Interserve have now released their preliminary results for the year ending 2014.
When compared to last year, revenues increased across most business sectors with large increases seen in the UK and International Construction being the only one to suffer a small decline of £8M. Cost of sales increased at a slower rate so that gross profit increased by £63.7M to £329.3M. When compared to last time, the one-off costs were higher with a £15.6M increase in amortisation of acquired intangibles, an £8.2M of transaction costs relating to the Initial deal and a £10.2M of integration costs. We also see other admin expenses increasing by £32.5M to give an operating profit some £800K lower than last year, although this is clearly due to the Initial transaction. The main finance charges related to bank loan interest, increasing by £8.2M and a slightly lower tax charge meant that the profit for the year was some £5.1M lower than in 2013 at £49.9M, although clearly if the £18.4M of costs relating to the transaction were discounted, there is an improvement in underlying profits.
When compared to the end point of last year, total assets increased by a massive £495.3M. This increase was driven by a £193.3M hike in receivables, a £153.4M increase in goodwill, an £84.5M increase in other intangible assets and a £39.4M growth in the value of property, plant and equipment, somewhat offset by a £21M fall in deferred tax assets. As would be expected, liabilities also increased due to a £254.7M increase in borrowings and a £156M hike in payables. Due to the fact that some of the largest increases in assets were in goodwill, net tangible assets actually fell by £128.6M to -£44.9M and I would like to see the upcoming year as one of consolidation for the group as I am starting to feel a little uneasy about the balance sheet strength in the event of an unexpected downturn in economic activity. The board have suggested they are still able to take advantage of further acquisition opportunities, however, so it seems they disagree with me.
Before movements in working capital, cash profits increased by £19.8M to £94.5M. Unfortunately a huge increase in receivables meant that cash generated from operations was £41.2M, some £13.8M lower than last year. When the hire fleet transactions and higher tax payment are included, this exacerbates the situation further with a £36.8M fall in net operational cash flow to just £700K. The group then received more dividends from associates than last time which, along with the interest received and the operational cash flow nearly covers the capital expenditure but not the £10.4M spent on investments in joint ventures (reflecting increasing investments in property development schemes) and certainly not the £243.7M spent on acquisitions. The resultant free cash flow swung to the negative of £32.9M to an outflow of £10.9M. Further increased cash costs included interest and dividends and we also see that the group acquired a net £254.7M in new borrowings and £75.2M from the issue of new shares which meant a cash flow of £23.5M and a decent cash buffer of £76.6M at the end of the year.
The group ended the year with a record workload of £8.1BN, a 26% increase on last year. The group’s strategy is to extend out from their core business to enter and grow in adjacent markets. There is quite a disparity in margins earned by each of the group’s businesses. UK support services delivered an operating margin of 4.8%, a slight improvement on last year’s 4.7%. International support services improved margins from 4.4% last year to 4.8% this year. Construction margins fared less well with the already thin UK construction margins falling from 1.8% to 1.6% and international construction margins falling from 5.1% to 4.7%. The clear winner as far as operating margins are concerned, though, is the Equipment Services business that saw margins improve from 11.9% to 13.6%.
The UK Support Services division delivered a strong 24% increase in operating profit to £81.4M with a decent 9% increase in organic performance. The healthcare business which supplies care in the home for patients grew well, benefiting from increased investment during the year and expects to expand further during 2015. The group started to mobilise a new contract in the Justice sector after they secured a massive seven year contract worth £622M to provide probation and rehab services for low and medium risk offenders in five areas in England. The group also remains one of the MODs key delivery partners, having won a new five year £322M contract to manage its National Training Estate with the option to extend for a further five years. The defence portfolio includes Welbeck Defence Sixth Form College and the permanent overseas bases such as the Falklands. The group were, however, unsuccessful in their bid for the new NTE contract that will result in a net reduction in the scale of their defence business in the near term.
Work winning was strong during the year at £2BN with a number of notable successes such as with the DLR, Exterion Media, Southampton NHS Trust and the RNLI. Initial’s performance during the year was in line with expectations and while the first wave of integration and re-branding of the business is complete the final phase is due for completion in 2015. Due to the acquisition the group has been able to increase its portfolio of private sector clients, and in the transport sector in the UK they now provide cleaning at 16 major Network Rail stations and recently agreed a two year extension of their contract for London Underground. In addition they also won a new contract to deliver cleaning and security services for the DLR. In Spain, the significant transport operations were added to by winning a contract to provide cleaning, maintenance and assistance to passengers with restricted mobility for airport operator Aena.
