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OPINION

Renewing an uptrend

Renewing an uptrend
June 21, 2016
Renewing an uptrend

It looks like another buying opportunity to me as half-year results released last month were bang on the money and highlighted double-digit growth in underlying revenues in the company's core engineering services division. The unit accounts for 85 per cent of Renew's revenues and 90 per cent of operating profit and focuses on the key markets of Energy (including Nuclear), Environmental and Infrastructure, which are governed by regulation and benefit from non-discretionary spend with long-term visibility of committed funding.

The contribution from this segment was the key driver in the 9 per cent rise in the company's pre-tax profits and EPS to £10.3m and 13.3p, respectively, and means that almost half of analysts' full-year forecasts are in the bag. Moreover, buoyed by an order book up 9 per cent to £515m, all of the company's second-half revenue is already secured. Analysts at Numis Securities and WH Ireland both predict the company will deliver pre-tax profit of at least £21m and EPS north of 27p in the 12 months to end September 2016 to underpin a 14 per cent hike in the dividend to 8p a share.

On this basis, the shares are rated on just 12.6 times earnings and offer a 2.2 per cent dividend yield. That's a low rating for a company that has just reiterated guidance of hitting its operating margin target of 4.5 per cent in the 12 months to end September 2017, implying a 50 basis point improvement on the first half just reported.

 

Margin gains and bumper cash-flow performance

That's significant because the margin gain on £550m of revenue for the 2017 financial year accounts for virtually all of the £2.7m operating profit growth that WH Ireland and Numis have factored into their forecasts. In other words, if Renew increases revenues by 5 per cent as analysts suggest it will, and boosts margins to the 4.5 per cent target management are guiding towards, then expect pre-tax profits and EPS to surge by around 14 per cent to £24m and 31.1p in the 12 months to end September 2017.

On this basis, the shares are only trading on a forward PE ratio of 11. They also offer a forward dividend yield of 2.6 per cent based on the payout per share rising by a further 12 per cent to 9p. In the first half, the dividend was hiked by 18 per cent to 2.65p, a clear indication of management's intention on the course of future pay outs.

If that rating looks attractive as I believe it is, then the prospect of acquisitions can only enhance the investment case further. That's because Renew's net debt was cut by more than two thirds from £13.9m to £4.2m year-on-year (excluding finance leases of £5m) and, with a strong seasonal working capital cash inflow likely in the second half, then analysts are predicting a year-end net cash position of £6m. The bumper cash flow performance should enable the company to complement organic growth with selective earnings accretive bolt-on acquisitions - something I believe could act as a catalyst to drive the shares back to the resistance level between 400p and 418p that has halted progress this year. It also underpins the double digit growth predicted in the dividend.

 

Multi-year contracts

Of course, these numbers only look attractive if Renew manages to hit them. But the odds favour a positive outcome as the key here is that Renew has several substantial multi-year contracts to underpin revenue projections. Furthermore, given its keen focus on improving operational efficiency then small improvements in the margin earned have a substantial positive impact on profits. And the company continues to win very profitable new business too.

For instance, in the energy market, Renew has been awarded a position on the Decommissioning Delivery Partnership framework for Sellafield, a 10-year framework agreement that's an essential part of the site's long-term decommissioning strategy and which has an indicative value of £500m and potentially could be worth as much as £1.5bn.

In the Environmental market, the group's Lewis Civil Engineering subsidiary has been appointed by Wessex Water to the Civils & EMI Capital Delivery Partners AMP6 (Asset Management Programme) framework, which will run until 2020 and has an estimated total value of £350m. There is an extension option to cover the AMP7 period through to 2025.

Renew is also a national leader in engineering skills for works on rail tunnels and bridges. In fact, it's the sole provider on seven infrastructure projects with a contract value of £450m over the five-year term, and undertakes high volumes of individual tasks through six asset management framework agreements.

 

Target price

Numis Securities has fair value at 390p and WH Ireland is more aggressive with a target of 450p. I favour a target closer to the higher end of that range. At 420p the shares would be rated on a reasonable 14 times next year's earnings estimates and that's before accounting for any earnings enhancing acquisitions as seems likely.

So having advised running profits at the start of the year, and again at the start of April, I feel that Renew's shares are worth buying on a bid-offer spread of 345p to 349p and have an initial target price of 420p. Buy.