HomeServe looking frothy

The company has said it should return to earnings growth in its next financial year after a difficult few years marked by a Financial Conduct Authority (FCA) investigation into mis-selling that sparked the temporary suspension of all selling and marketing activities. The most recent update indicated that HomeServe had increasing confidence it would be able to stabilise its UK customer numbers at a level of at least 2m, having dropped from just over 3m in the year ended March 2011. Analysts are now pencilling in earnings growth for the next few years. This is obviously better than shrinking earnings, but the growth is more modest than what you would expect given the stock's punchy rating. On JPMorgan Cazenove forecasts, compound earnings growth is forecast to be a fairly modest 4.5 per cent over the next three years.

Another concern is just what HomeServe has had to do in order to achieve stabilisation in the UK business. The group has come up with more attractive products and stepped up its customer service levels. That doesn't come cheap and HomeServe said in its recent update that the increased cost of these actions will result in a drop in net income per customer. The FCA investigation does at least seem to entering its final stages with an announcement in January that the FCA had proposed a £34.5m fine for the mis-selling. This led HomeServe to increase its provision for the fine by £30m, but did provide some welcome clarity on the issue. That said, there is still a little uncertainty as to the final cost as HomeServe's customer re-contact exercise, which involves checking historic complaints were handled correctly, will not be completed until the end of March. The issues also highlight the risks of selling any kind of financial product to the public at a time when new scandals seem to crop up every couple of months.

The international operations have become increasingly important as they take up the slack from the scandal-hit UK business, with the US and Spain in particular clocking up good customer growth and HomeServe keen to expand into new markets. But customer acquisition in HomeServe's largest overseas market, the US, is slowing and the UK still makes up the lion's share of profits, contributing around four-firths of group adjusted operating profits in the first half.