of expectations in terms of earnings and cash and the business is on track for further strong growth. The only data provided is that the order book remains strong at £267m. The trading news is overshadowed by news that CEO Ian Lawson is unwell and is replaced temporarily by FD Alan Dunsmore and Chairman John Dodds will assume an executive role for a while. Let’s hope Ian has a speedy recovery.

G4S was the most popular stock in our universe rising 1.5% yesterday to 302p. The message from the results is starting to get through and at present 300p seems to be the level, plus/minus 10p.  It was closely followed by SIG, one of our picks for 2017, which closed at 112.7p, a level at which it seems highly resilient. The new CEO and FD are ready to grow the business from its strong base, from what we can see. We stick by our view from the start of the year that a substantial rise (+50%) from 103p at 31st December 2016 by the end of this year is possible. The revenue level, the average margins in the sector and the prospects in growth areas such as SIPS and air handling suggest that current forecasts could be well short of the likely outcome, even this year and certainly for 2018.

Predictably Babcock was the back marker after its news yesterday on the Magnox nuclear decommissioning contract. It fell 4.3% to 877p. The damage was subdued, due in part to it being anticipated and also because as the company has time to fill any gaps in revenue and earnings, which it says it shall do. Believe us; the company would love to have kept the contract! The company needs to become more credible in the post Pete Rodgers era. It’s difficult for the new CEO, Archie Bethell, as the “rules of engagement” in a company with Babcock’s ambitions and scale make it tough for an internal appointment, especially given its goal of geographic expansion.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
27 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 27th March 2017

The only formal news this morning is that Babcock’s partnership working on the nuclear decommissioning project on 12 Magnox sites has reached agreement with the Nuclear Decommissioning Authority to end the contract in 2019. News later this week comes from Wolseley tomorrow with its interims and from T Clarke with its finals for 2016.

The only formal news this morning is that Babcock’s partnership working on the nuclear decommissioning project on 12 Magnox sites has reached agreement with the Nuclear Decommissioning Authority to end the contract in 2019. There has been an amount of turmoil over the award of the contract in any event but today Babcock has stated that the workload is different from that originally envisaged, opening up the possibility of a legal challenge. The impact on Babcock is not immediate in financial reporting terms, it will lose £100m pa of revenue from 2020/21 onwards and the order book will fall by £800m to £19bn and the pipeline will be £1bn lower at £10bn. The company is keen to emphasise that this will have no impact for some time and that its client is satisfied with the JVs performance. This is not good news for Babcock despite the lack of any real short term impact and the long period the company has to replace this work. This was billed as a £7bn/14 year project when it was first won two years ago in March 2014. The numbers released today do not quite square with the original figures but Babcock pulling out because the workload is not as originally expected may be only one of a number of factors.

News later this week comes from Wolseley tomorrow with its interims and from T Clarke with its finals for 2016. We get a day off from formal news on Wednesday, based on current plans and on Thursday Tribal and Polypipe report finals for 2016. Some news on the Bovis/Galliford/Redrow might be expected this week as it is over two weeks since the proposed bids were revealed and discussions started. What seems to be clear from the pattern of share price moves is that there is no viable alternative bidder to the two companies currently involved.

Capita was the leader on Friday last with a 3% increase to 576p. There is a two way pull; if there is an equity fund raise the stock is probably too expensive at present and if there is not and a credible CEO is appointed or there is predator interest the stock is probably too cheap. Our sense is that as with G4S and Serco a strong business will emerge at some point, probably with revenue of around £4bn and operating margins of 10% and organic revenue growth of 2-4%. The route from where we are today to that position, as with Serco and Mitie is unlikely to be smooth and may be long. We should add Rentokil to the list of services stocks that has regenerated itself, as it was trading as low as 33p in November 2008 and closed at 244p on Friday. The point we make is that we may not be at the bottom with Capita but if management takes the right decisions and, given it has substantial know-how and long term contracts in its markets, there is a good chance we should see a strong uplift longer term. But it’s not for widows and orphans at this stage! 

Kier was the main faller on Friday, down 2.0% to 1473p and its fellow decliners were Galliford Try, down 1.5% to 1519p and Morgan Sindall down 1.7% to 998p. We missed the fact that Redrow, Bovis and Galliford Try all went XD on Thursday last which accounted for some of the slippage we saw. On Friday, however the dips in GFRD and Kier were probably echoing the general concerns about the housebuilders and the increased concern that while construction companies are well placed right now public sector funding is slow to emerge (other than the normal seasonal first quarter boost). Morgan Sindall has very limited exposure to housing sector risk. Macro issues and in the case of GFRD the Bovis bid are likely to be stronger drivers of sentiment on the largest fallers on Friday than stock specific issues in the coming months, in our view.

Moves last week

The sector’s performance last week was a little better than the markets 1.2% fall; the construction and materials stocks were broadly unchanged while the housebuilders and services stocks fell by around 0.8%. YTD the market is up around 3% and the sector by 5% with the housebuilders leading the way, up 10.7% so far. The first quarter bounce in the sector may fade as the year progresses in our view but much depends on the two way stretch in the short term of funding for projects being available and the emergence of price inflation in the sector. The latter has so far been suppressed by hedging last year and absorption of its effects into margin.

The largest decline last week was at Berendsen as the big brokers ganged up on the stock in a series of notes that cast doubts on future performance. It closed down 6.5% over the seven days at 793p while forecasts remain in the 60-65p for EPS this year. Our sense is that there is a good business at Berendsen and this may be a very good buying opportunity but to date the presentation of what is going on in the business is capable of better explanation and there does seem to be far too many “initiatives” going on.

The best performance was at Grafton which rose 4.1% to 680p and the shares are now up 23.5% YTD. The stock started the year in an oversold position, in our view. The increase in recent weeks is part of a growing recognition that the growth prospects in Ireland and Belgium are good and that in the UK its Selco format is performing very well. With EPS forecasts at 47p for this year and 52p for next year the stock is not cheap now but the business performance bears out that it has not lost touch with its core customer base.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
24 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 24th March 2017

Henry Boot, the small property, construction and land development company provides us with its finals to end December 2016 this morning. The sector had a spring in its step yesterday as it recovered some of the fall of the two previous trading sessions.

Henry Boot, the small property, construction and land development company provides us with its finals to end December 2016 this morning. The company has been indicating for some months that it had a very good 2016 and the numbers this morning bear that out. Revenue was up 74% last year to £307m and PBT was up 22% to £40m. The main area of improvement was in property investment and development where revenue rose to £176m from £50m in the prior year as several major projects came through but clearly margins were not as high as in 2015 as operating profit only doubled (!) to £15m; the company is quite conservative in profit recognition. The read across from all three divisions is positive for the sector and the company is not flagging any real concerns, 2017 has started well so no blots on the landscape for Henry Boot.

The sector had a spring in its step yesterday as it recovered some of the fall of the two previous trading sessions. Doubts persist about the macro picture as evidenced by Carillion’s and Kier’s concern about progress on major construction projects, other comments and delay in work in some areas and lots of evidence that the housing market is at or is getting nearer a cyclical peak. There is no cliff edge in sight of course and avoiding anything like it is optional at present. Grafton moved 4.7% higher yesterday and has been tearing ahead since its results meeting even though there were elements of caution in its statement about UK progress. Consensus forecast show 47p of EPS for this year and the stock closed at 685p last night so the valuation is reasonably full at 14.6x p/e but the risks are now seen on the upside. The FD buying stock at 656p (a short £50,000 worth) helped with sentiment we suspect. Kier also moved up at a fast pace rising 3.8% to 1508p following a solid set of results which we discussed yesterday. We attended the results meeting and the level of confidence seems high and of course with its wide range of activity it has options; going a long way back to just after it floated the CEO Colin Busby could always find a few areas of strength which ensured it met expectations if some areas had problems. Kier seems to have re-established that flexibility and adaptability.

Galliford Try slipped a little yesterday, down 2.3% to 1541p, for no obvious good reason other than the pure housebuilders wobbled as macro data was weak. The pursuit of Bovis continues as far as we are aware but there is obviously no formal news as yet. Bovis saw its share price slip to 885p yesterday from a close of 914p on Wednesday. The 3.2% slip in Bovis, a tad more that GFRD’s fall is probably not that significant but it suggests that Redrow, up 2.2% yesterday might be seen as a more likely candidate at the moment. The housebuilders that want to grow clearly run the slide rule over the smaller guys all the time, that is normal but Redrow looking at Bovis goes back further than most and the geographic, market positioning and product ranges are compatible. There is logic for both Galliford and Redrow to combine separately with Bovis in our view. The Bovis board’s task is to decide whether it’s better to go alone and if not which combination will look best in 2/3 years’ time, as both proposed bids are all or mainly all shares. There is no sign of another interested party that might break any deadlock.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
23 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 23rd March 2017

Kier’s half year numbers are the main headline today, Crest Nicholson has issued an AGM update and WYG has also updated. Kier has announced a bit more than good numbers as in other announcements it also states that it will soon have a new Chairman and it has created a JV with east of England based Cross Keys Housing into which it will transfer some land and developments worth £97m in exchange for £64m cash now and 90% economic ownership of the JV (50:50 split of voting rights).

