Support services and construction group Interserve (LSE: IRV) is trading at a ‘bargain’ valuation. At a share price of 68p and with a consensus forecast among City analysts of earnings per share (EPS) of 33.2p, the price-to-earnings (P/E) ratio is a mere two.
However, despite the low P/E, I don’t believe this £99m FTSE SmallCap stock is a bargain. Indeed, I’m steering well clear of it. Here’s why.
Continuing lack of visibility
In exiting its Energy from Waste business, Interserve made a provision of £70m for incurred and anticipated losses in May 2016. It raised this to £160m in February this year, to in excess of £160m in September and to £195m in October.
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Meanwhile, trading in the group’s remaining core operations — UK support services and construction (together 75% of group revenue) — deteriorated markedly in Q3. And in the space of five weeks, the board went from being “confident” of the company meeting its banking covenants at the end of the year to believing “there is a realistic prospect that we will not meet the net debt-to-EBITDA test.” As a result, it’s now in “constructive and ongoing discussions” with its lenders.
Management has clearly had little handle on even the near-term prospects of the business. And due to the continuing lack of visibility on provisions, trading and financial position, it remains firmly on my list of stocks to avoid. However, readers may also wish to check out the contrarian case put by my Foolish friend Bilaal Mohamed, who argues the pendulum has swung in favour of it being a value play.
Tremendous growth
I’m far more bullish about another small-cap firm in the support services sector. AIM-listed Marlowe (LSE: MRL) has released its half-year results, sending its shares up 3.8% to 353p and giving it a market cap of £121m.
The company reported a 104% increase in revenue to £36m for the six months to 30 September and said its current 12-month run-rate revenue is in excess of £80m. Acquisitions account for the tremendous top-line growth. Following on from eight last year, there were four during the latest period and two since the period end.
Marlowe emerged from a cash shell in May 2015 and is pursuing a strategy of building the UK’s leading group of critical asset maintenance businesses. Its two divisions are Fire Protection & Security and Water Treatment & Air Hygiene and it says it has a well-developed pipeline of acquisition opportunities to continue to add further scale to the group.
Buy-and-build strategy
I’m generally quite wary of companies pursuing buy-and-build strategies but Marlowe appeals to me for a number of reasons. First, the chief executive has previously generated value for shareholders at other companies by employing this strategy. Second, Marlowe’s acquisitions to date have been integrated smoothly and delivered synergies in line with those anticipated. And third, I like the areas of business on which the group is focused, which have a significant element of non-discretionary spend, and strong regulatory and legislative drivers.
Forecast P/Es of 28 for the current year and 23 for next year are not extortionate, in my view, and with likely earnings-enhancing acquisitions in the pipeline, the shares look very buyable to me at their current level.
