No grand designs for Mouchel

The fact that George Osborne's Emergency Budget was big on cuts, but small on details, is set to weigh on the share price of consultancy group Mouchel for some time yet. At least until decisions around the 25 per cent reduction in departmental spending are made clear on 20 October.

This is because the consultant's divisions most susceptible to discretionary spending delays or chops - government services and highways - make up 86 per cent of the group's forecast operating profit for this year. Worryingly, Mr Osborne has announced an "immediate freeze on unnecessary consulting over £1bn". Prior to the Budget, around £2bn of capital expenditure projects had been dropped with a further £8.5bn placed under review.

Government measures to cut the Budget deficit, and similar actions by local authorities, are already impacting Mouchel's business, the group revealed in June’s pre-close trading statement. Management's tone was subdued and the uncertain outlook has led to a restructuring of the business, with the view to save £2m-3m in the next financial year. Analysts at Investec Securities reckon this means the group will now miss forecasts for this year, if one-off costs for this restructuring are included. The cost-cutting is likely to come in the form of further headcount reductions and Investec forecasts staff numbers will fall by 5 per cent in the year to July 2011, having been reduced by 6 per cent in the current financial year. However, having fewer staff is likely to lead to fewer revenue opportunities. Based on an average profit per employee of £4,000, Investec calculates that full-year adjusted pre-tax profit of £35.1m in the 12 months to 31 July 2010 - excluding £37m of impairment and one-off costs - will fall to £32.3m in 2011 or £25.3m on a reported basis.

But what's worse is that the contracts supporting these forecasts look fragile. Both the order book and the bid pipeline fell from £2bn and £2.3bn at the time of the the half-year results in March, to £1.9bn and £2bn, respectively, at the end of May. Several of the booked contracts could be deferred or cancelled, and it's worth noting that the group's tender win rate slipped last year from a targeted rate of one in three to only two in five. While the win rate has since returned to normal, it could slip again just as quickly as rival firms look to offer more for less.

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On a positive note, Mouchel's Highways business has been performing strongly and the group's joint venture with maintenance outsourcer, Enterprise, won two contracts with the UK Highways Agency earlier this year. But even this division has seen some commissions delayed or cancelled. Unfortunately, this is also the case for regulated industries. Mouchel has secured more contracts in the new regulatory water regime than in the past five-year period, but the start of this work has been "slower than anticipated." And the projects are now expected to be back-loaded towards the end of the five-year regime which will impact revenues in the near term.

It is possible though that shareholders, who have seen the share price fall by more than 50 per cent since February, could be rescued by a bid for the company, having seen VT abort its planned takeover earlier this year. However, in our view, other players in the sector look more attractive both as investments and as takeover candidates. Analysts recently upgraded Hyder's earnings forecasts and Management Consulting Group has a new investor and chief executive.