Kier’s half year numbers are the main headline today, Crest Nicholson has issued an AGM update and WYG has also updated. Kier has announced a bit more than good numbers as in other announcements it also states that it will soon have a new Chairman and it has created a JV with east of England based Cross Keys Housing into which it will transfer some land and developments worth £97m in exchange for £64m cash now and 90% economic ownership of the JV (50:50 split of voting rights). Kier tell us the JV will be earnings accretive in 2019 (slightly negative until then) and cash generative from the outset, completion is due at the end of this month. The group trading numbers are said by the company to be in line with expectations showing underlying revenue broadly level at £2bn and underlying operating profit up 4% at £57m. EPS at the halfway stage are up 11% at 38.9p which is in line with the 10% CACR promised to 2020 but the guidance is that this full year may be a little below the target five year average. More Below

Crest Nicholson reports that trading has been robust, a term usually associated with being mainly good but not as good as it was. The numbers bear that out with open market forward sales level at £312m versus last year and total forward sales up just 5% at £506m. Sales price inflation is said to be modest but that is helping affordability and high employment and good mortgage availability are aiding market conditions. The main message is that the company is continuing to expand its operations and is on track for 4,000 units in 2019 and £1.4bn of revenue. So all is cool at Crest but the economic backdrop for jobs and cheap mortgages is getting a little worse than it was so much depends on how the economy reacts to Brexit, especially in the South east which is most affected by financial sector jobs.

WYG’s share price took a post Referendum bashing from which it recovered about six weeks ago. Today’s news might send it back down again a little as the company has warned that it needs to restructure in Poland and there will be a cost of £2.5m and that, more importantly, UKL profits will be impacted by delays and lower than expected utilisation. The company points to operating profit of £9m this year and revenue in excess of £150m; the revenue is in line with expectation and up 13% but the 25% rise in operating profit and a few £m short of expectations. The international operations show improved underlying revenue and earnings, as expected. We have followed the stock from a short distance and believe the management when it says this is a blip in strong progress rather than a substantial issue. It looks as though in the UK at least it has just tried to go faster than it should, with hindsight! Net debt will be £6m at the year-end so the balance sheet presents few problems on that issue. So forecasts for EPS are likely to fall to the 11p level (compared with 12.3p currently forecast by the market) which makes the closing price last night at 128p a tad vulnerable in early trading today.

For the second day running our screen had far more red than blue as stock prices dipped. Only two risers among our universe of 22 closely watched stocks, Mears, up 0.3% and SIG up 0.1%. The volume on Mears at 577,211 shares traded was well above the norm levels and is therefore a tad more representative than the normal position. The stock closed at 502p. 2017 forecasts were trimmed a little after the results on Tuesday due only to a £2.5m non-cash pension service charge which the company treated as part of normal costs; Mears does not indulge in practices such as capitalising bid and mobilisation costs. In 2017 the market now expects EPS of 35-36p with the risk on the upside as higher margin work in housing increases. Berendsen was the back marker as it struggles for support, falling 3.9% to 781p; there are reports of target prices as low as 700p which is harsh but after two profit warnings and with the corporate improvement programmes still unproven investors do not yet have faith in the top team changes.

Kier is trading as expected according to the numbers released today, from what we can see. There are few ups and downs within the numbers that are of little impact on the overall piece. The small improvement in the margin in Construction to 2.0% from 1.9% is encouraging and the highways operations, focussed mainly on maintenance are seeing a strong level of demand. The housing operations as might be expected have performed well in the private sales business and in mixed tenure revenue was up 10% and this remains an area with strong prospects. We shall dash to the analysts meeting now and report later as appropriate. The business is on track for £150m of PBT for the year and with debt controlled at £179m at the half year (c £150-160m for full year) it looks well set to fulfil expectations. 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
22 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 22nd March 2017

Redrow has issued an unexpected trading update today and has organised a visit to its Colindale site on 4th April and Kingfisher’s final results for the 12 months to end January 2017 are released as expected.

Redrow has issued an unexpected trading update today and has organised a visit to its Colindale site on 4th April and Kingfisher’s final results for the 12 months to end January 2017 are released as expected. Redrow’s news comes five weeks after the interim results were announced. The new news is that trading has been stronger than expected (prices and volumes) so management is confident it will hit at least £306m of PBT in the year to end June 2017, 22% higher than the £250m last year; the reporting accountants and the main bank to the company have signed off on the number. No other detail is provided and the estimate is not much different from market consensus, some of which may not include the positive impact of the acquisition of Radleigh Homes. Redrow’s price has slipped a tad since the near all share proposed offer for Bovis so this provides a sensible underpinning and the reasons for it are clear.

We are about to enter a sticky patch for the house builders in our view, in terms of macro news flow. There are an increasing number of articles suggesting that the era of ultra-low interest rates is starting to end. Average house prices are some 7x average incomes, higher in London. ONS yesterday revised downwards its estimates of house price rises in November and December 2016; OK it was from 7.2% in December, for example down to 5.7% but that is still a high level compared with income growth. The new house builders have had a strong run YTD as they are the main source of supply, in a market in which many home owners are staying put and waiting to see what post Brexit Britain looks like. Remember March last year provided a strong comparator as there was a buying frenzy 12 months ago ahead of Stamp Duty changes. There is no real evidence that the prospects for the housebuilders has altered from what we can see, on an 18 month view but the news flow is likely to be less helpful than recent information.

Kingfisher’s group level numbers look positive with 2.3% organic sales growth at CER, 8.7% reported at AER and adjusted operating profit up 13.5% at AER. The group plan for improvement is said to be on track but we are just over one year in to a five year plan so it’s still not fully proven. We look at Kingfisher mainly to see read across to the UK and the news is positive enough to show good market conditions and yet not so positive it raises alarm bells for the performance of rivals! L4L sales were up at B&Q and Screwfix by 5.9% to a reported level of near £5bn. B&Q saw sales fall by 3.3% to $3.7bn as the planned store closures proceeded but rose 3.5% L4L. Screwfix sales rose by 23% to £1.3bn (14% L4L) said to be due to specialist sales teams in plumbing and electrical areas and the roll out of 60 new stores bringing the total to 517 at the y/e; the new plan is to take the total up to 700 which is quite aggressive! That number is not dissimilar from the Howden’s target so clearly they are using the same population data analysis! The Kingfisher target for stores is something to which we expect other Merchants will react but they already must have expected it so what has really changed for them. Not much, it would seem.

The Merchants had a good day on Tuesday 21st with Travis Perkins, SIG and Grafton being the leaders for most of the session. In the end only the first two ended in positive territory up 1.6% and 0.2% respectively and were two of only three risers on the day. Grafton closed down 0.5%. The support for the Merchants is welcome though we suspect that if housebuilder news flow is less positive there may be some adverse impact on the Merchants. We are also concerned about disintermediation of the Merchants’ role in materials distribution. It has already had a significant adverse impact on the Plumbing and Heating segment, of course. But as Merchant destock have less samples available at their branches and using tablets and phones gets even easier and third party logistics improve the role will alter much further. The scenarios are many and too much for a morning note. So far the main Merchant’s have ridden the wave with their internet offerings allied to smaller stores and in one case the unique Selco format. 

Berendsen was the back marker, down 5.4% as one of the big brokers highlighted what we said last week, that the company is trying to do too much, too fast in a company that was pretty good to start with and, after two profit warnings in less than a year, demonstration of competence at running the existing operations is a priority. The shares closed at 812p and while the prospect of the third profit warning is low, given the company’s markets and positioning with so much change it cannot be ruled out. While the new CEO’s track record at his former “home”, Invensys, might be very good there is little evidence in the public domain that the same is true for the other newbies he has appointed as it is not usually publicised. At 812p at close last night the shares may be harshly treated with 63p of EPS expected this year but a level of change in the business that seems to border on hyperactivity has raised the level of risk.