Other contract wins include a £35M contract extension with B&Q to provide services across its entire store estate, up from just 182 stores previously, along with new contracts with Alliance Boots and Southwark Council. During the year the five year facilities management contract with the BBC was mobilised which involves the management and delivery of services across 150 locations. The contract with the Foreign and Commonwealth office was also expanded and extended by two years to deliver support services in France as well as the UK estate, and the group were appointed by Sony Europe to support their business in 27 countries, providing services at 40 locations.
There was very strong growth in organic operating profit growth in International Support services, increasing by 37% which, together with the impact of businesses acquired in 2013, resulted in an overall growth of 80% to £7.4M. Highlights during the year included a new three year contract to provide Qatar Shell GTL with a range of mechanical services and a five year facilities management contract with ExxonMobil in Qatar. The group also secured a three year extension to the longstanding logistics and oilfield services contract with Occidental Petroleum in Oman. Other contract wins included two mechanical services contracts with the UAE military, consultancy work for Dubai’s Roads and Transport authority and facilities management contracts for several schools and colleges in Qatar.
In Saudi Arabia, contracts were won to manage services at the IT and Communications Complex and King Abdullah Financial District in Riyadh. Management are also encouraged by the recently launched joint venture with the Rezayat Group which will deliver facilities management services in Saudi Arabia. The addition of Esg to the group also creates a platform to extend front line services into Saudi, where the group operates three further education colleges which complement the existing safety and management skills training activities in Qatar and Oman. With the two acquisitions last year the group have developed a greater reach and capability across the oil and gas services sector in the Gulf region. The two businesses, TOCO and Adyard delivered strong work winning and started 2015 with record order books. Key new wins included contracts with ZADCO, NABORS, GASCO, Hyundai Engineering & Construction, Asia Gulf Power Service, TAPCO, Gulf Petrochemical Services and Enerflex.
Against a backdrop of improving demand but increasing supply chain pressure, UK Construction performed well, growing revenue by 21% to £970.7M. The growth was boosted by a strong performance from Paragon, the specialist fit out and refurbishment business the group acquired in 2013 and by the growing energy from waste activities. Operating profits rose by £700K to £15.4M at a margin of just 1.6%. Future workload grew 39% to £1.4BN, benefiting from the successful targeting of a mixture of new and existing frameworks.
The group made further progress in the EfW market, entering into an agreement with Derby City and Derbyshire County Councils to build and operate a new waste facility in the city in a joint venture with Shanks Group under a 27 year £950M PPP contract. This adds to a pipeline of EfW projects that they already have underway in Glasgow, Peterborough, Rotherham and East Lothian together with a number of other opportunities in this growing sector. In education the group were selected as a preferred bidder in the Priority School Building Programme to develop seven secondary schools across Hertfordshire, Luton and Reading. Contracts were also won to build facilities for the Universities in Birmingham, Southampton and Wolverhampton. In the health sector the group won significant contracts to design and build a cancer therapy facility for the Christie NHS foundation trust in Manchester and a centre of excellence for the Scottish National Blood Transfusion Service in Edinburg.
During the year the group was awarded a place on the Highways Agency’s four year collaborative delivery framework scheme valued between £25M and £50M which should provide opportunities on a large programme of infrastructure investment over the coming years. Other contract wins include the construction of an advanced experimental station and electron microscopy facility on the Harwell Oxford Campus; two further city development schemes featuring a range of retail and leisure clients, a project to build a Premier Inn hotel in Edinburgh and the development of a multi-use project in Newcastle. Since becoming part of the group, Paragon has won more than £160M of new work including contracts to fit out three floors of Markel Insurance’s Fenchurch Street offices and BWM’s UK HQ in Farnborough.
