Safe home in Connaught

Repair-and-maintenance outsourcing firm Connaught continues to go from strength to strength, yet its share price remains 20 per cent below its high point set a year ago. It's unlikely that the disparity between trading and share price performance can go on forever.

The group's results for the first half of 2008-09 delivered the kind of performance that shareholders have grown used to. Connaught reported a 34 per cent rise in pre-tax profits thanks to a combination of strong organic growth and earnings-enhancing acquisitions, while the order book continued to improve in both size and quality.

The magic formula that fuels Connaught's defensive growth is supplying services in fragmented markets that are starting to consolidate. The larger of its two operations is repair and maintenance of so-called social housing, which accounts for 81 per cent of revenues and 65 per cent of operating profits. While social landlords - mostly housing associations, but also local authorities - lack the funds to expand, this does not affect Connaught. It is paid from landlords' rental income.

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Indeed, the pressure on landlords to cut costs helps Connaught because it prompts them to consider larger, longer, multi-service contracts provided by a single supplier. These contracts are supposed to be more cost effective and Connaught is one of the few outsourcers large enough to fulfil them. The trend towards larger contracts has been reflected by gains in market share for the 10 biggest players in the sector. Since 2004, their market share has jumped from 13 per cent to 22 per cent.

Connaught itself accounts for about 5 per cent of the UK market, which makes it number one. It has won 10 major integrated-services contracts in the past year and a half and 20 per cent of its first-half order intake consisted of turning single-service contracts into multi-service deals. In fact, integrated and multi-service contracts now represent 71 per cent of the social housing order book. An added bonus is that these wins should improve the quality of its order book because they move the group away from its roots - doing work under the government's 'decent homes' initiative, which is being phased out.

Connaught's social housing clients are also proving a good source of business for its other division - compliance. This ensures that organisations - chiefly those in the public sector, utilities, care homes and charities - comply with the raft of legislation that dictates how they should treat their staff and customers. Again, this spending is largely compulsory for Connaught's clients. Yet it also offers a defensive income stream because the amounts involved are relatively small.

This market is also very fragmented, with the top 10 players accounting for only 15 per cent of the market. So there should be plenty of scope to move customers from single-service to multi-service contracts. Unlike its social-housing side, Connaught's compliance side has been built through acquisitions. Lots of potential remains to grow by acquisition, though that route does bring its own special risks.

And Connaught can expand from its core markets. In particular, it is seeking to tap 'green' budgets by insulating houses for local authorities. What's more, as the business grows, profit margins continue to improve. In the first half of 2008-09, margins in social housing ticked up from 5.5 per cent to 5.6 per cent and from 13 per cent to 13.7 per cent in compliance. Future revenues also look assured. Currently, Connaught's order book stands at £2.7bn. In the social-housing division, 99 per cent of turnover that analysts expect for 2008-09 is already in the books, as is 92 per cent of turnover for 2009-10.