Apologies if we seem a bit negative this morning. The sector usually does well in Q1 and that is true this year. But the good news flow we have seen in most cases we suspect will give way to a bit of profit taking as we end the quarter, as Article 50 blues hit us as the press focusses on that and, as stated earlier, inflation increases as FX hedges expire and the 15% devaluation bites harder and, as stated earlier the prospect of high interest rates. We remain positive about Infrastructure providers, FM outsourcers with transparent accounts, companies with well invested capital and sustained demand (e.g. the brick makers) and some companies with wide international exposure. But valuations in some areas look stretched if the news flow worsens and growth slows.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
21 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 21st March 2017

Mears and Bellway provide results this morning, the former its full year numbers to end December 2016 and the latter interims to end January. There was very little movement among sector stocks yesterday. The sector is currently becalmed as the puzzle of what post Brexit Britain might look like unfolds.

Mears and Bellway provide results this morning, the former its full year numbers to end December 2016 and the latter interims to end January. Mears numbers are in line with revenue up 7% to £940m and adjusted operating profit up by 8% to £42m. The group results was held back by a £1.2m operating loss in Care as the company restructured its operations in that area; total revenue in the segment rose by 4% to £153m due to the full year impact of the Care at Home acquisition made in 2015. The company has downsized its Care operations to enable it to work with customers who value the proposition it offers; the statement this morning shows that the Care segment exited 2016 with an annualised revenue rate of £126m but with the charge rate per hour 14% higher than at the start of the year profitability should be achieved this year. The pipeline in Care is strong and good work is being won.

The issues in the Mear’s Care segment should not detract from the excellent and still improving performance in Housing; revenue in that area rose by 7% to £787m and adjusted operating profit was 4% higher. The lower margin in housing was due to several contracts being in the early stages of start-up. The work will yield improved margins this year as they ramp up. The company ended the year with net debt of £12.4m, versus a neutral position at end 2015 as a £10m payment on a deferred consideration was made and the organic growth in new work in housing absorbed working capital; the acquisition payment was a one-off and the working capital position will unwind. More below

The numbers from Bellway will not surprise the market. Revenue is up 6% to £1.2bn, 7% volume increase and an ASP slightly reduced to £256,140 due to an increased element of social housing in the mix. The operating margin has improved to 22% from 21.4% at the halfway stage last year. The efforts to grow the business towards 10,000 completions a year (4,462 units completed in 1H) are shown with the acquisition of 6,287 plots in the six month period. The company reports a high level of demand with the forward order book 18% higher now than this time last year at £1.4bn and the cancellation rate at 12% remains low. The only blot on the landscape might be that net debt rose to £175m from £59m last year; the company states the debt will reduce by the year end and points to average net debt of £106m in the period. From an investment perspective the expected volume and earnings growth at Bellway are a real plus but the net debt and the relatively low dividend (up 10% at the halfway stage), yielding just over 4% prospective are constraints on share price development. 

There was very little movement among sector stocks yesterday. The sector is currently becalmed as the puzzle of what post Brexit Britain might look like unfolds. The data show that not much is changed; well we have not left yet! What does emerge from the data is that London’s position among global capitals is threatened as evidenced by comments from banks and other financial institutions and by developers and property agents. The best riser yesterday was Homeserve, up just 2.0% to 565p and G4S fell 1.8% to 296p to be the largest loser. The latter had some downbeat broker comment and in any event short term retracement was likely after a strong recent run. The next few weeks will see some shifts we expect as the end of the first quarter approaches and as Article 50 is triggered. From the current perspective the balance is towards the downside, in our view as the possibility of political turmoil and a hard Brexit loom large.

Mears is a company in more transition than most. Arguably companies are always in transition! In Housing Mears has successfully transformed its model to include a much more comprehensive offering to a changing market place. Five years ago it sold mainly maintenance services to Housing Associations. Today it can deliver a full range of support to housing associations, local authorities and PRS owners, ranging from project funding and new build through to day-to-day management and running of a housing provider; it is a registered provider (RP) in its own right and has been used to the HCA to “rescue” troubled RPs. In Care the market place issues have received substantial publicity. Mears has taken the initiative, more swiftly and comprehensively than most by withdrawing from around 25% of its workload (in terms of hours delivered) as it focuses on local authorities that want a more comprehensive and mature approach to managing their budgets and fulfilling their responsibilities to disadvantaged groups comprising mainly, but not exclusively, older people.

The outcome for investors of the actions of Mear’s management in 2016 will show through more fully this year. Performance improved last year but remains below the best the company can achieve. We will attend the result meeting later this morning. Market forecast for EPS this year are for a rise to around 38p which we expect to hear confirmed in guidance today. Ally that with a solid balance sheet and 94% of consensus revenue for 2017 already secure and the risks for Mears at 500p look to be very low. The stock is quite thinly traded so moves can be exaggerated but the underlying long term position is very sound.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
20 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 20th March

News today comes from Michelmersh, the small UK brick maker, with its finals, JLIF, also with finals, Volution with its interims and Carillion with news of a £90m construction contract in Cyprus to build a communications centre for the MoD’s Defence Infrastructure Organisation (DIO). No news on the Bovis/Redrow/Galliford Try front.

News today comes from Michelmersh, the small UK brick maker, with its finals, JLIF, also with finals, Volution with its interims and Carillion with news of a £90m construction contract in Cyprus to build a communications centre for the MoD’s Defence Infrastructure Organisation (DIO). No news on the Bovis/Redrow/Galliford Try front. The key message from Michelmersh and Volution, both of which supply materials into the UK construction sector is that the new year has started well and while they keep expecting to see signs of Brexit uncertainty there are none yet evident in demand. Both companies have been able to date to mitigate much of the impact of FX changes since 23rd June.

Michelmersh had a revenue increase of 3% to £30m in 2016, PBT was stable at £4.5m and net cash rose £1.8m to £4.7m. The company had a wobble in production during 2016 so this represents good progress and the company seems to be in very confident mood, due to high order intake YTD, new plant performing well and the £2.7m sale of surplus land at Dunton. Average selling prices have been maintained. The read across to Ibstock and Forterra is positive, in our view. Michelmersh has quite specialised products but it still competes with the three mainstream companies that have 90% of the market capacity and needs good conditions in which it can thrive. The company lists some of its larger customers in the results update to show that it’s not just a small specialist of limited relevance. The company indicates that it is now ready to kick on from here, notwithstanding Brexit uncertainties, which it mentions. With £46m market capitalisation and because it is not set to grow substantially we have tended to give it limited attention.

The news from Carillion is interesting not just because it is a good contract to win but for two other reasons. Firstly, it signals that Carillion is still in favour with DIO despite some reports of difficulties in the early stages of the NGEC project and secondly, because Interserve does the FM for the MoD estate in Cyprus and might have regarded winning this capital project as a natural extension of its work. Clearly it is inappropriate to read too much into one contract but, it’s a collection of small signals, such as this, that tell us the sense of direction for a business. Our sense on IRV is that it is in a weak situation, which can only get worse as it waits until September for the new CEO to arrive. For Carillion this is small but clearly significant and it confirms the hints about future work awards provided at the recent results meeting.

Volution is a £365m market capitalisation company of which few people have ever heard. It is the leading supplier of ventilation products in the UK in residential and commercial. The numbers today are very positive with revenue up 19.3% at CER of which 2.3% was organic. Headline revenue at AER rose by 26% to £89m and adjusted operating profit was 7.7% higher at CER at £17m. The operating margin dipped as a result of recent acquisitions performing below the group average. Net debt was virtually unchanged, just £0.6m higher at £41m. We will not comment in depth on the business as we have not looked at it in depth. The read across to other companies in the materials area is the main reason to look at it and the news is positive. Its strategy of self-help and buying smaller rivals is producing good growth at a time when ventilation systems are becoming a much more important factor in building design. The company is expected to deliver 13p of EPS in the year to end July and the stock closed at 182p on Friday last; with 6.5p of EPS at the halfway stage the forecasts look credible.

We like to look at the Infra Cos as they provide a good steer on the long term value of many construction stocks and they are not widely covered. JLIF’s numbers today justify the recent strength shown in its share price. NAV was at 120p a share based on a portfolio value of £1.2bn at end 2016, up 40% on the prior year. As expected the dividend was raised a tad ahead of CPI, at 2%, for the six months to end December. During 2016 the company sold assets as well as acquired them where it can see better value from disposing. The company explains that there is a shortage of available projects in the UK both in terms of new ones coming to market and because many existing ones are in the hands of large, long term investment vehicles. It highlights its increased level of geographic diversity and in particular the opportunities in the US where it made its first investment last year. Whether the UK market for PF2 projects will emerge we shall need to wait and see. But clearly JLIF has taken action to ensure its own growth as have others in the space that are interested in both primary and secondary investment. The signal today from JLIF is that it will be taking a greater interest in some new geographies, especially the US as they provide a better risk/reward profile that some mature markets, in the mid-term. It has also announced a £90m equity fund raise to reduce debt and create firepower for more growth.