International Construction performed as expecting in a challenging but slowly improving market where competition remained high. Volumes increased by 1% on a constant currency basis and strong work winning led to a 37% increase in the order book to £300M at the end of the year. Profits, however, fell by £2.3M to £10.8M which is a little disappointing. Key contract wins in the UAE included work with Halliburton, DP World, the UAE Roads and Transport Authority, Meraas and the RIVA Group. Work was completed on the Beach retail and entertainment village and work was started on the £110M redevelopment, expansion and upgrade of the Mall of the Emirates on behalf of long standing client Majid Al Futtaim.
In Qatar the group was awarded a £323M contract to build Doha Festival City which will be the country’s largest retail and entertainment development. Work was also won on the Msheireb Heart of Doha development and a project to build a central energy plant at Education City for the Qatar foundation. In Oman, contract wins included the civil engineering works for the expansion of the Sohar refinery for Petrofac and an extension to the Muscat City centre Mall for Majid Al Futtaim. The power and water portfolio was developed by winning the civil engineering works to a seawater reverse osmosis plant in Barka for Osmoflo.
Performance at the Equipment Services business was strong with a 32% increase in profit to £26.6M with impressive operating margins of 13.6%, an increase from the 11.9% achieved last year. The group further extended their reach this year by opening new branches in South Africa, the USA and Panama as well as downsizing in the weaker market of Australia, relocating the fleet to exploit other opportunities. There was strong growth in the Middle East and Africa with increased demand from the UAE from the growing business confidence in Dubai and large projects such as a terminal project at Abu Dhabi airport. The group is well placed to take advantage of opportunities in Qatar as large scale infrastructure projects gear up while Oman has seen a significant increase in demand, boosted by projects such as the Nizwa Mosque which was completed during the period. Activity in Saudi Arabia also continued to grow, boosted by significant new contract wins including a new transportation complex being built in Mecca and early wins on major projects such as the King Abdullah Financial district and Riyadh metro.
In the Asia Pacific region demand in Australia continued to weaken reflecting more subdued economic conditions there and the completion of major energy and mining projects in Western Australia. Elsewhere in the region demand grew with Hong Kong being particularly buoyant due to a series of significant transport infrastructure projects including the Macao Bridge and West Kowloon Rail Terminus. The group traded strongly in New Zealand through a broad base of projects across the country. Performance was also good in the Philippines, in both the commercial and power sectors, aided by new contracts including the Davao power plant.
In Europe, performance was very strong in the UK as the business benefited from the development of a leisure and entertainment complex near Birmingham and from sizeable rail improvement works near Reading and Heathrow. Other major contract wins included work on Scotland’s new Forth Bridge and the bridge deck to support the Friargate development in Coventry while the Safety Screen was used on a number of high rise developments. The market remained slow across much of mainland Europe and further actions were taken to cut the cost base in Ireland and Spain reflecting continued weakness in demand in those countries. In the Americas, the recovery in the US construction market was somewhat slower than expected and government investment remains subdued. The expansion into California is progressing well, however, with ongoing work on a number of commercial developments in the Bay Area and San Francisco. The group continued to expand into Latin America by developing the business in Panama and Colombia but progress was hampered by difficult conditions in Chile due in part to a low copper price which supressed general economic activity.
In the investments business profits increased by £200K to £1.6M. Work was started on the Haymarket development in Edinburgh and the group also invested in projects to redevelop the Alder Hey Children’s Hospital and a centre of excellence for the Scottish National Blood Transfusion Service, also in Edinburgh. The group was appointed preferred bidder to finance, design, build and provide facilities management services for seven secondary schools across Hertfordshire, Luton and Reading. Their presence in Yorkshire grew significantly and work was completed on the last of three major developments for West Yorkshire police to provide a modern working environment for the officers there.
The year was characterised by two acquisitions, one being transformational. The group acquired Initial Facilities in March from Rentokil for a total cash consideration of £245.7M. It came with intangible assets of £87.8M, mainly relating to customer relationships that will be amortised over five years, and generated goodwill of £140.3M. Since acquisition the business contributed £440.4M to revenues and a £7.9M loss after exceptional items. Had it been acquired at the start of the year, it would have provided a loss of £5.6M. The group then acquired ESG for a cash consideration of £25.7M. The business came with £19.1M worth of intangible assets and generated goodwill of £11.9M. It contributed £3.4M to revenues and a £300K loss but had it been purchased at the start of the year, it would have generated a loss after exceptional items of £3.3M. A further £2.1M in cash was also paid relating to the 2013 acquisition of Adyard.
