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Mears ready to accelerate returns

Revenues and cash flow at Mears are growing; its debt is falling and its share rating is at a low - time to buy
August 23, 2012

After suffering from government cutbacks and a fractious relationship with the City, shares in social housing and care provider Mears have drifted down to ratings last seen 10 years ago. But the company has just reported record levels of activity, it is generating plenty of cash and, in the past five years, has doubled its sales and improved its earnings, yet the share price has gone sideways. Add in assured revenues and the potential for growth in its home-care business and we reckon the shares are worth buying.

IC TIP: Buy at 276p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Assured revenues
  • Busy with new contracts
  • Strong cash flow
  • Historically low share rating
Bear points
  • Pressure on public spending
  • Backlash against outsourcing

During the years of Blairite public-spending profligacy, social housing maintenance was a wonderful place to be. By late 2006, Mears' shares were touching 350p, trading on a multiple of over 25 times earnings. Then came the demise of Connaught and Rok, companies occupying a similar space to Mears. As a result, investors fled. Yet throughout this Mears weathered the storm, increasing its dividend every year. It has now emerged with less competition, more business, and a better outlook.

Mears' first-half results for 2012 were encouraging, with revenue up 5 per cent to £307m and adjusted pre-tax profit up 2 per cent to £14.3m. The order book was flat at £2.7bn, yet provides for 99 per cent of 2012's expected revenues and 85 per cent of next year's.

The numbers were all the more impressive because Mears mobilised a record number of new contracts in the period, whose annual revenues will top £50m. As chief executive David Miles explains, when Mears begins a new contract its takes in start-up costs, such as buying new vans and employing staff, upfront. As a result, contracts tend to lose money in the first six months, break even in the next six; then they move into profit, hitting peak profitability around the 18-month mark. Understandably, the social housing unit, which took on all this work, reported operating profit margins down from 5.5 per cent to 5 per cent, on sales up 4 per cent to £215m.

MEARS (MER)

ORD PRICE:276pMARKET VALUE:£244m
TOUCH:275-276p12M HIGH:294pLOW: 206p
DIVIDEND YIELD:3.3%PE RATIO:11
NET ASSET VALUE:178pNET DEBT:4%

Year to 31 Dec Turnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
200947018.418.85.70
201052416.417.76.75
201158920.619.97.50
2012*64627.522.78.30
2013*68130.024.99.10
% change+5+9+10+10

Normal market size: 1,000

Matched bargain trading

Beta: 0.5

*Investec Securities estimates

Mears has other plus points. Back in 2010, lack of cash did for Rok and Connaught, but cash flow is moving in the right direction at Mears. Cash generated from operating activities in the first-half improved from £7.5m a year ago to £12m, which allowed net debt to be halved from £13.4m to £6.2m in the first six months of 2012.

The care business is also forging ahead. Sales were up 8 per cent to £56m, with operating profits up 17 per cent to £4.5m. But City analysts were expecting faster growth. The slow progress is in part due to the government dragging its heels on the white paper on health and social care, but also down to a dearth of acquisitions. There could be progress on both fronts in the next six months. Mr Miles says he is looking to acquire a couple of care-at-home businesses in the third or fourth quarter, and the government should clarify support for domestic care in the next session of parliament. There are risks inherent in this, though. Pressure on public spending will remain intense and the backlash against outsourcing after the G4S debacle could stall decisions, especially as social care for the elderly leaves so much to be desired.