News later this week comes from Mears, Augean and Smart Metering (Finals) and Bellway (Interims) tomorrow. On Wednesday Kingfisher reports its finals which will have important read across. Thursday sees Kier provide its interims, and its Crest Nicolson’s AGM. On Friday Henry Boot provides its finals for 2016.

The moves Friday last saw Balfour Beatty take another small bashing for being a tad less positive about the next 12 months than it might have been, down 2.4% to 265p. The concern is always what lies beneath statements when they suggest caution. The mood at the meeting was quite upbeat. Forecasts for BBY have slipped downwards a little in the light of the underperformance in 2016. The value of the PPP/PFI portfolio at £1.2bn is sustained, despite distributions and disposals of £253m as the unwind of the NPV discount and expected operational improvements raised the value. As all recent sales have been at values in excess of Director’s valuation we are inclined to go along with the board’s view. Higher interest rates may change things but despite several rises in US rates the Infra co’s valuations are sustained. The news from JLIF today puts BBY’s portfolio of investments and its prospects for the future into a positive light. At 265p the shares look good value, in our view.

Homeserve got some support on Friday last, rising 5.2% to 554p. Optically the numbers for 2016/17 (March y/e) will look quite good due to FX but our doubts about the long term remain. The lack of transparency in the numbers and the need to replace nearly 20% of the customer base every year in the UK and the US make us concerned. The company is expected to update around its year end which is March. We are not optimistic about what it will say given market conditions.

Moves last week

The sector performed a tad ahead of the market last week rising 1.2% versus the markets 1.2% rise. The Construction and Materials segment fell a little last week as Balfour’s decline did not help. YTD the sector is still outperforming the market’s 4.2% rise with a 6% increase. But as we often remind investors Q1 Is always nearly good for the sector in relative terms and its exposure to risks arising from Brexit are not really yet apparent in demand or share prices.

Interserve was the main faller last week, down 7.7% and we fear for its long term capability to survive. Debt is too high, there is likely to be a vacuum at the top lasting well into 2018 as the new CEO finds her feet and appoints her team and customers, suppliers and employees will find more stable situations where they can trade. Balfour was the other large faller, down 6.7% on a knee jerk reaction to the trading numbers and the short term outlook.

Berendsen and Capita both rose by 5% last week as investors sought value in companies that have tarnished reputations. Both stocks remain well below historic valuations and it may be they will need to adjust to lower operating margin expectations in the future and that is part of what is happening to them. Capita has the most obvious attractions as a Special Situation recovery play and the prospect of the need for an equity fund raise is fading and in any event is not possible until a new CEO arrives. Capita would seem to have a ceiling of around 600p on the share price, in the short term, until key issues are resolved.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
17 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 17th March 2017

Berkeley Group’s trading update this morning emphasises the turbulence it has faced in the last 12 months (since the rises in Stamp Duty). There are three key messages Balfour Beatty was the backmarker yesterday with a 4.3% fall to 271.8p.

Berkeley Group’s trading update this morning emphasises the turbulence it has faced in the last 12 months (since the rises in Stamp Duty). There are three key messages, firstly the business is fully on track in terms of earnings and cash returns; secondly, that some market stability has returned when measured by cancellation rates and pricing resilience;  and, thirdly, (using our words) government measures have aided a 30% reduction in housing starts in London in the last 12 months, at a time of housing shortages. Berkeley has contributed to and been beneficiary of the near 40 year boom that London has enjoyed, which started with the privatisation of BT in 1984 that made getting telecoms capacity in London very easy at a time when trading was becoming computer based and of Big Bang. The third point in its update (as we see it) is that continuation of that growth is threatened by a lack of housing at a time of great economic uncertainty, caused by many factors. Berkeley is not making a political point as such but using it update to emphasise that there is a very delicate balance to continuing London’s growth and, while it will perform well over the next five years, due to its relationships and embedded knowledge about the market, overall there are many more threats to success than there were previously. More below

Balfour Beatty was the backmarker yesterday with a 4.3% fall to 271.8p. CEO Leo Quinn knows how the gig works in these turnarounds, having two notches on his gun already, before joining BBY. It’s about simple messages, get in the cash, make people take responsibility and sort out the information flows so you know what’s happening. And then just hang on tight as the ride might not be 100% smooth! Oh, and remember to have a deal at your sleeve to create a good finish! Of course it never that easy and 2016 might have been a bit less positive than some hoped. The turnaround at BBY will require patience, one of the messages from yesterday. Being patient is made easier in BBY’s case by the existence of the £1.2bn PPP/PFI portfolio and £173m. On a conventional EV calculation therefore the £8bn+ of revenue in the mainstream operation is valued at around £500m (Market Cap of £1.9bn less £1.2bn of PPP/PFI portfolio and less £173m of net cash). Obviously it’s the earnings that matter and the presentation yesterday helped us to recognise that the flight path to better margins is much clearer than it was but there is some turbulence.

One issue not explored yesterday at BBY’s meeting was the rising costs and potentially increasing shortage of building sector labour. BBY is exposed to that in the UK and due to its geographic exposure in the Southern States of the USA (the so called Southern Smile). BBY does a great deal to support skills training and the recruitment of apprentices so its contribution is not in question. But it operates within a broader context of course. The increased use of MMC techniques is expected to make an important contribution. The company is bringing volumetric pods built in China for one development of student housing. The quality of such product is vastly improved in recent years and we know that many UK companies are looking in that direction. The recovery at BBY is not threatened directly by labour and skills shortages but the potential for turbulence arising from such issues is higher now than in the pre Brexit and pre Trump eras.

There were four companies that rose by over 1% yesterday Polypipe (1.8%), Carillion (1.7%), Serco (1.6%) and Berendsen (1.4%). There is little connection between these companies so no real trend emerged. Serco’s gain was probably due to the award of PB status on the Grafton prison project in Australia. Revenue and earnings on that work do not really start to flow until 2020 when the asset build is finished, though there will be project management fees from this year onwards, assuming financial close is achieved. So the “win” was good news for the company but the earnings impact is longer term, hence the muted but positive reaction.

Berkeley’s Tony Pidgely, as most readers will know has read the market very well for many years. Today he is saying that he and Rob Perrins are running the business in increasingly tighter constraints in London. And while Berkeley can cope in the mid term the overall picture for what can be done will be diminished if London living costs remain very high due to housing shortages.

The company is continuing with its plan to return cash to shareholders via buy backs and dividends. The cash return plan was altered six months ago to include buy backs as the BKG was at a level that represented great value, according to management. The company will pay 85.3p per share of special dividend on 24th March which allied with the £21m spent on share buybacks up to 23rd February completes the promised £139m of promised cash returns in that phase. The next £139m is due to be paid by 30th September and teh proportions of that spent on buybacks and dividends will not be known until August, as the rate of share acquisition is not yet known.

Trading data supplied today supports the company’s views about its ability to fund the promised cash returns to 2021. PBT in the current year to end April is likely to be at the top end of the current range of forecasts, we are told. The final outcome depends upon the timing of completions. The consensus is at around £770m PBT and 415p of EPS. The share closed last night at 2963p. On the basis of the current valuation the market is giving a big thumbs down to London’s prospects and not just Berkeley’s. Forward sales at end April at BKG are expected to be over £2.6bn, based on current sales rates. In is working on 58 sites at present and has 22 more nearly ready to commence but held back at the moment due to planning or site infrastructure issues. The macro call on London is unhelpful to the company’s share price. But we know through its JV’s and relationships with landowners and ability to read the market it will adapt to the environment it faces, as it has before. So the balance between in the market of being bearish on London and positive on Berkeley remains. The view this morning does not aid clarity on London’s prospects and arguably could not do so but the message that stability has broken out is useful.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

16 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 16th March 2017

Balfour Beatty has announced its results for 2016 and Serco has bagged one of its “Elephant” contracts, becoming the preferred bidder on the 20 year/£1.6bn contract for the new Grafton correctional centre in NSW Australia.  Babcock was the best gainer yesterday rising 2.3% to 914p as investors were reassured by the presentation on the new reporting structure.Serco’s news is very positive and adds to its reputation for winning big projects under the new team

Balfour Beatty has announced its results for 2016 and Serco has bagged one of its “Elephant” contracts, becoming the preferred bidder on the 20 year/£1.6bn contract for the new Grafton correctional centre in NSW Australia. The performance in 2016 at BBY was not quite as positive as expected in earning terms (revenue was up 3.6% at £8.5bn at AER and PBT was £60m versus a loss of £123m last year) but the performance on cash and the resolution of the issues in UK Construction will bolster the share price performance. Getting back on track fully was always more likely to happen in 2018 and the news today suggests that has not altered. Net cash in the mainstream business was £173m at the year end and average net debt was £46m in the year; good trading and working capital management was balanced by investments in the PFI portfolio and operations. The company claims it exceeded its Phase One targets for Build to Last of £200m cash (it reached £439m) and £100m of reduced cost (it achieved £123m); we shall hear more alter this morning about how it will sustain progress to reach Phase Two of industry standard margins in Construction and Support Services by 2018 (Phase Three is about hitting above industry margins but a lot may change between now and 2021!) . The company states that its markets remain positive More below

Babcock was the best gainer yesterday rising 2.3% to 914p as investors were reassured by the presentation on the new reporting structure. We are generally sceptical about “moving the deckchairs” though clearly the allocation of trading units in the divisions had some anomalies and the new structure allows a broader geographic brief. There often always problems and crossovers which product/market sector/geography structures so usually it’s the least worst option that prevails in order to get the best possible use of group-wide know-how and technology. The rise in the last two days is though more likely to be based on the reassuring trading situation at the back end of last year and positive statements about future growth, along with the weak performance recently driving down the valuation to a cheap level.