The pension scheme is still costing the group about £9.2M per year with £8M of that being service cost and £1.6M being administration costs. In August further action was taken to reduce risk in the pension scheme by entering into a buy-in transaction. This has put in place an insurance contract with Aviva covering about 35% of the scheme liabilities, protecting the group from the associated risks. Apparently if the scheme had not been entered into and the pension assets had instead been invested in the FTSE100, the net deficit would have been £35M higher. I won’t pretend to understand what this is about so I can’t really comment on this arrangement. The next triennial valuation process is currently underway after the last one set the annual deficit recovery payments at the hefty rate of £12M per annum.
The group does have some headroom with regards to borrowings. This year they put into place a $350M US Private Placement which has a weighted average maturity of 2024 and are fully hedged at a fixed interest rate sterling amount. There is also access to revolving bank facilities totalling £250M which have been extended to the start of 2019. I have mentioned before that this level of debt is starting to look a bit full for my taste.
There have been a number of board changes. Nick Salmon and Russell King both joined the board as non-executive directors with David Thorpe retired from the board in August after five and a half years. Les Cullen will be retiring as senior independent director at the forthcoming AGM after nine years on the board and Chairman Lord Blackwell will stand down within about a year after nearly ten years in the job.
There are a number of risks associated with the group. A shift in the economic climate of the UK and worldwide, including changes in the oil and gas industry could adversely affect earnings with the construction business being particularly susceptible. Alterations to the UK government’s policy with regard to expenditure on improving public infrastructure, buildings, services etc may affect some of the group’s large government contracts and internationally civil unrest could also affect some of the markets where they are active, although the board regard all their markets as being politically stable.
Going forward, the management expect the Support Services business to make further progress as the group continues to win new contracts and extend relationships with existing clients. The increased private sector exposure following the Initial acquisition should mitigate any short term uncertainty surrounding government outsourcing before the general election. In the Middle East, it is believed that the spread of activities in the support services market will mitigate against the potential impact of continued weakness in the oil price. In constriction further volume growth is expected in the UK although margins are likely to remain close to the current supressed levels. In the Middle East, volume progress is expected as the group delivers contracted orders and pursues opportunities throughout the region. The Equipment Services business is expected to continue to grow in expanding global construction markets, benefiting from further operational gearing.
At the end of the year, net debt soared by £230.3M to £268.9M predominantly as a result of the acquisitions. At the current share price, the P/E ratio stands at 19.4 on reported earnings but underlying P/E is a much cheaper looking 10.6 which falls further to 9.7 on next year’s consensus forecast. After a 7% increase in the dividend, the shares yield 3.7% at the current share price, rising to 4.1% next year.
Overall then this has been a transformational year for the group. The acquisition of Initial has significantly increased scale along with debt. The reported profit was lower than last year but taking off the one-off costs, the underlying profit improved. Net tangible assets fell, though, to a rather concerning negative £44.9M which does put me off slightly. Cash profits were strong but adverse movements in working capital along with increased investment in the equipment services fleet meant that there was no free cash flow. The group ended the year with a record work load, as would be expected after the acquisition and operationally both the support services and equipment services are doing very well although the construction business seems to be slowing on falling margins. The lower oil price could filter through to reduced investment in some of the group’s markets but they do seem quite diversified with a number of infrastructure projects to mitigate against this. Closer to home, the general election is likely to cause some uncertainty around the government outsourcing contracts. All in all, this seems to be an exciting time for the group and I may look to get involved with a share purchase but be ready to sell if some of these concerns take effect.
As can be seen, the results were received well and it does seem as though this might be the impetus the share price needs to break out of its recent downtrend.
On the 26th February the group announced that chairman Lord Blackwell is intending to step down no later than the 2016 AGM after spending 10 years at the company.
On the 12th March it was announced that in a joint venture with Babcock & Wilcox Volund, the group has been awarded a £150M contract to build a biomass fired power station in Rotherham. The power station will be fired with locally sourced waste wood from Stobart Biomass and have a capacity of 45MW, enough to power 70,000 households and reduce carbon dioxide emissions by 360 tonnes per annum. Babcock will operate and maintain the plant once it becomes fully operational, expected to be in Q2 2017. The building work still start in the next few weeks and Interserve’s portion of the project is worth around £50M – this is a decent, large contract for the group.
