The trick in these markets, if you think they have stabilised with the FTSE 100 index at about 6,000, is to work out which companies’ shares have suffered disproportionately. Among these looks to be Interserve, the construction and support services group.
The shares, as the graph shows, were above 600p in October and hit a three-year low last week on the publication of a note from Liberum that cast doubt on earnings forecasts for 2016. The company has full-year figures out next week and is therefore in closed season and not able to defend itself.
The shares added 20p to 396½p yesterday. If you assume, then, that the 2015 figures are unlikely to contain too many shocks, that fall still looks overdone. The support services sector generally has been hit by macroeconomic concerns and the move to the national minimum wage. On the first, the pressures towards outsourcing public sector functions are unlikely to go away. As to worries over wages, other outsourcers have indicated that these should be passed on to their respective customers.
There was not a lot in the third-quarter figures from Interserve to worry the market, with forecasts for 2015 unchanged and a robust trading statement. UK construction will barely break even because of three loss-making energy contracts, but this should be in the price.
The Liberum note worries mainly about the prospects for Middle East construction. It came out days after a trading update from WS Atkins which expressed some caution over its own prospects there. Interserve is exposed because of its equipment services side and straightforward construction. The former is an early-cycle business, with a short order book, and Liberum thinks this could tail off quite quickly. Against this, there are a couple of big contracts that could swing it around.
There is no question that there are stresses on state spending in the Gulf, but some countries, such as Qatar, ahead of the 2022 World Cup, will keep spending. Interserve shares sell on about seven times 2016 earnings and offer a yield of 6 per cent. Barring any terrible downturn in the Gulf, and any shocks next week, those numbers should make them look cheap.
2016 revenues secured at Q3 60%
£270m-£300m Forecast for year-end debt
MY ADVICE Buy
WHY Prospects for Middle East are unclear, but the rest of Interserve is holding up well with few further shocks expected
Another share that would seem to have been sold off rather more than the fundamentals would suggest is Babcock International. The shares added 29p to 922p yesterday after a positive note from Shore Capital, but they are still almost 10 per cent lower than at the start of the year.
The engineer’s half-way figures in November contained few negatives, and I chose them as one of my tips for this year. I would see the current weakness as a buying opportunity. As to the negatives that have been worrying the market, Peter Rogers, the long-serving chief executive, said last month that he would be retiring in August, and the market does not like uncertainty.
There have been doubts over the accounting of joint venture revenues, about 14 per cent of earnings. The main concern here is that earnings from these take a while to come through to Babcock itself, something the market should have factored in. In addition, organic revenue growth of 10 per cent half-way can only slow, perhaps to nearer 7 per cent, a fact openly conceded by the company.
There are still worries over the March 2014 purchase of Avincis, the helicopter business, its exposure to the oil and gas sector and its ability to find new markets. The positives are a £10.5 billion pipeline of possible work, 70 per cent of it in the form of new contract bids, and the diversity of business areas from which this will come.
A £20 billion order book suggests 90 per cent of this year’s work is in the bag, while last autumn’s defence review means more in future. On 12.5 times this year’s earnings, the shares look undervalued.
Pipeline of potential work £10.5bn
MY ADVICE Buy long term
WHY The decline in the shares is hard to understand
If you come to the stock market as a relatively small housebuilder, you need some unique selling point to set you aside from the bigger, better capitalised national concerns that enjoy greater economies of scale and so better margins. Countryside Properties, whose shares began trading at a respectable premium yesterday, 15p ahead of the float price at 240p, gets about half its revenues from regeneration projects on local authority estates and has worked on about 50 of these so far.
The other half is straight new housebuilding around London. This sees margins at about 16 per cent, well below the industry average. The plan is to double output from the 653 units built last year over the next three years, with some improvement in margins. Less easy to forecast is that partnership business with local authorities.
The trouble is that the company’s hybrid nature makes it hard to value, which may have contributed to the shares being floated at the bottom end of the range. Housebuilding should be valued on net assets, those partnerships on an earnings basis.
While this uncertainty remains and there is no clear track record, the shares may have difficulty making much more progress.
Initial price range 225p-275p
MY ADVICE Avoid for now
WHY Hybrid nature makes shares hard to value
And finally...
The AIM-quoted machine tool maker 600 Group is the latest company to warn about a slowdown on world industrial markets. The shares lost 29 per cent of their value and are now below 10p after a trading update that quoted a range of statistics, including a fall of 17.5 per cent from an American trade association for machine tool orders in 2015. Weak manufacturing forecasts mean that customers are leaving decisions on purchases to the last minute, and 600 has order books stretching out over little more than a month.
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