SIG was the worst performer, down 4.1% to 110.3p as it gave up some of the post results/post new CEO gain. The decline, while large, was just trading ebb and flowing our view. The opportunity to improve margins remains very clear and achievable and involves no new risks or unusual approaches that threaten the market structure.

The news today from Balfour Beatty is all about it progress really, rather than expecting it to have reached a destination in its UK operations. And it seems to be well on track. Some may have been seeking a faster turnaround but in large scale construction project resolution can be a glacial process, even with some global warming! Of the 89 large troublesome projects in te UK 90% have now reached practical completion and over 70% financial completion; but it will take into 2018 to get to 100%. WE shall comment on country and segment performance after the meeting but there seems to be little of note in the statement that might alter views. The order book at £12.7bn at AER is ahead of the £11.0bn level at the end of 2015, though boosted a little by FX. The dividend was confirmed at 2.7p for the full year versus 7.0p of EPS, which will be welcomed and reflects the improved balance sheet. The PPP/PFI investment portfolio was valued at £1.2bn at the year end, roughly the same as at end 2015. The tone of the messages and the comments on trading and the restructure and upgrading of the business are very positive suggesting that the company could have perhaps come in with higher figures but wants to hold back until the picture is a bit more clear. It says as much in a comment about profit declaration on UK projects in construction. At 283p at close last night we remain positive and look to 30p of EPS in 2019 as the man prize and the basis to think of in terms of valuation. But it may that value is achieved through some corporate restructure before Phase Three is reached.

Serco’s news is very positive and adds to its reputation for winning big projects under the new team, following the Barts hospital win late last year. As with Balfour the goal is to create a solid business for the mid and long term not maximise short term earnings. So this win provides a good long term earnings stream and enhances Serco’s position in Australia which is no bad thing given its position on other important projects. The shares closed last night at 115.6p and seemed to have settled in a 110-120p range after the results, which brought a small dose of reality to the price. Contract wins are important milestones and gaining PB status Grafton is another one that has been passed.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
15 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 15th March 2017

It’s a day for the heavy side materials producers to report. Forterra and Marshalls have delivered their 2016 results this morning. Forterra had a revenue increase of 1.5% last year to £295m and underlying EBITDA rose 4.6% to £71m. Marshalls shows revenue up 3% in 2016 at £397m and EBITDA up 17% at £61m. As a consequence of those improvements and lower interest charges and tax rates EPS rose by 32% to 18.95p (consensus was at 17.8p).

It’s a day for the heavy side materials producers to report. Forterra and Marshalls have delivered their 2016 results this morning. Both are justifiably pleased with the 2016 outcome and cautiously optimistic about 2017. Forterra had a revenue increase of 1.5% last year to £295m and Underlying EBITDA rose 4.6% to £71m; sales volumes rose during the year but the impact was offset a little by a change in the mix of sales with some lower priced product showing a greater increase in volume that the average, creating an adverse mix. Importantly the year has started well with higher sales and price increases are now agreed that “cover the increases in costs”. EPS last year ended at 21.5p which is in line with expectations, perhaps a little towards the top end of the range but not above it. As things stand the first half of 2016 looks like it will be very good, based on trading YTD and orders but, obviously visibility for 2H is low at present and the company quite rightly counsels some caution as the macro background is unclear. Net debt was £92m at the year-end, 1.3x EBITDA, so, as indicated in the pre close update the company has a solid balance sheet and the ability to expand. More below

Marshalls shows revenue up 3% in 2016 at £397m and EBITDA up 17% at £61m. As a consequence of those improvements and lower interest charges and tax rates EPS rose by 32% to 18.95p (consensus was at 17.8p). The final ordinary dividend was raised by 22% and the supplementary one by 50% to 3p; so overall the annual dividend was 11.7p, a 22% rise on last year and was a 3.7% yield at last night’s close of 315p. Net cash was £5.4m at the year-end compared with £11.5m net debt in 2015. The company indicates that the new trading year has started well with strong sales and order intake; the indication provided has a more positive tone than other recent updates from its peers but no numbers are provided in the releases. The large increase in EBITDA is partly the product of a substantial operational efficiency programme along with strong branding and support to the installer network. Sales into the domestic sector in the UK, which is roughly 30% of total sales rose 10% and strengthened in 2H to a 14% increase. Clearly, given the data above, sales into the Public and Commercial sector (the other main division) were flat. The volume /price mix in the sales rise is not stated but the implications from the text are that in the Domestic area there was an improvement in both aspects but in public sector and commercial volumes rose possible at the expense of price as the company gained some share. The company points to a positive mid-term outlook and adds little to guidance for the current year. More below

Both Forterra and Marshalls place an emphasis on growing organically and if they are to acquire it will be via bolt-ons. Both companies seem to recognise the industry they are in is cyclical and it’s no time for big bold moves. There is expected to be growth in their markets but the focus is on self-help and performance improvement in what are well run, well invested operations.

SIG was the best performer yesterday, up 7.3% to 115p as the update and new CEO appointment went down well with the markets. The main thread of the presentation was that some quite basic operational disciplines, especially in sales and marketing, had been only loosely observed in recent years. The new team has promised higher sales and improved margins in relatively flat markets by being much better in its operations. Achieving that will require a better accommodation with suppliers; an element of the business we believe, as outsiders, was not handled as well as it might have been in recent years from what we observed. Working with the suppliers is key to what SIG needs to achieve and previous management seemed to be less mindful of that than the new FD (the new CEO was not at the meeting). At 115p, SIG might look a tad more expensive than it was but to many will still seem to be cheap given the potential for margin improvement. EPS of 10.5p, the consensus for this year more than adequately justifies the share price, in our view.

Carillion was the back market yesterday, down 4.0% to 223p as the post results roadshow came to an end. The uptick in the price in recent days may have been a bit of short covering as the plan to cure the balance sheet gains some traction and credibility but has a long way to go. We remain positive.

Forterra’s maiden set of full year results are fully in line with expectations. During the course of this year the benefits of 2015 and 2016 investments shall be more evident and the Claughton plant is expected to come back on stream. The business was in good shape when it came back to the market and in 2016 the only real issue was some overstocking in the supply chain which has now cleared. High levels of demand for housing and the FX changes that had choked off imports should aid performance. Any caution arises from macro factors from what we see. Forecast for 2017 are likely to go up slightly today and the risk on the current year is reduced. The market is expecting around 22.7p of EPS this year. Lone Star’s c 50% holding remains in pace and may act as a drag on valuation but the prospects for the business are very good indeed so as that holding is placed we expect the price to improve with targets of 250p being the average level.

Marshalls is expected to deliver 19.6p of EPS this year and we suspect that forecasts will trend slightly higher on today’s results. The price closed last night at 316p so the stock is trading on 16x current year prospective earnings. The market may take some encouragement from the results but target prices of 330-350p seem a likely level as the valuation is ahead of the peer group at present.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

14 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 14th March 2017

SIG is the main news today providing its numbers for 2016 and a new CEO. The main moves yesterday were the two ‘ Serves, Interserve and Homeserve. At the top end of our “league table” Capita got more support closing up 4.4% at 569p; investors perhaps now see the risk/reward and are accepting it.