On the 12th March it was announced that Old Mutual had sold over 1.5M shares in the group to reduce its shareholding to below 7%. This sale would have netted them about £9M so it is a substantial sale.
On the 23rd March it was announced that the joint venture with Kajima has reached financial close on a project to design and build seven secondary schools across Hertfordshire, Luton and Reading. The scheme has a capital value in excess of £135M and the joint venture will also be responsible for all maintenance services over 25 years. Construction started on all the schemes last month with the first due for completion in August 2016, all of the new schools should be open by November 2016.
Interserve has now released its annual report which adds a bit to the final results already published.
The balance sheet certainly now has more detail. That large increase in receivables was due to a £119.8M hike in trade receivables, a £39.4M growth in prepayments & accrued income and a £23.3M increase in amounts due from construction contracts. In intangible assets, the growth was driven by an £81.9M increase in the value of customer relationships due to the acquisition of Initial whilst the increase in property plant and equipment was due to an increase in the hire fleet and other equipment due to additions during the year. On the liability side, the growth in payables was due to a £63.3M increase in accruals and deferred income, a £36.3M growth in tax and social security payables, a £25.9M increase in trade payables and a doubling of “other” payables. The £23M swing from deferred tax assets to a £2M liability was predominantly due to deferred tax on the acquisition of intangibles from the Initial purchase. In addition to the negative net tangible asset level, it should also be noted that there are nearly £80M worth of operating lease liabilities off the balance sheet.
It was also revealed that included within the cash figure is £36M which is subject to constraints on the group’s ability to use it, mainly related to cash held in project bank accounts or minority interest shareholders. This corresponds unfavourably with a figure of £21.8M last year so a greater proportion of total cash is restricted.
We also see a bit more detail with regards to the performance of the joint ventures and associates. As far as joint ventures were concerned, there was a small £1M of profit attributable to the group from support services and £800K from investments compared to £800K from both joint venture categories last year. Associates contributed rather more to the results with £12.2M from construction associates and £2.6M from support services compared to £12.4M and £3.3M respectively last year.
We see that there is currently £3.5M worth of future capital expenditure not provided for in the financial statements which shouldn’t break the bank. Also there are at least three years until the group needs to start paying back those large loans taken out to fund the acquisition. With facilities of £112.5M being undrawn at this point. As we have seen, the pension scheme continues to drag on results and the group expects to pay £25.1M towards the various pension arrangements next year.
During the year non-executive director David Thorpe resigned and two non-execs were hired, Russell King and Nick Salmon. Russell is a current chairman of Hummingbird Resources and director at Aggreko, before which he worked at Anglo American. Nick is a non-executive director at Elementis and Acal and has previously been CEO of Cookson and Babcock.
So, these final results add a bit of extra detail but do not really change the investment case. I am a little dubious as to what those mysterious “other” payables are and there seems to be a high level of operating leases to pay. In addition, the balance sheet is not helped by the fact that a greater proportion of cash is held subject to constraints than last year. Actually the balance sheet is starting to look rather weak to me.
On the 12th May the group released a trading statement. The mobilisation of the Ministry of Justice’s Transforming rehabilitation is on plan and the ESG integration is now complete and has been rebranded Interserve Learning and Development. Trading wise, they have had a good start to the year, securing a number of significant new contracts. The main international markets in the Middle East are improving whilst UK construction remains tight. The expectations for the group’s performance are in line with previous guidance.
On the 3rd June the group announced that a joint venture with China State Construction Engineering Corp has been selected as preferred bidder by Chinese developer Dalian Wanda to build the £550M One Nine Elms scheme in Battersea. The project will include the construction of two towers of 57 and 42 storeys housing 494 apartments which will be among the tallest residential towers in the UK. A 187 room five star hotel will also be built at the base of one of the towers. Work on the scheme has already started with demolition nearing completion and piling works due to start imminently.
On the 7th July the group released a trading update. Overall trading continued in line with the board’s expectations. Performance in support services, equipment services and international construction was good, offsetting UK construction where near-term conditions remained more challenging. The board are encouraged by the further development of the future workload, particularly with the preferred bidder appointments for UK construction projects such as the One Nine Elms and the Defence National Rehabilitation Centre.