SIG is the main news today providing its numbers for 2016 and a new CEO, Meinie Oldersma joins the group from April onwards having left Brammer following its sale into private equity in early February. There is not much time between roles but his experience of distribution should be put to early good effect. The story at SIG is very similar to Brammers’, difficulties in the short term, long term in a good position; how many times have we written that? The numbers for 2016 from SIG are in line with the lowered expectations. Organic revenue was broadly flat across the group, up 4.4% in constant currency (including acquisitions) and up 11% at the headline level as FX flattered 2016 sales versus 2015. Underlying PBT was down 12.5% at AER, £77.5m as guided in the most recent update. Reducing the dividend (rebasing it’s called) will not be popular with all investors but at 3.66p for the full year, versus 4.6p last year the reduction is realistic and proportionate, given the net debt position and underlying EPS last year of 9.7p, versus 11.3p in 2015. The actions over the next 12-18 months are about getting right what exists within the business to improve returns and lower net debt which was £260m at the year end (2.1x EBITDA). Sales in 2017 YTD are said to be in line with expectations which does not sound as positive as the updates from some rivals and will therefore be a topic at the results meeting at 9am today. More Below

The main moves yesterday were the two ‘Serves, Interserve and Homeserve’. The former fell 4.9% and the latter 6.7%. In our view even with the falls, to 223p and 523p respectively they remain stocks to avoid. The root cause in both cases really amounts to management. We look for three things, Men, Money and Markets when taking a view. In other words, does the management have the resources to achieve its goals in the markets in which it operates? The ‘Serves fail in both cases ion at least two counts. Interserve has unproven new management, a tough balance sheet and known difficulties in its markets. Homeserve has issues in all three areas of our “Men, Money & Markets” hypothesis of the essentials for companies to succeed.

At the top end of our “league table” Capita got more support closing up 4.4% at 569p; investors perhaps now see the risk/reward and are accepting it. Equally, it may be said, that on a day when M&A was the key talking point, Capita might be an interesting acquisition for many companies.

Bovis/Redrow/Galliford Try seems likely to rumble on. The GDV of the landbank is the best guide to the value of the company, in our view and that was £5bn at end 2016, using the company’s data. The existence of a large strategic land bank at Bovis, something that the company was early to enter compared with rivals, makes calculation quite tricky. NAV is no longer a relevant measure given the way in which land is transacted today. The debate for investors is whether Bovis is better alone in 2/3 years from now or with a larger entity and if so which. Inevitably the board has looked at the short term valuation posed by both suitors. But that should not be the only or the main criterion. If the offers were all cash the valuation now would be 100% the issue. But they are not so the board has a much more complex issue to face and there is no evidence it has done that. In the meantime of course others will be running the slide rule over Bovis but at a time when the land market is benign the risks might seem higher buying Bovis than building a landbank.

SIG tells us today that the strategy is OK and it was just a matter of execution; you know what that sounds about right to us. With a new CEO and a new FD SIG should be able to take advantage of its strong position in its core markets. The company indicates today that the search for better performance with its strategic initiatives caused the top team to be distracted from satisfying customers in the short term (if that sounds familiar then look at what is happening now at Berendsen). In SIG’s case revenue has been sustained at a high level (£2.8bn) despite the issues referred to and with large revenue and willing suppliers and customers a business can make progress.  The company points to some uncertainty in UK markets but a brighter picture in Euroland. The £4m loss on £26m revenue in Offsite Construction is disappointing but break-even is said to be likely this year as production issues are resolved and given the strong order book. We remain confident that SIG is a sleeping giant in its area of Merchanting and the basis exists for a very strong recovery in the company and therefore the share price from the close last night at 106.7p.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
13 March 2017 · 2 min read

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

Galliford, Redrow and Bovis have all made announcements this morning in a bid/merger battle that may take a while to play out. Our belief is that Bovis will be asked by shareholders to get back to the table with both parties as a deal will be the best and quickest way of restoring much eroded value in the shares. As both approaches are indicated to be mergers shareholders will have difficulty in choosing, if they wish to retain sector exposure in any combined entity.

Galliford, Redrow and Bovis have all made announcements this morning in a bid/merger battle that may take a while to play out. Bovis has rejected both potential merger approaches which were at 814p from Redrow (125p cash, 659p in new Redrow shares and 30p final dividend) and 886p in an all share merger bid from Galliford Try. Redrow’s proposal was made in late February and is based on an undisturbed price of 774p while GFRD’s approach is based on a more recent price, it quotes the 10th March price of 828p as the basis for its calculation of the bid. Bovis tell us that the conversations with Galliford Try continue but ceased with Redrow on 6th March.

Our belief is that Bovis will be asked by shareholders to get back to the table with both parties as a deal will be the best and quickest way of restoring much eroded value in the shares. As both approaches are indicated to be mergers, shareholders will have difficulty in choosing, if they wish to retain sector exposure in any combined entity.

Galliford and Try struggled after they “merged” in 2000. It took 18 months for the parties to realise that there are only takeovers and once the dominant party captured the reins the operations started to improve.

In our view there are economies of scale in housebuilding from which investors can gain benefits. These arise from common designs, procurement, technology and overhead absorption. The ability to procure well, often directly from manufacturers of components and assemblies, is rising rapidly in importance and should not be ignored. The scene in housebuilding is changing and whereas in the 2005/2007 merger wave it was about land and size alone now it is about design, strategic plots, technology, build efficiency and supply chains. There is no doubt that housing is a local operation in many ways as location trumps brand when customers make a buying decision and, its why the regional operations of the large housebuilders rarely exceed 1,000 units a year and most operate at 500 units or less.

So in our view combining Bovis with either Redrow or Galliford makes sense in simple operational terms. From a geographic perspective the evidence is that Bovis/Redrow provides a better fit as one the former provides the new entity with spread north and south whereas Bovis/Gallford Try does not give the new entity much new exposure up north. However it must be said that in both cases the new entity would not be so unwieldy in any one area that reducing scale is needed.

Some observers will see this as another stage in a repeat of 2005-07 when “mergers” where another stage towards the end of the Recovery phase of the Boom – Bust – Recovery cycle in the industry. News today from Countrywide that it believes that rents in the north will grow faster than rents in the south is another element of evidence for the cautious. Certainly rental demand has reduced in the south for some two years now as cutbacks in international transfers due to reduced energy prices and now added to by Brexit uncertainty hit demand. Are we the only observers who recognise that reduced migration of the nationalities that have high birth rates might just slow demand for housing and make a the shortage smaller. A rising population in the UK is taken for granted in most views about future growth; there are early signs in attitudes to immigration and rates of migrant retention that assumptions about population growth might be challenged.

In the context of Bovis merging soon the logic is clear and in our view is a positive development. It is not a repeat of the mergers of 2005-07, in our view. There are few signs of boom yet in housing outside the M25 area and even within the M25 there are areas that are only now seeing strong recovery. Who wins Bovis, if anyone does, will come down to price in the end. We doubt that another entity will enter the bidding at this stage.

Companies reporting this week include SIG with its finals for 2016 tomorrow; Safestyle, Forterra and Marshalls update on Wednesday all with Finals; followed by Balfour Beatty on Thursday with its report on 2016 and Berkeley Group will provide a trading statement on Friday. We are expecting positive progress in all cases with Forterra and Balfour’s the most likely to provide a surprise on the upside.

The moves on Friday last were mainly upwards with Berendsen at last getting some support, up 3.7% to 808p. It will take a set of good numbers to get BRSN back into investor’s good books and it has said already that some improvements will not kick in until 2H’17. With EPS of around 65-68p expected this year and 70-73p in 2018 the shares look cheap compared with historic valuations. But with so much change at the company the risk level is higher. Evidence that the changes are succeeding is needed now after two profit warnings. G4S was the second best performer on Friday, up 2.5% to 294.4p. It has taken some time for the company to achieve it turnaround but it will be seen to have been a swift process in a few years’ time, when we suspect the share price will be much higher; short term retracement after the recent swift rise would not be unusual or of concern.

Only four stocks slipped downwards on Friday last, Capita (0.9%), Mears (0.7%), Babcock (0.5%) and Homeserve (0.2%). Mears is the exception in this group and because the move is based on just 16,749 shares traded it is not representative. There are real reasons for concern at CPI, BAB and HSV, in our view. Homeserve has furthest to fall from current levels, in our view. It should be updating the market soon and while the revenue figures will be boosted at headline level by FX we expect the earnings will disappoint. The business model is built only for growth and the lack of news recently on new affinity partnerships, along with mild weather and fading growth in real incomes, we suspect that growth momentum has slowed.

Moves last week

The sector’s improvement YTD continued last week with a small 1% rise spread equally across Housebuilding, Services and Construction. The market fell slightly so the sector outperformed, and is now up 6% YTD compared with the market up by 3%.

The best riser was G4S up 11% last week as it bounced back after its results were greeted positively as well as its indications of much better to come. Grafton, Capita and Carillion also showed strength last week with rises of over 5%. The backmarker was Mitie which suffered from negative broker comment. There was no new data just a few brokers waking up to the fact that the company has yet to indicate the full depth of its accounting policies, or rather the impact of some fairly unusual approaches to calculating revenue and cost that need to be corrected. Unlike in the case of Serco the main difference will be that the cash costs are minimal, confined we suspect, mainly to restructuring; the previous regime at Serco had made promises and obligations that had a cash cost in the future. We understand that Mitie has made no similar commitments though we also believe that future profits will be diminished by some promises made regarding performance benefits for customers that are due in the next few years.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
10 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 10th March 2017

There is limited newsflow today. The OFCOM decision that Openreach will remain part of BT but on an arm’s length basis should be treated as positive for Carillion in particular but also the utility supply segment in general. Capita saw some support yesterday, rising 4.6% to 549p as investors struggle to work out whether the current level is a great buying opportunity or not.

There is limited newsflow today. The OFCOM decision that Openreach will remain part of BT but on an arm’s length basis should be treated as positive for Carillion in particular but also the utility supply segment in general. It avoids the upheaval that hiving off Openreach might have created for Carillion, the largest supplier of network support to Openreach. It also holds out the prospect that more will be spent on the network which some observers regard as being needed but held back due to BT’s approach and its finances. Civitas Social Housing has spent a little more of the £350m it raised a few months ago and has paid £9.1m for a portfolio of 20 supported living properties (freeholds and leaseholds). The initial yield is 6% unleveraged.

Capita saw some support yesterday, rising 4.6% to 549p as investors struggle to work out whether the current level is a great buying opportunity or not. There is no obvious CEO candidate operating in the quoted area at present and new leadership with such experience is essential sooner rather than later. The Chair has not led a quoted entity before. Our view is that having experience of leading quoted entities at Chairman and/or CEO level in an investee company is a very important consideration. On the fundamentals at Capita it seems to us that when all of the restructure is completed, and it take a couple of years, what remains will be a company with operating margins of 10-12% and revenue of £4-4.5bn. Disposals and some time for operating cash to accumulate, could be enough to avoid an equity fund raise. So the possibility of there being an attractive business with EPS of 50-60p a year at current tax rate is a real possibility and there is no 100% certain case to reduce the dividend. For patient investors who are prepared to take some risk CPI may be an opportunity but getting leadership that understand the City is crucial if Capita remains an independent quoted entity.

Wolseley was the weakest performer yesterday, down 1.4% to 4960p as it has ceased to get further Trump Bump boosts. A few week’s ago when £ fell against the US$ Wolseley’s share price rose but that effect has diminished as well. The company is scheduled to deliver its half year results on 28th March. We expect they will be in line with expectations but cautious in tone. The UK Plumbing and heating market is clearly still very difficult and while it comprises around 10% of WOS total revenue it has been one of its more difficult areas; the news from Travis Perkins and Grafton show the difficulties faced by the traditional companies in the space are not resolved. At the current level and with around 300p of EPS expected this year WOS is priced for the news being good and there being no adverse shocks. In that context we draw attention to Homeserve, which is also highly dependent on US activity and $ FX; the shares are down 10% from the mid December peak and in our view are vulnerable. They closed 0.5% down yesterday but have further to fall , in our view as market conditions in the UK and the US have been unhelpful in the final quarter of its financial year, ending 31st March.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
9 March 2017 · 1 min read

Market Commentary - Housing, Infrastructure, Construction and Services 9th March 2017

There is no directly relevant news from companies this morning. The Budget yesterday made few changes that will affect the industry other than the change in NICs which is bad news for the sector, which has a high level of self-employment.

There is no directly relevant news from companies this morning. The new Chair at Interserve bought £60,000 worth of stock which is noted but such moves make little difference when done by NEDs, the sum is around 30% of his annual fee. The CEO at Speedy bought £70,000 worth of Speedy stock ahead of it going into close period as well and that is more significant, in our view as the CEO dipping his/her hand into the pocket is meaningful.

The Budget yesterday made few changes that will affect the industry other than the change in NICs which is bad news for the sector, which has a high level of self-employment. How that proposed change will work out has yet to be seen. Short note today as we are offsite.

It’s been a week of wild moves and the 8% rise in G4S to 289p, the biggest riser yesterday was another. A FTSE 100 stock that is widely covered and comes out with good results (signalled already) and a statement of intent about the future that could be seen coming a mile off should not rise that much. It’s now 20% up YTD. The herd mentality among analysts does not aid independent thinking on G4S and several other stocks that have risen (mainly) and fallen substantially in the current results period. Communication in the market is supposed to be such that big shocks are avoided; the system of company signalling and analyst research is supposed to reduce “shocks”. More independent research is needed, not tied to banks. The level of questioning at meetings is low, in our view.

We went along to the G4S meeting and the tone was positive on future growth in revenue and earnings, the balance sheet improvement and competitive positioning. The company pointed to growth of revenue of 5-6% a year and improving margins which is realistic, as we have been saying. There was particular focus on cash management in for large customers, an area in which G4S has built a lead that rivals are struggling to replicate. But in the mainstream manned guarding operations there have also been improvement led by technology and improved working practices. There were stories too of areas where improvement is needed and changes are being made. The US provided the biggest fillip to the numbers last year but the largest spend in its addressable market is in Asia Pacific. The message yesterday from the top was that since mid-2013 the company has been rebooting itself and that phase is now over. At 289p and with EPS at c 18p G4S is no longer very cheap but it is cheap.

Bad boy Berendsen was the backmarker yesterday, down 2.7% at 775p. The bold plan for a complete overhaul of the business somehow does not quite ring true given the performance prior to a seasonal glitch last summer. If it is needed there are a lot of moving parts in the plan, certainly plenty enough to confuse the situation. £450m investment over the next three years is a big bet for a company that has issued two profit warnings in the last six months and operates in mature markets that have structural change (Rentokil/Haniel). The City would be more reassured, we suspect, with greater focus on a few key issues rather than the current root and branch reform of a business that was regarded as pretty well run. 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
8 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 8th March 2017

G4S, Breedon and Tyman provide news this morning. G4S has produced excellent numbers with revenue at CER up 6% and PBITA by 10% at CER. The management is signalling that after four tough years it has turned the business around and is now on a growth path with an organisation that has strong foundations. Breedon’s march to glory continues with a 43% rise in revenue to £455m and a 58% rise in EBIT to £60m. Tyman ‘s revenue rose by 1% L4L last year and the underlying operating profit increased by 5%.

G4S, Breedon and Tyman provide news this morning. G4S has produced excellent numbers with revenue at CER up 6% and PBITA by 10% at CER. The management is signalling that after four tough years it has turned the business around and is now on a growth path with an organisation that has strong foundations. The statement is bold and intentionally so, from our interpretation. The reduction in net debt has been achieved and it was £112m lower at £1.7bn and but for FX would have been £222m lower; it is now 2.8x EBITDA and is heading for less than 2.5x by the end of this year, as promised in 2016.

Breedon’s march to glory continues with a 43% rise in revenue to £455m and a 58% rise in EBIT to £60m. The big event in 2016 was the completion of the acquisition of Hope Construction materials which took the company into cement manufacture as well as extending its geographic and product scope. That substantial deal did not stop progress in the “ordinary” operations or with bolt-ons, the company acquired Sherburn in November, a 110 employee operation in the North East. The big picture in terms of demand looks favourable for Breedon, a company statement today attests, with housebuilding sustained at an increased level and the promise of more and the infrastructure programme moving ahead with product intensive projects in rail, roads and water moving forward.

Tyman ‘s revenue rose by 1% L4L last year and the underlying operating profit increased by 5%. The headline numbers at AER show revenue of £458m and underlying operating profit of £70m. 2016 was a tough year with three substantial acquisitions and the outcome of the Referendum to handle. The good news evident this morning is that the challenges seem to have been met and importantly 2017 has started well. The latter point is shared by others in the building sector so is the “norm” as market have remained strong and the weather mild, but the company still has to perform! There is a hint of caution in the statement insofar as the company points to the need to manage input costs this year, where it arises and clearly the ability to pass through such costs in the UK in particular will be crucial. More below

The market liked Grafton’s numbers a little more than we expected shown by the stock rising the best of our universe, up 8.2% to 656p. The numbers for 2016 were slightly ahead but with trading YTD positive and no adverse shocks of any kind, unlike the results from Travis last week the market became enthusiastic about Grafton. Its Selco format has not been copied effectively. It seems to be more down to earth in its approach than some rivals and exposure to the Netherlands and Ireland provide some important growth opportunities.

Mitie fell 5.6% yesterday to 198p on unfavourable broker comment. It’s inevitable that the new top team will make a large provision so investors have to be realistic about short term moves. They will want to do it once and will not yet properly know all of the skeletons in the cupboard; they will have a very good idea but will err on the side of large than needed. Our sense is that Mitie will become a £2bn a year revenue business with margins and annual growth of 5%, in which case 18-20p of EPS will be the right level to think about as a target, but that will not happen convincingly until 2019, we believe.

We did not mention Interserve’s new CEO announced yesterday because we needed to do some homework. Debbie White takes over in the Autumn departing her global role at Sodexo as CEO of Government and Health. It’s easy to see the attractions of the IRV role with a lower level of travelling and the company being at or near a low point, certainly in share price terms. At Sodexo the next step up would have been group CEO which is a tough ask. There is no doubt that she has relevant FM experience but will possibly find the going tough in construction and in cracking the City and its ways. On the former is arguable that managing a services business is very different from managing a construction business and that may have been a relevant factor for the outgoing IRV CEO who came from a services background. We shall need to watch who she recruits in the area or who she appoints to sell it! In the meantime there is the very difficult task of unravelling the Energy from waste operations, one that could occupy some of the best minds in contracting for a long time. The 3.1% fall in the share price yesterday, to 232p as possibly harsh but the appointment shows how tough it is to get somebody who ticks all of the boxes in terms of experience.

The detail of growth by segment and geography is important at G4S but in a short morning note there is a great deal to digest before saying something sensible. The key point this morning is that the transformation stage is being signalled as completed and the growth phase of earnings and revenue has begun. The operating margin at group level last year was 6.7% and we shall attend the meeting today to get a view on where the margin may trend in the future as across each of the parts of the business performance is variable in that regard. The full year dividend is maintained at 9.4p based on EPS of 15.9p which is slightly ahead of expectations and with 18.5p expected this year the shares may just continue the good recent run, closing last night at 267p, up 14% YTD, so far.

Breedon’s share price usually reflects its excellent habit of beating expectations and the ownership of assets that cannot be replicated easily, if at all. It closed at 77p last night which is a good rating based on EPS of 3.5p last year. Net debt at the year end was £160m after the acquisition of hope; we expect to see it fall given the cash generation capacity of the business but not at the expense of growth. If the markets for its products expand as expected there is every reason for the company to see further growth and we suspect that forecast will nude ahead today based on the numbers and messages in the statement.

Tyman’s share price has hovered between 250 and 290p for the last 18 months. This morning’s news will help to keep it at the top end of the range, which at 280p at close last night it has achieved. Underlying EPS was 25.4p last year, easily ahead of consensus forecasts; perhaps not all contributors adjusted fully for FX moves which are considerable for Tyman. The messages from Tyman are that the US will be a tad better this year; Euroland will see some recovery and the UK will be variable. The company is one of the earliest to warn that declines in real incomes in the UK may be adverse for demand. Is it a view we share with Tyman as some of the signs are appearing already. But also remember that some of its product goes to markets that are a distress purchase; householder’s only replace windows and doors when they really have to do so, in most cases. The business is really well operated from what we can see as outsiders but progress in 2017 depends not just on the very experienced top team but macro factors outside its control.

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
7 March 2017 · 2 min read

Market Commentary - Housing, Infrastructure, Construction and Services 7th March 2017

Grafton and Ibstock delivered full year numbers for 2016 today and Ashtead its Q3 and YTD progress.  Ashtead shows us progress with Q3 and YTD rises in revenue of 13% and operating profit of 9%; the UK operations showed positive growth in revenue at 14% which is a positive read across to Speedy and others though EBITDA margins are down a tad at 36.6% from 37.5%.  Lakehouse has decided that enough is enough on the main market and it is flipping to AiM. And McCarthy and Stone has issued an update in which it tells us that trading has remained stable having previously indicated that order books in its segment of the market were a constraint on growth. Its guidance is that full year expectations are unchanged.

Grafton and Ibstock delivered full year numbers for 2016 today and Ashtead its Q3 and YTD progress. Ashtead shows us progress with Q3 and YTD rises in revenue of 13% and operating profit of 9%; the UK operations showed positive growth in revenue at 14% which is a positive read across to Speedy and others though EBITDA margins are down a tad at 36.6% from 37.5%. Lakehouse has decided that enough is enough on the main market and it is flipping to AIM. McCarthy and Stone has issued an update in which it tells us that trading has remained stable having previously indicated that order books in its segment of the market were a constraint on growth. Its guidance is that full year expectations are unchanged.

Grafton increased revenue by 10% last year at CER “broadly” split between organic growth and acquisition; we suspect broadly means evenly. The revenue at AER was £2.5bn, a 13% increase and operating profit rose by 12% to £142m. Net debt reduced by £17.3m to £96m and the dividend was increased by 10% to 13.8p. The main headlines show that the company ended the year well in the UK, despite the post Referendum wobbles that affected all companies and in Ireland conditions were strong all year. The Selco proposition was successful again last year and the proposal is to further expand it in 2017; the model requires relatively high levels of stock but the attraction to customers of availability of materials and transparent pricing in big sheds in busy places is working. The company tell us that the UK restructuring is now completed. The concern this morning, if there is any will be around the decline in profitability in UK Merchanting where L4L revenue rose by 2.9% for the year and in headline terms it rose 6.6% to £1.7bn and operating profit fell by £6m to £100, margins were 5.6% versus 6.4% last year. The issues in that segment were expected and tough conditions in Plumbing and heating markets were the primary issue and 28 branches were closed; the channels to market have altered in the segment and the mainstream operators have struggled to adjust. The shares closed last night at 607p and with EPS at and expected to be 43p this year after 39.6p last year the shares are arguably up with events. The boost from trading in Ireland is good but not enough to offset some of the tough UK market issues.

Ibstock, the UK’s largest brick maker, ended 2016 with a 5.3% rise in revenue to £435m and a 4.3% rise in EBITDA to £112m, on a pro forma basis. EPS at 18.1p for the year just ended compares with a price at close last night of 202p. The story from Ibstock about it markets is familiar from trading updates and rivals, which is that market conditions improved in 2H as the supply chain destocked and house building volumes were sustained despite the uncertainties of Brexit. The plans to invest in new capacity in Leicestershire, 100m bricks pa, is proceeding and will be on stream in 2H2017. The expected level of housebuilding, FX making imports unattractive and the enduring preference for brick as the facing material should mean the capacity is absorbed. The company has other improvement projects that should help its progress in 2017. The final dividend of 5.3p was declared making the total 7.7p for the full year. Nervousness about the housing market is holding back the valuation at Ibstock, we believe and all of the signs suggest that volumes in the mid-term are likely to rise. Trading YTD has been ahead of last year. The net debt has fallen to 1.2x EBITDA so that is not a constraint on value, in our view.

Barratt did something interesting yesterday. It announced the sale of 172 homes in Central London for £141m to Henderson Park and Greystar, both of which are PRS operators. It may be that the market for two bed apartments in sub prime locations at £800,000 each is just not there right now and it has good uses of the cash elsewhere. The main part of the sale was Barratt’s 118 unit tower at Nine Elms which we pass each day and ponder when the stuff will hit the fan on that whole project. We count 14 tall units currently under construction going past them each day into Waterloo. Progress is glacial on the sites, despite global warming! Barratt arguably is just recycling its capital effectively but the temptation to read in to their action a 12-18 month dip in activity in London, extendable depending on Brexit, is hard to resist.

In some five years since we started this Commentary yesterday was probably the one with the least to talk about. G4S was the leader, rising 1.2% to 268p; it has results on Wednesday this week and we reckon that CEO Ashley Almanza will have some pretty good news triggered by positive trading and boosted by FX, at the headline level. The shifts in the price lately are in line with what we have been saying on the stock. Just do not get too carried away when the numbers appear. 300p is the best short term target we suspect though long term there is still much to go for and large corporate moves should not be ruled out. But this time any discussion will be from a position of strength at G4S.

Mears was the back market down 1.8% but with just 24,220 shares traded the move is not representative. Serco was the other weakest performer, down 1.4% on 10.4m shares traded to 112.4p; again there is not much to be read into that move. The market got a tad over exuberant on the shares and is adjusting a little. Serco is a good company and it getting better. But in EPS terms, or by any other well used valuation measure, it is likely to be 2018 at the earliest when the real impact of the work to regenerate the business done over the last two years shows through fully. The markers along the way, that could cause enthusiasm to return, include is winning one or more of the six “elephant” projects for which it is currently bidding and/or a return to the dividend list and/or early and good resolution of one or more of the larger Onerous Contract provisions (OCPs). On a three year view 112p could be quite cheap. 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote the independence or objectivity of investment research.

Stephen Rawlinson
6 March 2017 · 2 min read

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.

 

Disclaimer - Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This document may contain materials from third parties, which are supplied by companies that are not affiliated with Edison Investment Research. Edison Investment Research has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of publication and is subject to change without notice. While based on sources believed reliable, we do not represent this material as accurate or complete. Any views or opinions expressed may not reflect those of the firm as a whole. Edison Investment Research does not engage in investment banking, market making or asset management activities of any securities. The material has not been prepared in accordance with the legal requirements designed to promote